2004 Lane Reports


Wednesday, September 1, 2004
by John Lapinski, J.D.

Tax Exempt Organizations Come Under The Microscope

The movement towards instituting new organizational oversight and corporate governance to prevent abuses revealed by recent scandals has largely focused on the for-profit sector. However, attention has recently shifted in the direction of the not-for-profit corporate boardroom.

In June the Senate Finance Committee held a hearing on "Charity Oversight and Reform: Keeping Bad Things from Happening to Good Charities."

Proposals for the reform of tax-exempt organizations were solicited from practitioners, officers and directors of charities, academia and other interested parties. The Finance Committee's staff prepared a discussion draft of the proposals being considered, to encourage and foster additional comments before the Committee considering possible legislative action. Some of the more significant proposals being considered are presented below.


The Finance Committee draft report provides a detailed description of the duties a board of a tax-exempt organization, or a trustee for a charitable trust, would be required to follow in performing their duties:

"… a Board member has to perform his or her duties in good faith; with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and in a manner the director reasonably believes to be in the best interests of the mission, goals, and purposes of the corporation. An individual who has special skills or expertise has a duty to use such skills or expertise. Federal liability for breach of these duties would be established.

Any compensation consultant to the charity must be hired by and report to the board, and must be independent. Compensation for all management positions must be approved annually and in advance unless there is no change in compensation other than an inflation adjustment. Compensation arrangements must be explained and justified and publicly disclosed (with such explanation) in a manner that can be understood by an individual with a basic business background.

- The Board must establish basic organizational and management policies and procedures of organization and review any proposed deviations.

- The Board must establish, review, and approve program objectives and performance measures and, review and approve significant transactions.

- The Board must review and approve the auditing and accounting principles and practices used in preparing the organization's financial statements and must retain and replace the organization's independent auditor. An independent auditor must be hired by the Board and each such auditor may be retained only five years.

- The Board must review and approve the organization's budget and financial objectives as well as significant investments, joint ventures, and business transactions.

- The Board must oversee the conduct of the corporation's business and evaluate whether the business is being properly managed.

- The Board must establish a conflicts of interest policy (which would be required to be disclosed with the 990), and require a summary of conflicts determinations made during the 990 reporting year.

- The Board must establish and oversee a compliance program to address regulatory and liability concerns."

In addition to these oversight duties imposed upon the board of directors, the Senate Committee is considering a number of government regulations.


One of the proposals under consideration is an IRS review of tax-exempt status of charitable organizations every five years. On every fifth anniversary of the IRS's determination of the tax-exempt status, the organization would be required to file information that would enable the agency to determine whether or not the original determination letter should remain in effect. Information to be filed would include current articles of incorporation and by-laws, conflicts of interest policies, evidence of accreditation, management policies regarding best practices, a detailed narrative about the organization's practices, and financial statements. This information would be used to evaluate whether the organization continues to operate exclusively for the exempt purpose and would be made publicly available. Failure to file the five-year review would result in the organization's loss of its tax-exempt status.


Several proposals encouraged limiting the amounts that officers and directors of charitable organizations can spend on travel. For purposes of paying expenses for travel, meals, and accommodations, charities would be subject to the applicable U.S. government rate. A penalty for failure to comply would be 10 percent of the excess payment, payable by the organization along with disgorgement of the excess by the individual.

Other proposals were designed to provide incentives in order to encourage private foundations to make additional grants. For example, each year that a private foundation pays out more than 12 percent of the foundation's non-charitable assets, the foundation would not have any liability for the excise tax on net investment income.

Apply private foundation "self-dealing" rules to public charities
Self-dealing transactions generally include the sale, exchange, or leasing of property; the lending of money or other extension of credit; the furnishing of goods, services, or facilities; payment of unreasonable compensation by a private foundation; transfer to or use by a disqualified person of a private foundation's income or assets; and certain payments to government officials. With the exception of the payment of unreasonable compensation, these rules would be extended to public charities so that, in general, self-dealing transactions between a public charity and a disqualified person would result in excise taxes.

Limit compensation of private foundation trustees
Under another proposal, compensation to trustees of a non-operating private foundation would not be permitted, or permitted only up to a statutorily prescribed, de minimis amount. Excess compensation could trigger filing of additional supporting material with the IRS, which would be publicly available.

Treatment of administrative expenses of non-operating foundations
Private non-operating foundations that have administrative expenses above ten percent of the foundation's total expenses would be required to file additional supporting material with the IRS, which again would be publicly available. These expenses are defined as any expense of a private non-operating foundation other than a grant to charity. A review by the IRS of such supporting material would include a review for purposes of determining whether the administrative expense was "reasonable and necessary."

Establish standards for acquisition/conversion of a non-profit
A suggestion was proposed calling for standards for review by state and Federal authorities when a non-profit organization acquires, or converts to, a for-profit corporation. To ensure that the acquisition or conversion best serves the interests of the intended beneficiaries of the organization's assets and necessary to serve the public interest, a review by a state or Federal authority would be required. The proposal would impose modified self-dealing or excess benefit transaction rules with respect to severance arrangements and stock (and stock option) arrangements with respect to successor entities. There would also be rules to address officer and employee compensation arrangements after conversion.


The Form 990 is an annual information return filed by most exempt organizations each year with the IRS. In general, its purpose is to provide detailed financial and programmatic information about the organization. Since Form 990 plays a significant role in public and governmental oversight of tax-exempt organizations, several proposed reforms have been made to ensure accurate, complete, timely, consistent, and informative reporting by exempt organizations.

Form 990 to require signature by Chief Executive Officer
One such proposal is a requirement that the chief executive officer of a tax-exempt organization sign a declaration under penalties of perjury that the chief executive officer has put in place processes and procedures to ensure that the organization's Federal information return and tax return comply with the Internal Revenue Code. In addition, a statement that the CEO was provided reasonable assurance of the accuracy and completeness of all material aspects of the return.

Penalties for failure to file complete and accurate 990.
Currently, failure to file Form 990 or to include required information is $20/day up to the lesser of $10,000 or 5 percent of gross receipts. Under one proposal, the penalty for failure to file would be doubled and for organizations with gross receipts over $2 million per year the penalty would be tripled. Failure to file a required 990 for two consecutive years could result in loss of tax exemption.

Independent audits or reviews.
Another example of oversight, is a proposed requirement that Form 990 (and/or annual report) would be subject to a review by an independent auditor for conformity to established Form 990 filing standards. The auditor's report would be attached to the Form 990 and would be a public document. In addition, for an exempt organization with over $250,000 of gross receipts, an independent audit of the organization's financial statements would be required, including certification regarding the organization's exposure to the unrelated business income tax. A new auditor must be used at least every five years. If the organization's gross receipts exceeds $100,000 but is not more than $250,000, its financial statements must be reviewed by a certified public accountant.

Enhanced disclosure of related organizations and insider transactions
Additional disclosure attachments to Form 990 would include:

- An affiliations chart showing the organization's relationship with its affiliated exempt and nonexempt organizations.

- Reporting of formation of taxable subsidiaries, and enhanced disclosure of an exempt organization's transactions with such organizations.

- Reporting of insider deals and ancillary joint ventures.

- A schedule listing all partnership interests and the tax exempt organization's role in the partnership.

- All tax opinions received by the organization involving agreements with insiders, and all conflicts of interest opinions.



1. Disclosure of financial statements - exempt organizations would be required to disclose to the public the organization's financial statements.

2. Web-site disclosure - exempt organizations with a Website would be required to post on such site any return that is required to be made public by present law, the organization's application for tax exemption, the organization's determination letter from the IRS, and the organization's financial statements for the five most recent years.

3. Publication of final determinations - the results of audits of tax-exempt organizations and closing agreements with tax exempt organizations would be disclosed without redaction.


Recent scandals in both the public and private sectors have led to necessary reforms as well as placing affirmative duties on corporate boards to perform their responsibilities with diligence. How many of these proposals will ultimately become law remains an open question. But the message is clear: this is the right time for tax-exempt organizations to review their structures and policies. A "legal audit," evaluating - - and improving - - the organization from top to bottom, from its charitable mission to its investment policies, is a step worth taking now, and one we're fully equipped to spearhead.

Please call on us. We are eager to help nonprofits pursue their missions more effectively while protecting them, and their officers and directors, from legal and tax liabilities.


John J. Lapinski serves as an Associate Attorney, and the Firm Administrator for The Law Offices of Marc J. Lane, a Professional Corporation and its investment affiliates, Marc J. Lane & Company and Marc J. Lane Investment Management, Inc. Mr. Lapinski is a graduate of Chicago-Kent College of Law (J.D.) and Elmhurst College (B.S.).


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The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

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