Article Archives >> Lead Stories >> July 1-15, 2005

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Nonprofit Panel Recommends Changes
To Improve Transparency, Accountability
Proposals include new legislation, new regulations,
and improvements to best practices for organizations

The Panel on the Nonprofit Sector organized by the Independent Sector has issued its Final Report “to Congress and the Nonprofit Sector,” which Senate Finance Committee Chairman Chuck Grassley (R-IA) says “will inform the committee and its work.”

The Report includes a wide range of recommendations including some new legislation, changes in Regulations and reporting requirements, expanded governmental enforcement action, and education of the sector on recommended “best practices.” It calls for certified financial statements of all charities with revenue of more than $1 million a year, new restrictions on donor advised funds and Type III supporting organizations, tightened rules on conservation and façade easements, and requirements for independent members of charity boards.

It specifically recommends against some of the proposals advanced in the Senate Finance Committee’s white paper last summer (See Ready Reference Page: “Senate Committee’s White Paper Proposes Vast Expansion of Federal Power Over Charities.”) and by the Joint Committee on Taxation (See Nonprofit Issues, February 1-15, 2005.)

The Panel recommends:

Enforcement. Congress should appropriate more for enforcement activities of the Internal Revenue Service and create a fund to assist states to increase oversight and educational activities. Congress should amend federal tax laws to allow more exchange of information with state enforcement officers.

IRS reporting. The IRS should move forward on electronic filing of Form 990 series tax returns. The chief executive officer, chief financial officer, highest ranking officer, or a trustee if a trust, should sign the returns under penalty of perjury. Organizations that don’t have to file an annual return because they do not normally receive at least $25,000 in revenue should nevertheless file an annual notice giving contact information for the organization. Organizations going out of business should be required to notify the IRS. Form 990 tax preparers should be subject to the same penalties for errors as preparers of business or individual returns.

Periodic review of exempt status. Congress should not require charities to requalify every five years as proposed in the Finance Committee white paper, but Boards should voluntarily review their governing instruments, financial transactions and compensation practices at least every five years.

Financial audits and reviews. Congress should amend the Tax Code to require audited financial statements for charities with more than $1 million in annual revenue and reviewed financial statements for charities with revenues between $250,000 and $1 million. According to statistics in the report, 73% of all charities have revenue of less than $500,000 a year, and 83% have revenue of less than $1 million a year.

Disclosure of performance data. Congress should not authorize the IRS to require detailed information about performance evaluations because “the diversity of the sector and the subjective nature of performance measures … would not provide meaningful information for the public or for regulators.”

Donor advised funds. Congress should define donor advised funds and require aggregate distributions of at least 5% of the aggregate asset balance every year, with certain exceptions. Certain funds could be excluded from the definition, such as those where all advisors are governmental entities or other public charities, and other types of funds where the donor does not control the advisory committee. A sponsoring charity should be required to distribute 20% of the assets of any fund for which donor advice has not been given and distributions have not been made for three years and should be required to terminate advisory privileges for any fund from which no distributions (other than the mandatory distributions) have been made for five years.

Sponsoring charities should be prohibited from making grants to private non-operating foundations or grants to foreign entities that are controlled by the donor or any related party. Donors and advisors should be prohibited from receiving any substantial benefit in return for or in connection with a grant recommendation, and grants, loans or other payments to or for the benefit of donors, advisors or any related parties should be prohibited. Sponsoring charities should be prohibited from providing compensation or reimbursement of expenses, including fundraising expenses, to donors, advisors or any related parties. Congress should amend the Tax Code to provide penalties, like private foundation excise taxes, for breach of the prohibitions. Congress should also prohibit charitable contribution deductions for gifts to donor advised funds unless there is a written agreement giving the sponsoring charity exclusive legal control over the fund and should require both the donor advisor and the recipient grantee to certify that there has been no substantial private benefit from a grant.

Type III Supporting Organizations. Treasury Regulations should be amended to provide private foundation type requirements on Type III supporting organizations. They should require at least 5% of the assets be used for charitable purposes every year; prohibit grants, loans or compensation to or for the benefit of the donor or any related party; require more reporting from the SO to the supported organization; and limit the number of supported organizations to five. The IRS should also require all supporting organizations to state the type of SO on their Form 990 tax returns. Although the Report has a specific paragraph recognizing that many health care and educational systems utilize Type III SOs to provide control and management (See Nonprofit Issues, Tax Matters, May 1-15, 2005.), the recommendations do not suggest that the management type SOs should be under any different constraints, including the limitation of five supported organizations.

Abusive Tax Shelters. Congress should amend the tax laws to make clear that exempt organizations are subject to the same penalties for tax shelter abuse as others, to require reporting of listed transactions, and to ensure suitable penalties.

Non-Cash Contributions.

Appreciated property. Congress should amend the tax laws to tighten the definition of qualified appraisers, impose additional penalties on taxpayers who claim inflated deductions, and impose new penalties on appraisers who make excessive evaluations. Congress should also mandate electronic filing of the Forms 8283 and 8282 for reporting gifts and disposition of non-cash gifts.

Conservation and historic façade easements. In addition to the previous recommendations, Congress should enact the current regulatory requirement that easement deductions be reduced by any financial or economic benefits the donor receives from the transaction. Congress should also require a written agreement from a qualified charity, and penalize the charity for failing to enforce the restrictions unless the requirement is waived by the IRS.

Clothing and household items. Congress should not change the present rules for allowable deductions for clothing and household items. The Joint Committee on Taxation report had suggested a total annual limit of $500, without regard to the number or value of gifts made.

Board compensation. Congress should amend the tax law to make Board members and foundation managers liable for approving self-dealing or excess benefit transactions not only if they knew that the transaction was improper, but also if “they should have known” it was improper. The Panel says that would occur if they “failed to exercise reasonable care, such as following the ‘rebuttable presumption’ procedures or other appropriate processes” in determining the value of a transaction. Congress should also increase penalties for violation of the rules.

Executive compensation. Congress should amend the tax law to require any “disqualified person” accused by the IRS of having excess compensation to prove that compensation is not excessive. (This would apparently eliminate the rebuttable presumption that arises when the Board follows the present excess benefit tax procedures.) Congress should increase penalties on excess compensation. The IRS should revise Form 990 to get better reporting of all aspects of executive compensation, and charitable organizations should incorporate in their governing instruments a requirement that the full Board approve CEO compensation when there is any change other than that previously contracted for. The Board, rather than the executives, should hire any independent compensation consultant, and the Board should review the staff compensation program generally on a periodic basis.

Travel Expenses. The IRS should require charities to report on their Form 990 whether they have a travel policy and should make clear what is required to avoid the automatic excess benefits that are now being imposed for failure to adequately document appropriate expense reimbursements. (See Ready Reference Page: “IRS Issues Tips to Agents on Collecting ‘Automatic’ Excess Benefits Taxes.”)

Governing Boards. Congress should direct Treasury to amend its Regulations to require that most charities (excluding churches and perhaps a few other types) have at least one-third of their board members who qualify as "independent” to qualify for 501(c)(3) status. An individual would be independent if not compensated by the organization within the past year, if his or her own compensation is not determined by individuals who are compensated by the organization, if he or she does not receive material economic benefit (other than as a member of a charitable class served by the organization) from the organization, or if he or she is not related to any individual described above. The Form 990 should be revised to require identification of “independent” directors. Congress should also prohibit anyone who has been barred from serving on the board of a public corporation or convicted of a crime related to breach of fiduciary duty from serving on the Board of a charity.

Audit Committees. As a “best practice,” but not a legal requirement, charities should seek Board members with “some financial literacy” and should establish Sarbanes-Oxley type audit committees. (See Ready Reference Page, “Charities Consider Role for Audit Committee”.)

Conflict of Interest. The IRS should revise Form 990 to require a charity to state whether it has a conflict of interest policy (as the IRS has done with the Form 1023 application for recognition of exemption), and each charity should adopt and enforce an appropriate conflicts policy as a best practice, not as a legal requirement. (See Ready Reference Page: “Conflict of interest Policies Help Avoid Problems.”)

Sen. Grassley reiterated his intention to have draft legislation “this summer” for Committee members to review and mark up to formal consideration.

This Report is a thoughtful and comprehensive document submitted after substantial discussion and reflection by the Panel and its many contributors. It does not endorse, and in some cases specifically recommends against, some of the more off-the-wall recommendations from Congress. It does not give Congress much, if anything, in the way of additional revenue from the sector. We can only wait to see what Congress is really interested in.

Article Archives >> Lead Stories >> July 1-15, 2005