The charity's primary purpose was to pursue the study of how the interaction of land use, disturbance, and climate impact the structure and biodiversity of a particular region, and publish papers relating to such study.  The charity had only one staff member who also functioned as the President.  The charity's governing board consisted of three immediate family members - the President, his father (Vice President), and his wife (Secretary/Treasurer).

The IRS noted that the President had no employment contract with the charity and the charity itself had no Conflict of Interest Policy in place to determine how any conflicts, potential or actual, would be addressed.

1. The President routinely made "loans to officers," but never fully substantiated the purpose of these loans.  Moreover, the charity's board approved these loans, which were withdrawals from the charity's checking account and payments for the President's personal expenses, "after the fact."  Note that since the charity had no Conflict of Interest Policy, the President who made these loans in the first place, then approved these "loans" with his wife and father.  All of these amounts went into a "Loans to Officers" account and inadequate records were kept on how this money was spent to further the charity's exempt purposes.

2. The President sold luxury vehicles to the charity, but never transferred title, and performed upgrades without being able to prove that the vehicle even existed or was owned by the charity.  Similarly, the charity paid for the President's car expenses without asking for business substantiation for these expenses.

3. The charity paid the President's personal legal expenses.

Interestingly, the IRS focused on the President's withdrawals from the charity's accounts that could not be substantiated as being for the furtherance of the charity's exempt purpose and also touched on ways in which the governing board was not providing proper oversight.  In fact, the IRS noted that the charity's inurement issues and excess benefit transactions "resulted from the organization being under the control of one-person with a family-based governing board."

Moreover, the IRS noted that because of the charity's structure, "sufficient safeguards ha[d] not been put in place to prevent future violations...."  Charities should be aware that governing procedures and policies, including a Conflict of Interest Policy and a recordkeeping policy, can provide these types of safeguards and help an organization function more efficiently and effectively.  In fact, this ruling is a staunch reminder that these policies should be used where appropriate and tailored to the needs of each organization.

This ruling should force each charity to examine its organizational and governing structures to ensure that its board constitutes an independent body so that, unlike the charity here, its governing board has no "inherent conflict of interest when placed in a position to approve financial transactions...."  

The amount of compensation paid was also at issue here because the President's salary was considered excessive based on the size of the organization's budget.  Accordingly, charities, particularly smaller charities, should use comparability data, to the extent possible, in determining the salaries of its various officers and other staff.  Also, having a well-written employment contract with senior employees or officers may help a charity better defend the terms and scope of an employee's or officer's employment and compensation.

This ruling confirms that the IRS is paying close attention to what charities are doing in their "back" offices.  Consequently, charities that are not exercising good governance practices will certainly be at risk for revocation of their tax-exempt status.

For additional information on good governance practices for charities, please see our Good Governance, Getting Back to Basics, and Lessons Learned blog entries. 

The CFA Institute intends for the Code of Conduct to be a "Best Practices" guide for those in the organization responsible for managing the organization's financial assets.  The Code of Conduct also contains ethical principles, along with general policies and procedures related to the management of financial resources.

• Act with loyalty and proper purpose
• Act with skill, competence, prudence, and reasonable care
• Abide by all laws, rules, regulations, and founding documents
• Show respect for all stakeholders (this includes the general public)
• Review investment strategy and practices regularly

Organizations that would like to implement the principles from the Code of Conduct must adopt detailed policies and procedures that reflect and address the five general principles above.  The Code of Conduct contains illustrations and examples of some of these policies and procedures.  The illustrations and examples are not exhaustive, however, and the actual policies and procedures for each organization will depend on the particular circumstances, along with the regulatory and legal landscape, of each organization.

The Code of Conduct and a detailed description of the general principles stated above can be found here.

For more information and background about investment management rules affecting not-for-profit organizations in New York, please see our October 7, 2010 blog entry. 

The draft Form 8941 is available on the IRS website.  The IRS states that the final Form will be available later this year.

For additional information on the health care tax credit, please visit the IRS page on this topic or review our April 7, 2010 blog entry.

The MCC interview highlights the Firm's commitment to pro bono service, both on a domestic and international level.  Read more about the interview here.

In addition to the many pro bono matters, including asylum, adoption, and advocacy projects, on which the Pro Bono Initiative works, the Initiative also represents all kinds of not-for-profit and exempt organizations (including community organizations and start-ups) that meet the financial criteria for pro bono services.

On July 26, 2010, the IRS also posted a list of the organizations at-risk of losing their tax-exempt status because, according to the IRS, they have not filed their returns for 2007, 2008, and 2009.  Organizations should confirm whether or not they are listed on this list.  And even if an organization does not appear on this list, it should still check its records and determine whether it is at risk of automatic revocation because of not satisfying annual filing requirements.  In fact, the IRS acknowledges that the list may be incomplete and certain organizations at risk of automatic revocation may not be listed. 

To become compliant, small organizations required to file Form 990-N can go to the IRS website, supply the eight information items called for on the form, and electronically file it by October 15.  On the other hand, under the VCP, tax-exempt organizations eligible to file Form 990-EZ must not only file their delinquent information returns by October 15, but must also pay a compliance fee. 

Importantly, the relief announced by the IRS is not available to larger organizations required to file the Form 990 or to private foundations that file the Form 990-PF.

Organizations that have not filed the required information returns by October 15 will have their tax-exempt status revoked, and the IRS will publish a list of these revoked organizations in early 2011. Donors who contribute to at-risk organizations are protected until the IRS publishes the final revocation list.  At that point, donations to these organizations will no longer be tax deductible.

This one-time relief is extremely helpful to many small organizations that are at risk of automatic revocation.  As IRS Commissioner Douglas Shulman stated, "...[I]f you do not have your filings up to date, now’s the time to take action and get back on track."

For additional information about losing tax exemption because of failure to file, please see our April 5, 2010 blog entry.  For additional information about the VCP, please visit the IRS website and frequently asked questions about the VCP.

This evolution has made it almost necessary to create and adhere to a pluralistic model where some charities receive more favorable treatment than other charities.  The problem with this approach is that you are effectively elevating one cause for favorable policy, regulation, or tax treatment over another.  And latent in this treatment is the question of who exactly should decide what constitutes a service worthy of special initiatives and why a particular cause should receive favorable treatment in the first place.  Moreover, choosing the formula to decide what constitutes the favorable kind of treatment can also be complicated.

A lingering question within this discussion is how this new tax treatment would affect the L3C, often referred to as the for profit entity with a not-for-profit soul.  The L3C would seemingly fit the quasi-charitable and for-profit goals qualifying for a different tax treatment so it will be interesting to see how this entity would be treated under any new tax treatment rules for charities, including the development of a pluralistic model.  We will just have to wait and see.

The not-for-profit challenged property tax assessments for the 2002 and 2003 tax years on office condominium units it owned in the township. The not-for-profit argued the property was exempt under N.J.S.A. 54:4-3.6 as property actually used in the work of a not-for-profit corporation organized exclusively for the moral and mental improvement of men, women and children.  Following the township's denial of tax exemption, the not-for-profit appealed to the New Jersey Tax Court.  The not-for-profit admitted that a portion of the property was leased to unrelated and related for-profit organizations, and did not claim an exemption for the portion of the property used for those purposes.

The court focused in on the third prong and its exception that exemption extend to cases where the exempt organization's work is supported partly by fees received from the occupants, as long as the building is wholly controlled by and all of the income is used for the not-for-profit's exempt purposes. The Tax Court found that the not-for-profit operated and maintained the property for the purpose of making a profit. 

In short, all not-for-profits should be aware of and avoid any or a combination of: (i) the provision of professional services that are not “charged back;” (ii) below-market rents; (iii) unsecured loans that do not appear to have been timely repaid; (iv) lending their names and reputations to promote joint profit-making ventures; and (v) promotion of a for-profit's products.  These factors are potential downfalls for a nonprofit corporation.

Importantly, the court did not allow the not-for-profit to lose exemption on only a portion of the building because of its for-profit activities, as permitted by the statute and argued by the not-for-profit, but instead prevented property tax exemption entirely even though the court believed that the not-for-profit had a public benefit purpose and was operating to further that purpose.  Accordingly, not-for-profits applying for property tax exemption in states that have partial exemption denials should carefully scrutinize their activities with for-profit entities to ensure that their properties would not be viewed as operating for profit, preventing them from claiming property tax exemption for the entire property.

In this case, the plaintiff alleged that it entered into an agreement to purchase real property from the defendant charities.  The defendant charities submitted two petitions before the NY Supreme Court asking the court's permission to sell the property.  The first petition stated that no member vote was held by the charities on the proposed sale of the property and a revised second petition was later filed stating that no members of the charities were entitled to vote on the sale.  The court authorized the sale by Order.  One year later, the plaintiff demanded return of its payments with interest, alleging that the defendants lacked the required approvals and consents by law to agree to sell the property and were in material breach of their representations and warranties in the agreement.  The defendants later informed the plaintiff that because it did not make a scheduled payment under the agreement, they were retaining the down payment as liquidated damages.

The defense to ultra vires is found in Section 203 of the NPCL.  It provides that "no act of a corporation and no transfer of real or personal property to or by a corporation, otherwise lawful, shall, if duly approved or authorized by a judge, court or administrative department or agency...be invalid by  reason of the fact that the corporation was without capacity or power to do such act or to make or receive such transfer...."  The Section provides three circumstances in which such a lack of capacity or power may  be asserted: (i) by a shareholder of the corporation; (ii) by the corporation itself; and (iii) by the attorney general.

In arriving at its decision, the court reasoned that the sale was authorized by order of the court and since all of the counts, including the breach of contract or fraud claims and enforcing an alleged lien on the property, depended on whether the agreement was void, which it was not, they all had to be dismissed as well.

This case shows how NY charities can successfully apply the ultra vires defense to breach of contract and fraud claims if the proposed transaction is duly authorized, as Section 203 requires, and none of the three exceptions under Section 203 apply.  In this case, successful use of the defense enabled the charities to keep the plaintiff's down payments.  Interestingly, the charities could have asserted the ultra vires doctrine to back out of the contract altogether.  Accordingly, it is extremely important to determine the scope of the authority and power of any charity with which a corporation, including another charity, contracts.

1. Governance - If you did not think that the way that you ran your organization was anybody's business but your own, you will have to immediately adjust that frame of mind.  To say that the IRS is focused on governance would be an understatement.  Governance matters are the motivators for a lot of the changes that the IRS has made in its policies affecting exempt organizations and we can see the IRS's approach to governance in its Form 990 revisions.  The IRS is looking at the management of each organization and how that management runs the organization.  Organizations that do not have good governance policies that are tailored for that particular organization, effective boards, and independent voting members are organizations that will undoubtedly raise a red flag for the IRS.  Moreover, the IRS cares a great deal about the organization's ability to follow its own governing documents and document the decisions that its governing body and officers make.  In short, the IRS is concerned about an organization's leadership being informed about the organization's activities and assets in order to effectively govern the organization.  If you have not implemented an effective governance policy or have an almost absentee board or management, you must address your governance procedures immediately.

3. Compensation - This area is one of the most active areas for the IRS.  As seen by the compensation surveys that the IRS has sent to hospitals and colleges/universities, the IRS is certainly interested in the kinds of salaries that the management of exempt organizations is receiving.  Moreover, in this difficult economy, the public has focused in on the amount of compensation that top executives in not-for-profit organizations are receiving.  So, if your organization had a "good year," you should still determine whether or not the executive's compensation for his strong performance is reasonable under IRS standards.  Just because a CEO performed well in one year is no defense for paying him or her compensation that is so high that it is unreasonable.  Using Boards to help determine compensation should be measured against the organization's sector, location, the job's responsibilities, the individual's skills and experience, and the size of the organization.  Importantly, each exempt organization should document the executive compensation decisions of its management and other highly compensated or key employees.  Increases in salary should be measured against both the organization's performance and the employee's.  Finally, if you do not have one already, you should put in place a compensation policy, which details your organization's compensation philosophy, compensation plan design, and how compensation decisions are generally made.  If necessary and practical, an organization should enlist the help of a compensation consultant.

4. Joint Ventures - The IRS is paying attention to exempt organizations' participation in joint ventures.  Specifically, the IRS is inquiring on the Form 990 about the revenues, expenses, assets, and liabilities that the venture generates for the organization.  Joint ventures are often structured so that the exempt organization does not recognize any unrelated business taxable income ("UBTI") or even lose its exempt status.  To that end, joint ventures should be structured so that they have adequate protections in place to ensure that the venture is operated for exempt purposes, including using binding charitable purpose provisions, preferred governance rights, and certain dissolution rights to the participating exempt organization.  This sort of partnership has arisen quite frequently in the health care field, where hospitals are often members of these types of ventures.  With the new Code Section 501(r) created by the Patient Protection and Affordable Care Act, tax-exempt hospitals will have to comply with additional requirements to maintain their tax exemption.  Accordingly, when hospitals enter into joint ventures, it is important that not only that the Section 501(c)(3) requirements are kept in mind, but that the requirements of Section 501(r) are also considered.

5. Endowments/Investments - With the economic downturn, nearly every exempt organization has looked at its endowment or investment policy and tried to determine what it could do better or differently in order to increase or maintain the funds that it currently has.  On a state level, there has been statutory development around UPMIFA, which updates UMIFA, a statute that provides uniform and fundamental rules for the investment of funds held by charitable institutions and the expenditure of endowments to those institutions.  UPMIFA establishes a more clear and precise set of rules for investing funds in a prudent manner and also eliminates the idea of "historic dollar value," which under UMIFA, is the threshold for what a charity can prudently spend an endowment down to.  Accordingly, investment officers at charities should be clear on these rules if they apply in their state.  Investment policies should reflect any change in state law and the investment committee's adherence to such policies.  Failure to adhere to appropriate state standards and manage your institution's funds under these standards will certainly draw the attention of the IRS.  Note: New York is one of a handful of states that have not yet enacted UPMIFA.  Please visit our blog for a more in depth discussion on fiduciary obligations and the prudence standard for endowments in New York.

For more information on current developments in the law of tax-exempt organizations, please visit Bruce R. Hopkins's Nonprofit Law Center.

Eligible small businesses can claim the credit as part of the general business credit starting with their 2010 income tax return.  For tax-exempt employers, however, the IRS will provide further information on how to claim the credit.

For additional information, please visit the IRS page on this topic.

Starting this year, organizations that fail to file these information returns for three consecutive years will automatically lose their exempt organization status.

A list of the revoked organizations will be publicly available on the IRS website.

If an exempt organization fails to file and loses its exempt organization status, it will have to reapply for tax-exempt status.  Moreover, any income that it incurs after it loses its exempt status, but before the application is approved may be taxable.

Form 990 (all series) is due on the 15th day of the 5th month after the organization's taxable year ends.

For more information, please visit the IRS page on this topic.

Qualified disaster relief payments include amounts to cover necessary personal, family, living or funeral expenses that were not covered by insurance.  They also include expenses to repair or rehabilitate personal residences or repair or replace the contents to the extent that they were not covered by insurance.

The IRS will presume that disaster relief that a private foundation provides to employee-victims and their family members in areas affected by the earthquake in Chile is consistent with the foundation's charitable purposes.

For additional information on disaster relief, please refer to the IRS Publication 3833 on Disaster Relief and other disaster relief resources for charities and contributors on the IRS website.

The legislation also includes a provision that allows individuals who sent their contributions via text message to use their phone bills as proof of their contribution.  The bill must contain the name of the charitable organization and the date and amount of the contribution. 

The legislation was introduced by Ways and Means Committee Chairman Charles B. Rangel (D-NY) and a host of other co-sponsors.  Though not obligated to do so, charities assisting in the Haiti relief effort may want to make their donors aware of the possibility of the acceleration of deductions.

The IRS also announced on Friday that it has issued guidance designating the Haiti earthquake as a natural disaster for federal tax purposes.  The guidance allows recipients of qualified disaster relief payments to exclude those payments from income tax.  The guidance also allows employer-sponsored private foundations to assist employee victims in areas affected by the earthquake in Haiti without affecting their tax-exempt status.

For additional information on disaster relief, please refer to the IRS Publication 3833 on Disaster Relief and other disaster relief resources for charities and contributors on the IRS website.

The poll states that only six percent of the nonprofit organizations that responded plan to decrease their overall allocation to alternative assets, such as hedge, private equity, real estate, venture capital, and other privately offered funds. 

Despite this statistic, the poll is not all good news for the private funds industry.  The poll also shows that a significant percentage of its respondents will be addressing liquidity concerns by aligning portions of their portfolio with spending requirements (49%), developing a formal liquidity policy (36%), shifting assets into short-term fixed income (35%), decreasing liquidity and lock-up tolerance for alternatives (29%), and attempting to negotiate shorter lock-up periods (28%).

Within the last year, Harvard and Stanford both sought to sell billion dollar alternative portfolios.  Ultimately, Stanford pulled its proposed sale and Harvard closed on certain transactions, but at prices noted as having been at the bottom of the market.  To put this point in perspective, Cogent Partners reported back in August in its Secondary Pricing Analysis Interim Update, Summer 2009 that median pricing for private funds was 45.1% of the 2008 year end net asset value. 

Between the presumably daunting bid-ask spreads and known long hold times, nonprofit investors have had little choice other than to be committed to their alternative investments.  The poll shows that nonprofit organizations are now focused on addressing their liquidity needs, fiduciary roles and responsibilities, and conducting an overall evaluation of the complete investment management process. 

Rather than asking whether nonprofits are committed to alternatives, the real question may be, in addition to addressing fiduciary concerns – given the liquidity concerns highlighted by the SEI poll – whether nonprofits would be as committed to alternative assets (or at least their current managers) at all if they had viable secondary market options. 

A summary of the SEI report is available at seiresearch@seic.com.

Accordingly, grantors and contributors to these organizations may no longer rely on previous rulings or designations in the IRS's Cumulative List of Organizations (Publication 78), or on the presumption arising from the filing of notices under Section 508(b) of the Code. 

Notably, the listing does not indicate that the organizations have lost their status as organizations described in Section 501(c)(3) of the Code, which are eligible to receive deductible contributions.  Instead, these organizations are simply no longer public charities.

Continue reading for the full text of the Announcement.

1. Revenue procedure to provide terms for hosts of Cyber Assistant software (used to generate Form 1023 exemption applications eligible for reduced user fee).
2. Final regulations on the new requirements for Type III supporting organizations, added by the Pension Protection Act of 2006; proposed regulations were published in September 2009.
3. Notice under Code Section 4943 (excess business holdings), as amended by the Pension Protection Act.
4. Guidance on program-related investments of private foundations (Code Section 4944).
5. Final regulations on excise taxes on prohibited tax shelter transactions and related disclosure requirements; proposed regulations were published in 2007.
6. Proposed regulations on new excise taxes on donor advised funds, as added by the Pension Protection Act.
7. Regulations on group returns (Code Section 6033).
8. Proposed regulations to update regulations under Code Section 6104(c), relating to disclosure to state charity agencies for changes made by the Pension Protection Act,
9. Final regulations on church tax inquiries and examinations (Code Section 7611); proposed regulations were published in 2009.
10. Revenue procedure on prototype plan documents for Section 403(b) tax-sheltered annuity plans, and guidance on termination of such plans.
11. Guidance for ruling requests for church plans (Code Section 414(e)).
12. Several items on guidance for deferred compensation plans of tax-exempt organizations and state and local governments (Code Section 457).
13. Final regulations on appraisal requirements for certain charitable contributions of property; proposed regulations were published in 2008.
14. Guidance on charitable lead trusts (Code Section 642(c)) and charitable remainder trusts (Code Section 664).
15. Regulations addressing the application of the lookback interest rules (Code Section 460) to certain pass-through entities with tax-exempt owners.
16. Final regulations regarding the disclosure of certain administrative actions that are required to be made available to the public (Code Section 6104).  Proposed regulations were published in 2007.
17. Regulations under Section 6109 regarding the use of preparer tax identification numbers (PTINs) by tax return preparers.
18. Regulations regarding interest on tax overpayments by tax-exempt organizations (Code Section 6611).
19. Update of guidance concerning user fees.
20. Regular updates to procedures for letter rulings, technical advice, and user fees.

For more information about any of these items, please visit the IRS website.

• $400 for organizations whose gross receipts are $10,000 or less annually over a 4-year period (Currently $300)
• $850 for organizations whose gross receipts exceed $10,000 annually over a 4-year period (Currently $750)
• $3,000 for group exemption letters (Currently $900).

What's More...

Cyber Assistant, a web-based software program designed to help 501(c)(3) applicants prepare a complete and accurate Form 1023 application, will become available during 2010.  Once the IRS announces the availability of Cyber Assistant,  the user fees will change again:

• $200 for organizations using Cyber Assistant (regardless of size) to prepare their Form 1023
• $850 for all other organizations not using Cyber Assistant (regardless of size) to prepare their Form 1023.

We will let you know as soon as Cyber Assistant is available.

The L3C is taxed like any other for-profit entity and is not eligible for tax exemption under Section 501(c)(3) of the Internal Revenue Code.  L3Cs hope to encourage an influx of new capital into charitable causes that are too risky for for-profit ventures and that nonprofit dollars alone cannot sustain.  The L3C effectively creates a market for investment in companies that offer low rates of return, but contribute to the community, unlike the non-profit, which offers no rate (and sometimes a negative rate) of return on investment.  Therefore, if an entity has a charitable mission, but does not believe it can be profitable, or has a social mission, but probably could not secure program-related investments ("PRIs") from private foundations, it would be better off forming as a not-for-profit or for-profit entity, respectively. 

L3Cs envision a tiered investment structure. The first tier relies on PRIs to cover the areas of highest risk.  Under current law, private foundations are required to spend at least 5% of their net asset value annually.  PRIs essentially function as loans that will be, at least theoretically, repaid.  Even with no interest, the PRIs will still count as qualifying distributions towards the 5% requirement.  The L3C creators believe that private foundations will make PRIs with L3Cs because the PRI requirements are incorporated directly into the L3C structure itself, eliminating the need for private foundations to apply for private letter rulings from the Internal Revenue Service ("IRS"), which can take up to 18 months to process and cost $50,000 or more in legal fees, plus a substantial fee to the IRS. 

If successful, however, L3Cs could allow organizations that rely heavily on donor support, such as symphony orchestras, to become self-sufficient. They could also help revitalize struggling, but vital industries, such as newspapers, and promote employment in those areas. For example, North Carolina’s L3C bill envisioned collaboration between local nonprofit organizations and failing furniture and textile businesses to help keep jobs in local communities.  The L3C model would also be especially helpful in the microfinance industry, where receiving different tiers of investments, particularly at the market level, would be integral to the success of microfinance institutions.  Opponents of the L3C are concerned that the creation of L3Cs will take away grant money that private foundations would have otherwise given to charities because the foundations will have given the money to L3Cs in the form of low-yield PRIs, which would decrease the amount of grants that the foundation could pay out.  Proponents of the L3C say that creation of the L3C does exactly the opposite and actually increases the amount of money available for charities since the L3C will be able to accept so many different types of investments.

The L3C is full of possibility, but whether that possibility will materialize is still up in the air.  For one thing, it is not clear how private foundations will react to the L3C structure, or whether private foundations will make PRIs without first seeking private letter rulings.  And without the initial influx of PRI funding, L3Cs will find it difficult to attract for-profit investors, which would affect the L3C model's viability.  But, if foundations make PRI investments with L3Cs and if those investments are followed by different conventional sources, the possibilities of a world with L3Cs may be realized.

Most importantly, the IRS has yet to really weigh in on whether private foundations investing in L3Cs is safe.  Ronald J. Schultz, senior technical advisor in the Tax-Exempt and Government Entities Division, said that L3Cs raise a number of tax issues, including PRI, private inurement, and private benefit.  Schultz also mentioned that private foundations that think that investing in an L3C was a "slam-dunk" on the jeopardy investment issue (where a foundation is taxed on any jeopardizing investments it makes), would be premature.  He said that the IRS and Congress have not yet signed off on the idea of L3Cs, and private foundations should consider whether investing in an L3C could jeopardize the private foundation's charitable activities.  For a great article discussing the response to Schultz's statements, please visit The Nonprofit Times.

For more information on L3Cs, please visit Americans for Community Development and the Nonprofit Law Blog L3C entry by Gene Takagi and Emily Chan.