Q&A #88 – Does theft or fraud need to be reported on the Form 990?

Question: I am the Executive Director of a 501(c)(3) organization. We recently discovered that an employee has been stealing from the organization. Do we have to report this theft on our Form 990?

Answer: Whether theft or fraud must be reported on the Form 990 depends on the amount, and also on the role of the individual who committed the offense. Part VI, Line 5 of the Form 990 (on page 6) requires organizations to disclose whether they became aware of a “significant diversion of the organization’s assets.” Also, if assets were stolen by a “disqualified person,” this must be reported as an “excess benefit transaction” on Part IV, Lines 25a and 25b (on page 4) and Schedule L.

With regard to reporting a significant diversion of assets, the key word is “significant.” The instructions to the Form 990 explain that:

“A diversion is considered significant if the gross value of all diversions (not taking into account restitution, insurance, or similar recoveries) discovered during the organization's tax year exceeds the lesser of: (1) 5% of the organization's gross receipts for its tax year; (2) 5% of the organization's total assets as of the end of its tax year; or (3) $250,000.”

If a diversion of assets exceeds this threshold, further details must be provided in Schedule O. Note, however, that this particular question is not present on the Form 990-EZ or the Form 990-N.

Planning Tip – Be thoughtful with your wording when explaining a significant diversion of assets in Schedule O. This is your opportunity to provide context that will hopefully mitigate any negative effects on the organization’s reputation. If applicable, consider explaining what steps were taken to retrieve the assets, whether these efforts were successful, and steps the organization took to make sure these circumstances don’t recur.

Many organizations are surprised to learn that theft and fraud can result in an excess benefit transaction, but this is made clear in Treas. Reg. § 53.4958-4(c)(1), which states that "in no event shall an economic benefit that a disqualified person obtains by theft or fraud be treated as consideration for the performance of services." In effect, this means that assets obtained by a disqualified person by theft or fraud are excess benefit transactions by definition, since the value of these “benefits” exceeds the value received by the organization (which is zero).

The key issue is whether the act was committed by a “disqualified person,” which generally includes Board members, officers, people who serve on a committee that exercises Board-delegated powers, C-Suite level employees such as the chief executive officer, chief operating officer, or chief financial officer, and other individuals who have “substantial influence” over the organization, as well as family members and businesses related to any of the above people. However, employees generally below the C-Suite level are not considered disqualified persons if their compensation is less than the amount specified for “highly compensated persons” under certain provisions of the tax code (currently $130,000, subject to periodic adjustment for inflation).

Lastly, note that theft and fraud are reported for the tax year in which they were discovered rather than for the tax year in which they occurred. For example, if theft occurred in 2019 but is not discovered until 2021, it would be reported in the 2021 Form 990, rather than amending the 2019 Form 990.

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