Governance and Compliance

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.


Compensation Scrutiny – Protect Your Charity

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…)


Percentage or Commission-Based Compensation

Often times a charity cannot afford to hire a professional fundraiser.  In addition, many fundraisers desire to be paid a commission based on a percentage of the revenues that they raise.  Therefore, offering a commission for fundraising services is often perceived as a “win-win” situation.  Before entering into any arrangement, however, a charity must consider certain limitations on so-called percentage or commission-based compensation under the federal income tax laws, including the private inurement, private benefit, and excess benefit / intermediate sanctions rules.  To avoid application of these rules, the commission, as well as the fundraiser’s total compensation (including the commission and any other compensation) must be reasonable.  For example, commissions must be paid for services actually rendered and commensurate with the services rendered.  The IRS has also suggested that a ceiling or cap on the maximum amount of compensation is an important factor to ensure that commission-based compensation is reasonable.  Commission-based compensation based on the achievement of charitable objectives or established to serve a business purpose of the charity is preferable to compensation merely paid based on gross revenues.  It is also worth noting, although state laws limiting fundraising commissions have been struck down, professional fundraising associations generally limit or even prohibit commissions based on revenues for their members on the basis that such commissions are harmful to relationships between the donor and the charity and detrimental to the financial health of the charity.  In conclusion, before paying a fundraiser percentage or commission-based compensation, the charity must consider these laws and should consider consulting an experienced advisor to help them work through these issues.

Change Your Activities? Don’t Forget to Tell the IRS

When a charity significantly expands or changes its activities, it must inform the IRS by disclosing the activities on its next filed Form 990.  The Form 990 includes questions regarding whether the filing charity has undertaken any significant activities not listed on a prior Form 990, whether the charity ceased conducting, or made significant changes in how it conducts any activities, and requires the charity to describe the changes in an attached schedule. The Form 990 also asks whether the charity made any significant changes to its articles or bylaws, and requires such documents be included with the Form 990.  Although disclosing the changes on the next Form 990 satisfies a charity’s obligation to update the IRS, it does not provide any comfort that the new activities do not jeopardize the charity’s exempt status because there is no guaranty any IRS agent will review (or approve) such changes.  

In addition to Form 990 disclosure, a charity may also inform the IRS of significant changes to its activities by filing with the so-called IRS “Correspondence Unit” (also referred to as the Adjustments Unit).  The benefit of filing with the Correspondence Unit is that the charity has some additional assurance an IRS Agent will review the new activities (and assuming no negative response, at least implicitly approves the new activities). At one time, a charity could also request and receive an updated determination letter that, taking into consideration the new activities, the charity still qualifies under Section 501(c)(3). These updated determination letters were a great benefit to charities since they provided direct assurance that the new activities would not jeopardize their exempt status. (more…)


Accepting Gifts… Should You?

Charitable organizations receive all types of donations, including cash,  personal property, and even business interests.  Often times, the charity is so excited about a potential gift that no diligence is completed prior to acceptance, and failure to complete diligence on gifts can turn out to be costly.    Take gifts of real property – these are very common and can be financially beneficial to a charity.  However, without completing diligence, the charity may find that it now owns a superfund site.   Another not-so-obvious example is a donation of stock.  Although most donated stock is marketable, certain types of stock, including stock in an S corporation (usually small, family owned corporations), are not.  This post explores the implications of a charity accepting gifts of S corporation stock.  

Subchapter S corporations can only have certain types of shareholders.  Generally, these “permissible shareholders” include individuals (who are not nonresident aliens), estates, certain trusts, and certain exempt organizations.  We will focus on the permissible exempt organization shareholder. (more…)


Charitable Gaming Overview

As contributions and grants have decreased, many organizations must get creative to raise the necessary funds to further their exempt purposes.  One common method of raising additional funds includes gaming activities, such as raffles, sweepstakes, contests, and 50-50 drawings.  Before engaging in any gaming activities, however, it is critical for your organization to analyze applicable state and federal law.   For example, certain gaming activities are strictly prohibited under state law (e.g., such activities may constitute an illegal lottery).  Certain gaming activities may be permitted but are often limited to specific organizations, such as Section 501(c)(3) organizations.  In addition, most states impose registration, licensing, and reporting obligations before an organization may conduct gaming activities.  It is important to consult with a professional familiar with each applicable state’s laws before conducting gaming activities. 

With respect to federal tax law, the IRS warns that “[a]ll exempt organizations conducting or sponsoring gaming activities, whether for one night of the year or throughout the year … must be aware of the federal requirements for Income Tax, Employment Tax and Excise Tax.”  IRS Publication 3079, “Gaming Publication for Tax-Exempt Organizations”.  These issues include the application of the unrelated business income tax, the potential obligation to provide Form W-2G, Certain Gambling Winnings and/or withhold taxes, and the application of excise taxes imposed on certain forms of wagering.  In addition to tax implications, certain record keeping and filing obligations may be imposed.  Before initiating any gaming activities, therefore, it is also important to seek the advice of a tax adviser who is knowledgeable regarding these rules.  For additional information regarding the applicable federal tax laws, please see IRS Publication 3079, IRS Notice 1335, and IRS Notice 1340.


Should your nonprofit organization obtain D&O Insurance?

We frequently get asked by new and existing nonprofit organizations about directors and officers liability insurance (“D&O Insurance”). Should you obtain coverage? Is it worth the cost?

Yes, you should explore obtaining D&O Insurance. If you want to recruit high-quality directors, you may find that they will not serve on your board without seeing a copy of your policy. They want to know that they will be protected. In addition, their employers may not allow them to serve on your board unless you have D&O Insurance.

On a related note, you might also want to review your organizational documents for provisions that indemnify your directors and officers against certain acts. The same potential directors who want to see a copy of your D&O Insurance policy may also want to see your indemnification provisions.

There are a number of organizations, some of them nonprofit themselves, that provide affordable D&O Insurance to nonprofit organizations of all sizes. When discussing your policy, make sure that you understand its terms and the acts it actually covers.


IRS Provides Relief for Small Organizations that Failed to File Form 990

Tax-exempt organizations that fail to file Form 990 (including Form 990-EZ and Form 990-N) for three consecutive years will automatically lose their tax-exempt status.  The IRS announced today that it is providing one-time relief to small charities to file a delinquent Form 990-N or Form 990-EZ and retain their tax-exempt status even though they failed to file for three consecutive years.  This one-time relief is available for Form 990-N (e-Postcard) and Form 990-EZ filers only. 

Small organizations that are required to file Form 990-N (e-Postcard) and whose Form 990-Ns are due on or after May 17 and on or before October 15 can maintain their tax-exempt status by filing the delinquent Form 990-N by October 15, 2010.

Other small organizations who are eligible to file Form 990-EZ (but not the Form 990-N) can use a one-time voluntary compliance program (VCP) to come back into compliance. To be eligible to participate in the VCP, an organization must:

  • File complete and accurate paper Forms 990-EZ and/or Forms 990 for its current and two prior tax periods by the extended due date of October 15, 2010;
  • Submit a signed checklist agreeing to the terms of the VCP; and
  • Submit a check for the correct compliance fee.

The IRS website includes a list of organizations that may be in jeopardy of losing their exempt status.  For more information regarding this relief, please visit the IRS website by clicking here.


Non-Profit Mergers

For a variety of reasons, several nonprofits have undergone mergers or consolidations over the last year or so.  At the same time, both the IRS and Financial Accounting Standards Board (“FASB”) have issued guidance on mergers of non-profit organizations.  So, although these rules are not brand new, they are relatively new and relevant for many exempt organizations.  IRS Publication 4779  describes the IRS rules and FASB Statement No. 164 (which you can access here after free registration) details the accounting rules.  A thoroughly-researched summary of each is located here.  For those of you with little time, I hereby summarize the requirements with brevity: (1) notify the IRS of any merger by filing a final Form 990, (2) have someone smart–preferably an accountant–explain FASB Statement No. 164 and (3) try to say “Financial Accounting Standards Board” 5 times fast.


Overview of Form 990 Governance Policies

The Form 990 includes numerous governance and management questions.   A brief summary of the more significant governance and management questions are provided below. The IRS has indicated that, although a negative response to a question on the Form 990 will not necessarily result in an audit, the IRS will use such negative responses in conjunction with other information on the Form 990 to determine whether further inquiry is necessary.  It is important for the leadership of public charities to become familiar with these provisions and should analyze each of the following:

  • Records Management Program – Form 990 asks whether the organization has a written document retention and destruction policy. Nonprofit corporations should adopt a document retention and destruction policy, along with a records retention schedule, utilizing the standards under Sarbanes-Oxley, 18 U.S.C. 1512(c), and the new Federal Rules of Civil Procedure regarding e-Discovery, Fed. R. Civ. P. 34. Such a policy should cover the responsibilities of staff, volunteers, board members, and outsiders to maintain, store, or dispose of the organization’s records.
  • Whistleblower Protection Policy – Form 990 asks whether the organization has a whistleblower policy. Nonprofit corporations should adopt a whistleblower policy, utilizing the standards under Sarbanes-Oxley, 18 U.S.C. 1513(e), that identifies specific staff members, board members, or outside parties to whom a staff member or volunteer can report information on illegal practices or violations of organization policy. (more…)

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