After attending the Georgetown University Law Center “Representing & Managing Tax-Exempt Organizations” Conference in April, 2010, we wanted to discuss some of the lessons that exempt organizations should take away in the following areas: governance; transparency; compensation; joint ventures; and endowments and investments.

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.

2. Transparency – Not only does the IRS want to make sure that your organization is doing the right thing, but it wants to know exactly how you are doing it.  Moreover, the IRS not only cares that you tell it about your processes, but it wants to make sure that the public is also aware of what your organization is doing behind closed doors.  Even on its Form 990, the IRS asks whether the organization makes not only the Form 990 available, which is required by law, but whether the organization also makes its Conflict of Interest Policy and financial statements available to the public, even though it is not legally required to make these documents available.  The IRS does not want to guess at how you accomplished something, it wants enough information about the process behind the result to feel as though its agents were beside you when you made the decisions leading up to the result.  If you are not already, you need to conduct your organization as though all eyes are watching…because in many ways, they are.

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.