How would your board of directors react if it discovered potential wrong doing?  The answer to this question is critical.  Recently, Robert Carlson, the Missouri Assistant Attorney General who oversees charity enforcement in Missouri, indicated that a board’s quick action to address an issue, such as a potential breach of fiduciary duty or misuse of charity assets, may keep the board of directors and/or charity from being sued by the Attorney General’s office.  Such a reaction includes a proper investigation of warning signs.  The IRS has similarly provided that a board’s reaction will be a key factor in determining whether the IRS will seek revocation of exempt status in instances involving private inurement, including whether the board has corrected the current situation (which may include firing and suing the offending party) and put safeguards in place to prevent future problems before the IRS gets involved.   See Treas. Reg. 1.501(c)(3)-1(f).  While it is not possible to prevent all acts of wrongdoing, the manner in which a board reacts when potential wrong-doing is discovered is critical to (i)demonstrate that the board has satisfied its fiduciary duties, (ii) protect the charity and board from potential lawsuit, and (iii) maintain tax-exempt status.

In 2008, the Form 990 was re-designed to include, among other things, significant governance disclosures.  The IRS justified the disclosures in part on the belief that organizations with good governance are more likely to comply with the law.  Since 2008, the IRS has been studying the connection between governance and compliance.  Among other things, the IRS developed a governance checklist that was used in exams to probe governance practices.   In a recent speech, Lois Lerner, the IRS Director of Exempt Organizations, provided that the initial results of the IRS study confirm that good governance and compliance go hand and hand.  Ms. Lerner stated that exempt organizations with a written mission statement, those that follow the procedures of the rebuttable presumption to establish compensation, and those whose Form 990s were reviewed by the entire board of directors, are more likely to be tax compliant than those that do not follow those practices.   Ms. Lerner’s full comments may be viewed by clicking here.

Although these comments are certainly no surprise, I strongly recommend all charities use the IRS governance checklist to perform their own self-assessment.  A copy of the checklist may be found by clicking here.   A copy of the checklist guide sheet may be found by clicking here.   The charity may also review its responses to Part VI of the Form 990 regarding governance.  I also recommend a review of our article, Having Good Policies is Good Policy.   Merely because a charity does not check “yes” to a particular question on the checklist or Part VI of the Form 990 does not mean the charity lacks good governance or that a change is necessary to ensure compliance.  However, it likely raises an issue for review and consideration by the board to determine whether a change may make sense.

On February 8, 2011 the Internal Revenue Service (“IRS”) announced a special voluntary disclosure initiative (“VDP”) designed to bring offshore money back into the U.S. tax system and to help people with undisclosed income from hidden offshore accounts become current with their taxes. The VDP will be available through Aug. 31, 2011 and taxpayers participating in the VDP must file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties by the Aug. 31 deadline. 

It is critical for charities and their boards to maintain documentation regarding their exempt activities.  This includes board minutes, financial records, receipts, and other documents related to its activities.  In PLR 201102065, the IRS revoked the tax-exempt status of a charity that failed to provide any documentation that proved it conducted charitable activities for the audit period.  Although this is an extreme case, it is a reminder for all boards to document through minutes their meetings and decisions, and organizations to maintain documents related to their exempt activities, including documents necessary to prepare Form 990.  You never know when the IRS or state Attorney General may require a charity and its board to account for its activities.

Senator Charles Grassley (R-IA) has been a driving force behind recent efforts to improve transparency in the charitable sector, including the revisions to the Form 990, Annual Information Return and focus on governance policies.  Senator Grassley recently turned his focus to churches and other religious organizations.  At his request, the Evangelical Council for Financial Accountability (“ ECFA”), a national accreditation organization for churches and other religious organizations, will lead an independent, national effort to review and provide input on major accountability and policy issues affecting churches .   According to ECFA’s website, the newly formed ”Commission on Accountability and Policy for Religious Organizations” will address some of the most challenging tax and policy issues involving religious organizations, including whether churches should file the same highly-detailed annual information return that other nonprofits must file (Form 990); whether legislation is needed to curb abuses of the clergy housing allowance exclusion; whether the current prohibition against political campaign intervention by churches and other nonprofits should be repealed or modified; and whether legislation is needed to clarify tax rules covering “love offerings” received by some clergy.  Although it is not clear whether Senator Grassley’s focus will result in major changes, it is advisable for churches to take a second look at policies with knowledgeable advisers regarding housing allowance, campaign activities, and love offerings – it is quite likely that these areas will be a focus of the Senate and IRS for some time to come.

The IRS Director of Exempt Organizations, Lois Lerner, recently conveyed that the IRS will be looking into the results of its May compensation survey for executives of colleges and universities.  More than one-half of the colleges and universities surveyed reported that they followed the procedures set forth in Treasury Regulation 53.4958-6 to establish a rebuttable presumption that executive compensation is reasonable (such procedures are discussed in a prior blog entry).  The IRS will now be digging further to determine whether the colleges and universities precisely satisfied these procedures, with a particular focus on whether peer compensation is truly comparable and the decision was properly documented.   It is my belief the IRS will continue to focus on executive compensation and will not limit its inquiries to colleges and universities.  Therefore, it is strongly recommended that your charity precisely follow the procedures set forth in the Regulations now to protect the compensation from scrutiny.

Volunteer board members often ask whether they are personally liable for the actions of the nonprofit corporation.  The short answer is generally “no” – unless of course, the board member engages in some willful misconduct that caused harm (e.g., criminal misconduct, gross negligence, reckless misconduct, or flagrant indifference to safety).  The Federal Volunteer Protection Act, along with the State law equivalents, generally protect volunteer directors of nonprofit corporations from personally liability. 

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As email has become a primary form of communication, more and more nonprofit boards are taking action by email vote.  I personally believe email voting is an efficient method of board approval for very specific questions where little or no discussion is necessary.  Unfortunately, most states have declined to adopt specific legislation regarding email voting. 

Without a special rule, email voting likely constitutes voting by written consent.  Unlike in-person or telephonic meetings that only require a majority vote to approve a resolution, most states require a unanimous vote of all the directors in order for a written consent to be effective. (more…)

As discussed in a previous blog, in most jurisdictions a “member” is someone (other than a director or delegate) entitled to vote for directors of a nonprofit corporation; members also generally get to vote for important corporate actions, like mergers and dissolutions. Most states ask for a response on the articles of incorporation to a question like the following: does the corporation have members?

Now, whether or not you like the concept of someone with rights like “members”, it is hard to imagine a worse term of art for nonprofit corporations. (more…)

Recently, the IRS, state Attorney Generals, and charity watchdog groups have raised concerns regarding the payment of excessive compensation to charity executives.  For example, the redesigned Form 990 includes numerous questions regarding compensation and related practices.  The IRS has sent compensation questionnaires to thousands of hospitals and universities.  Recently, Protect the Hershey’s Children sent a letter to the IRS Commissioner, Senate Finance Committee, and Pennsylvania Department of Banking alleging board compensation abuses at the Milton Hershey Trust School and Milton Hershey School. 

I believe it is likely that charities will continue to experience heightened scrutiny of executive compensation from the public, IRS, and Attorney Generals, especially in light of the additional compensation data that is now available on the Form 990.  In addition to negative publicity, payment of excessive executive compensation may result in loss of the charity’s exempt status (private inurement), the imposition of excise taxes on the executive who received and the directors who approved the compensation (excess benefit or self-dealing rules), and other potential penalties imposed by the state Attorney General. 

So what can your charity do to protect itself against scrutiny?  The answer is simple – follow the procedures set forth in the Treasury Regulations!  (more…)