Not-For-Profit/Exempt Organizations Blog : Non-Profit Lawyers & Attorneys : Proskauer Rose Law Firm : Tax & Corporate Law for 501(c), 501(3) Organizations

Here are some take-away points from each presentation:

Best Practices for Board Members.  Bob Kaufman, Partner, described how increased outside scrutiny of tax-exempt organizations requires increased attention by boards, particularly with respect to governance questions now asked on IRS Form 990.  Critical responsibilities of all board members are the selection, evaluation, and, if necessary, replacement of the CEO, but also support, encouragement, and assistance to the CEO.  Good practices include how replacement directors are selected, compensation practices and audit committees, and being able to answer "yes" to the Form 990 questions of whether the organization has certain key policies.

The Effects of Health Care Reform.  Elizabeth Mills, Senior Counsel, described highlights of this year’s health care reform act relating to tax-exempt organizations both as employers and as charitable organizations.  Health plans maintained by exempt organizations for their employees are subject to the same new rules as those of taxable employers, many of which are effective beginning January 1, 2011 or even sooner.  Depending on whether the plan is "grandfathered," these rules may include coverage of preventive services, limitations on waiting periods to obtain coverage, prohibition of preexisting condition limitations, and application of nondiscrimination rules to insured plans.  Tax-exempt hospitals are also subject to specific new requirements that are effective now.  Finally, the health reform legislation includes many funding opportunities for education and innovative care arrangements, some of which require partial funding from private sources.  More information can be found at Proskauer's Health Care Reform Task Force web page.

Executive Compensation Developments.  Lisa A. Berkowitz Herrnson, Senior Counsel, described how nonqualified deferred compensation for executives of tax-exempt employers is governed by the rules of Code Section 457.  If a plan does not satisfy the requirements to be an "eligible deferred compensation plan" under Code Section 457(b), it will be considered to be an "ineligible deferred compensation plan" under Code Section 457(f) and will then need to ensure that it also complies with the rules under Code Section 409A.  The IRS has announced its intention to issue additional guidance concerning certain aspects affecting "ineligible deferred compensation plans" in the near future.

Ethics Issues Facing In-House Counsel.  A. Nicole Spooner, Associate General Counsel at the Open Society Institute, described the New York Rules of Professional Conduct  and how those rules can apply to in-house counsel.  Specifically, in-house counsel should be aware of the level of protection and confidentiality afforded business and legal services that they provide and should determine the extent of their attorney-client relationships.  Moreover, in-house counsel should be aware of how their practice can be limited across state and international jurisdictions, including limitations on privilege and what information can be kept confidential.  Finally, in-house investigations should be conducted with these principles in mind and in-house counsel that are not the primary counsel in an organization should still realize that they have responsibilities under the Rules of Professional Conduct and can also be in violation of the Rules.

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Certain activities are completely off-limits to non-profits, while others must be undertaken after research and sometimes consultation with business or legal advisors.  The following list contains rules with which public charities must comply in order to maintain their tax exempt status:

1. No Private Benefit and Inurement.  Individuals and organizations may not obtain more than an incidental benefit from a public charity.  Additionally, any person with a private or personal interest in the activities of an organization may not be compensated unreasonably by the organization.  If any person in a position to exercise substantial influence over the affairs of an organization receives an economic benefit from it (in excess of the goods or services that the person has provided), the charity must report the transaction to the IRS as an “excess benefit transaction.”  
2. Political Campaign Intervention.  Public charities may not directly or indirectly participate or intervene in any political campaign – whether on behalf of or in opposition to any candidate for public office.  Public charities may engage in general “get out the vote” drives, as long as they are non-partisan.  Organization leaders can make political comments only if they clearly indicate they are speaking in a non-official capacity.  This absolute bar on political activity extends to issue advocacy as well – public charities cannot advocate for any issue that essentially functions as political campaign intervention.  The IRS has also issued detailed guidelines about when it is appropriate for candidates to speak at functions sponsored by a public charity.  Ultimately, failure to heed the restrictions against engaging in political activity can have severe effects on a public charity, ranging from the imposition of an excise tax to loss of tax-exempt status.
3. Lobbying.  Public charities may not try to influence legislation through substantial lobbying activities.  Whether an organization’s legislative activity is considered substantial enough to risk loss of tax-exempt status or imposition of an excise tax is determined by one of two tests.  The substantial part test looks at a number of factors to determine whether lobbying activity is substantial, while the expenditure test looks at how much an organization spent on lobbying activities compared to a set amount specified in the Internal Revenue Code.
4. Form 990.  Annually, public charities must file some version of the IRS Form 990 (Form 990-EZ, Form 990-N).  The penalties for failure to file or late filings vary, and are based on an organization’s annual gross receipts (but may range from $20 per day to $100 per day).  An organization that is delinquent in filing the appropriate form for three consecutive years may have its tax-exempt status revoked.
5. Employment Tax Returns.  All public charities that pay wages to employees must withhold, deposit, and pay employment tax (including federal income tax withholding, Social Security and Medicare taxes).  Public charities should have a Form W-4 on file for each of their employees to determine how much income tax to withhold.  Public charities must also report employment taxes on Form 941 (quarterly) or Form 944 (annually).
6. Recordkeeping.  Public charities should maintain books and records to demonstrate that they are in compliance with tax rules, and keep all documents that indicate the sources of their receipts and expenditures reported on the Form 990.  Generally, charities should keep records that support an item of income or deduction on a return until the statute of limitations for that return runs.  Failure to provide back-up documentation when requested by the IRS may result in a loss of tax-exempt status.  Additionally, charities should maintain records generally as a means to evaluate their programming, identify their donors over time, and monitor their financial health.  In addition, charities sometimes must prepare accurate and timely annual financial statements (per state law) and maintain adequate records and case summaries of grant-making activities.  An organization’s record-keeping system should include a summary of transactions (including gross receipts, purchases, other expenses, employment taxes, and assets) and all documentation supporting these entries (such as grant applications and awards, donor correspondence, sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks).
7. Governance.  As we have mentioned in previous blog posts, public charities should develop and adopt sound governance policies and practices.  At a minimum, public charities should adopt a mission statement, establish an active and engaged governing board, and implement policies relating to executive compensation, conflicts of interest, investments, fundraising, document retention, and whistleblower claims.  Also, a charity should document important governance decisions made by the board or other governing body. 

For additional issues that exempt organizations should consider in this new regulatory environment, please see our May 19, 2010 entry.

Below are some important drafting tips for governance policies to help a not-for-profit organization survive and thrive in this new regulatory environment.

1.)                Introduce Your Organization

            Governance policies are the face of the board to the CEO, staff, and the general public.  From the outset, before addressing the substance of the policies, governance policies should contain introductions that address an organization’s vision, mission, desired outcomes, and internal and external values that define its character.  This introduction should also address an organization’s functions, the percentage of its time devoted to each function, its strategies, and its goals. 

2.)                Describe the Role of the Board

            The most important part of governance policies deals with board structure and policies; specifically, these provisions address the “job description” of the board; disciplinary action against board members; accountability, self-monitoring, and evaluation; and how policy changes may be initiated. The board’s responsibilities should include:

§ Maintaining, reviewing, and updating the governance policies as times change;

§ Ensuring the financial solvency and integrity of the organization, which requires regular external audits and internal checks and balances; and

§  Selecting the CEO and reviewing his or her performance. 

3.)                Who Is Responsible for CEO Oversight?

            Board policies should address the selection and evaluation process and compensation of a CEO (whether the CEO is to be compensated and, if so, how compensation levels are determined).  The board should provide regular performance reviews and an annual performance report to the CEO based on his or her performance, and the governance policies should address precisely how such evaluation is carried out and delivered.

4.)                What Every Candidate Should Know Before Joining Your Board

            Governance policies should detail what can be expected of board members – including the criteria to become a member of the board and training for new and seasoned members.  These provisions should provide enough information to serve as a self-explanatory “orientation” for new board members who inquire about their responsibilities. The role of the chairman of the board should also be detailed, as should meeting rules, agenda-setting, and the evaluation process for determining if meetings are actually effective. The policies should outline a code of conduct so that board members are fully aware of what is expected of them, and what kind of behavior warrants discipline.  Included in a code of conduct should be a comprehensive conflict of interest policy.

5.)                How All the Moving Pieces Fit Together

            Policies should also address how the board, the CEO, and staff – and their varying responsibilities – are interrelated.  To avoid confusion, duplication of efforts, and finger-pointing, responsibilities should be clearly assigned among the various parties.  Policies should also include the CEO’s job description and how the CEO and the board should communicate with each other.  Staff hiring, termination, treatment, and compensation should be documented, and a whistleblower policy should also be adopted.  Including a whistleblower policy indicates that an organization is committed to complying with the law, and encourages a culture of transparency.

6.)                Establish Standing Committees

            Governance policies should provide for subgroups of the board, which are tasked with more specific agendas, depending on an organization’s needs.  The typical standing committees include committees focused on governance, finance, audit and compliance, advancement, programming, and executive responsibilities.  Advisory groups and task forces, consisting of both board members and outsiders, may be created to assist with particular projects that require more specialized knowledge and expertise.

7.)                Budgeting and Finances

            Policies should address budgeting and financial controls, as well as asset protection and investment principles, since every organization that plans to be fiscally healthy must develop a comprehensive, long-term plan to achieve and maintain good fiscal health. 

8.)                Programming and Fundraising

            A comprehensive policy includes a description of the programs an organization will offer, and how new programs will be developed.  It should also include advancement parameters, such as fundraising principles and a donor bill of rights, which ensure prospective donors that an organization is trustworthy, and that donors can have full confidence in the organization and the causes it asks donors to support. 

9.)                Handling the Media

            A provision should be included detailing how public affairs and communications will be managed, as well as the role and responsibilities of spokespersons.

10.)                        Develop a Theme

            Overarching themes in any well-respected governance document should be transparency and accountability.  Accordingly, provisions should be included which specifically address audit and compliance parameters and document retention.  Most importantly, information about operations and methods of self and outside evaluation should be widely available to the public.  

Developing effective governance policies will take time and require full commitment at the highest level of an organization.  A coordinator should be assigned to oversee the adopting and implementation of the various policies.  Many governance policy models are available, and can be tailored for each organization.  And they can implemented after a vote by the board.  In most cases, the board should seek legal review of these policies to ensure that they are both sound in their governance structure and tax compliant.  Because a governance policy is meant to be the voice of the board, it must reflect the board members’ vast differences in experience and perspectives and help make the organization's infrastructure stronger.