The climate is changing for nonprofit organizations, with both the Internal Revenue Service and Congress zeroing in on issues such as transparency, board oversight and compensation matters.While Sarbanes-Oxley requirements apply to only the public company sector, the scandals emanating from publicly traded companies over the past several years have affected the nonprofit arena as well, according to Geralyn R. Hurd, an executive in the tax services group at Crowe Chizek's Chicago office.
"Basically it traces back to Sarbanes-Oxley," she said. "Some nonprofit scandals put pressure on the IRS and motivated Congress to take a new look at the sector. [IRS] Commissioner Everson has made it a priority and has increased enforcement."
"It's a very hot topic now," agreed Susan A. Cobb, counsel in the tax practice group at the Washington office of Powell Goldstein LLP.
"It started with the intermediate sanction rules of code section 4958, [enacted in 1996] and Congress has been increasingly involved. Senators Grassley and Baucus [Charles Grassley R-Iowa, and Max Baucus, D-Mont.] of the Finance Committee have voiced their concern and are taking action, particularly in the realm of compensation," she said.
A panel on the nonprofit sector was put together in 2004 at the encouragement of the Senate Finance Committee, noted Hurd. "They hoped to accomplish best practices and have boards take ownership of nonprofits in an effort to keep the IRS out."
"They made recommendations regarding conflict of interest statements, disclosure of relationships, and higher levels of oversight and transparency within the organization. Many of the recommendations in its initial report were incorporated in the August 2006 Pension Act. So it's a good group to watch because it has the eyes and ears of Congress."
Most recently, the panel came out with its second draft of principles for effective practice. The draft, completed in January, lays out guidelines on legal compliance, effective governance, financial oversight, and fundraising, according to Hurd.
"What's interesting is that the IRS came out in February with their best practices, and many mirror what the panel had published," she said.
Principle 10 of the draft requires a substantial majority of the board of a public charity be independent. The background information to Principle 10 cites Sarbanes-Oxley, and noted that five states have legislative mandates for the independence of nonprofit boards of directors.
"The IRS revised Form 990 [Return of Organization Exempt From Income Tax] in 2005 and 2006," said Hurd. "Each year they make significant edits, but it's now in the process of being completely revamped. The revision for 2006 incorporated much of the Pension Act's changes."
"Form 990 has been an evolving document," said Cobb. "We expect another revision to come out in June."
Questions 75(b) and (c) of Form 990 ask for detailed information on relationships among board members.
"There was a huge public outcry when this was first inserted in 2005," Hurd noted.
"Comments suggested that this was not accomplishing anything. When it was revised in 2006 it didn't take away the need to identify relationships. It's a good thing, because board members need to understand wherever their conflicts of interest lie. There are a lot of good people trying to do good things on these boards, but they may not have figured out where they might have conflicts."
Since Form 990 is publicly available, board members' personal relationships and business interests could become easily accessed, according to Hurd.
"Nonprofits are confused about the rules and are weighing compliance with the disclosure requirements versus releasing sensitive information. The revised 2006 form and instructions provide additional guidance in this area."
Congress is particularly concerned with compensation issues, according to Nancy Ortmeyer- Kuhn, Esq., who represents several organizations now under examination.
"Grassley and Baucus have picked up on compensation as an issue for section 501(c)(3) organizations," said Kuhn, tax counsel at Powell Goldstein LLP.
"Under code section 4958 if you find comparable salaries for private positions as you have at a public charity, the charities are given the presumption that their salaries are reasonable, so long as the duties are the same or similar in the positions being compared."
Grassley paid particular attention to the compensation given the secretary of the Smithsonian Institution.
"Senator Grassley is concerned with the smell test of luxury or extravagance," she said. "For example, fancy chairs suggest that in some fashion, the nonprofit sector is an area of abuse."
In a recent speech on the Senate floor, Grassley noted that even the Smithsonian received over $700 million last year directly from the federal government, and another $200 million in tax deductible donations, despite the fact that its Arts and Industries building has been closed to the public due to damage to its roof.
Despite this, the Board of Regents approved over $1 million dollars in expenses for the house of the secretary, "Because they claim he does official Smithsonian entertaining there," said Grassley.
The most incredible expenditure, said Grassley, is that the Smithsonian paid for roof repairs at the secretary's house "at a time when the Smithsonian can't find the money to fix the roofs at the Smithsonian."
"Maybe there's nothing wrong at all, but asking employees to turn off the lights when they're making these types of expenditures can create the perception that a charitable purpose is being impacted by compensation," said Cobb.
In its just-released report on the Exempt Organizations Executive Compensation Compliance Project, the IRS found significant reporting errors related to excess compensation, according to Cobb.
"The IRS found significant reporting errors on Forms 990 and 990-PF [for private foundations], and is recommending additional training materials," she said. The IRS also found significant issues with regard to loans to officers and employees."
Smaller organizations may have problems keeping up with the changes in the rules, said Kuhn.
"The larger ones can hire accountants and lawyers, but many of the smaller ones are trying to wing it without specialized personnel," she said. "The IRS has a free interactive training program at stayexempt.org that these organizations should use."
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