Advisory Committee on Tax Exempt and Government Entities (ACT ...

The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesmembership groups, and innumerable voluntary standards and publications fromleading organizations regarding nonprofit governance. Because large, sophisticatedand complex organizations are subject to regulation and/or are accredited and, in anyevent, have numerous governance resources available to them, it is less clear what theIRS adds to the governance discussion in their cases. Conversely, while smaller andmore rural organizations have less governance resources available to them, there is agreater need to tread lightly because of the burdens flowing from encouragingunnecessarily extensive governance reforms, the fact that the costs of adoptingpractices that may be advisable for larger nonprofits simply may not be worth thebenefits, and the reality that the costs of governance will consume charitable assets thatcould otherwise be devoted to the organizations’ programs. Finally, while disclosureand transparency, facilitated by the public availability of Forms 990 and 1023,undeniably play an influential role in encouraging appropriate nonprofit governance,they have limitations. This section briefly reviews these regulation and self-regulationmeasures involving nonprofit governance outside of the IRS.B. StatesWhether formed as nonprofit corporations or charitable trusts, charities are creatures ofstate law. The laws under which they are formed and the laws controlling their structureand finances are state laws, and their internal affairs remain subject to state laws evenwhen they operate entirely in other geographical jurisdictions. 47 While not all statesdistinguish the formation and operation of nonprofit and business corporations byseparate statutory schemes, 48 every state accords to the attorney general the authorityto correct abuses by charitable fiduciaries and to bring them to account in the courts. 49As a mechanism to protect charitable assets, and flowing from the formative authorityfound in state law, states nonprofit laws speak with increasing specificity to governancepractices. 5047Under long-standing, although sometimes criticized, conflict-of-laws principles for business corporations, the “internal affairsdoctrine” holds that the law of the state of incorporation applies to regulate the intra-corporate matters of a foreign corporationauthorized to transact business in the forum state. However, a few states are particularly concerned about the “pseudo-foreigncorporation”—the entity whose only tie to the state of incorporation is incorporation itself. California and New York, in particular,have adopted statutes applying much of their domestic corporate law to foreign corporations operating in-state that meet a thresholdtest. For a discussion of the internal affairs doctrine in the context of nonprofit corporations, see, e.g., American Center forEducation, Inc. v. Cavnar, 145 Cal. Rptr. 736, 742 (Cal. App. 1978); National Association for the Advancement of Colored People v.Golding, 679 A.2d 554, 559 (Md. 1996).48See, e.g., Delaware General Corporations Law § 101.49The authority of the state attorneys general typically is very broad. See, e.g., In re Milton Hershey Sch. Trust, 807 A.2d 324, 328(Pa. Commw. Ct. 2002); In re the Charles M. Bair Family Trust, 208 MT 144 (April 29, 2008). While standing to enforce fiduciaryduties has long been limited to the state attorney general and insiders with sufficient stake in the nonprofit’s governance, such asdirectors, officers, and members of the corporation, see, e.g., Carl J. Herzog Foundation, Inc. v. University of Bridgeport, 699 A.2d995, 998 (Conn. 1997), the doctrine of limited standing has occasionally been relaxed to permit others to enforce these obligations,particularly in response to perceived inaction by the state attorney general, see, e.g., Smithers v. St. Luke’s-Roosevelt HospitalCenter, 281 A.D. 2d 127 (App. Div. 1 st Dep. 2001). See generally, Evelyn Brody, From the Dead Hand to the Living Dead: TheConundrum of Charitable Donor Standing, 41 GA. L. REV. 1183 (2007).50California has the most detailed state laws requiring particular governance practices, specifying among other things thecomposition of the audit committee for those corporate-form charities required by state law to have audited financial statements(Cal. Gov. Code Section 12586(e)(2)); the procedure by which the governing body of a charity, regardless of form, must review thecompensation of certain corporate officers (Cal. Gov. Code Section 12586(g)); and the maximum percentage of a nonprofit publicbenefit corporation’s board that may consist of persons who are compensated by the charity or family members of those whom thecharity compensates (Cal. Corp. Code Section 5227).ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 18