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

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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuessubstantial part on the information contained in the Form 1023, the IRS determineswhether exemption is merited. Both stages involve governance matters. We begin bylooking at the Form 1023 governance questions and we then consider the impact ofgovernance in the determination process.1. Form 1023 Governance QuestionsThe focus on governance issues as set forth in the Form 1023, Application forRecognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, hasevolved over the years. While the Form 1023 prior to the current version askedquestions regarding organization structure and governance, it principally focused on thecharitable activities of the organization. 109In contrast, the 2004 (the most current) version places an increased emphasis on anorganization’s governance by focusing on board and management relationships(independence) as well as compensation and other potential opportunities forinurement. For example, the form seeks information about:• Whether any of the officers, directors or trustees are related to each otherthrough family or business relationships, whether any organization officerdirector or trustee is related to or does business with the organization, andwhether they are related to any of the organization’s most highlycompensated employees or independent contractors (Part V).• Practices related to establishing compensation 110 for the organization’sofficers, directors, trustees, highest compensated employees, andindependent contractors, including whether:– the individuals that approve compensation arrangements follow aconflict of interest policy;– the individuals approve compensation arrangements in advance ofpaying compensation;– the individuals document in writing the date and terms of approvedcompensation arrangements; and109Questions on the prior version of Form 1023 included: Who will be on the governing body? Are they a member of the governingbody by reason of being a public official? Are any members of the governing body “disqualified persons” with respect to theorganization or do any of the members have a business or family relationship with “disqualified persons”? Is the organizationcontrolled by or financially accountable to another organization? Is the organization a membership organization? – if so, the formwent on to ask the nature of the members and how they were solicited, with no questions as to how the members govern theorganization.110Part V also seeks information about compensation and other financial arrangements with officers, directors, trustees, employees,and independent contractors; and Part I, Line 8 asks “was a person who is not one of your officers, directors, trustees, employees,or an authorized representative paid or promised payment to help plan, manage, or advise you about the structure or activities ofyour organization, or about your financial or tax matters?” (If yes, must provide name, address, amounts paid, and description ofthat person’s role.).ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 32
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issues– the organization records in writing the decision made by eachindividual who decided or voted on compensation arrangements(Part V).• Whether the organization has adopted a conflict of interest policyconsistent with the sample policy in Appendix A to the instructions; and, ifnot, what procedures will be used to assure that persons who have aconflict will not have influence over their compensation setting and/orbusiness deals with themselves (Part V).There also are specific governance questions relating to churches 111 and hospitals. 1122. Governance Issues in the Administration of DeterminationsWe were not able to find guidance as to how the IRS takes governance issues intoaccount in the determination process except in limited instances in the health care andlow-income housing joint venture areas. 113 We certainly appreciate that governancecan bear on the operational test, among other issues. Our personal experience andresearch for this report suggests, however, that specific governance practices may berequired on an ad hoc and inconsistent basis. This can include determinationspecialists requiring independent boards or at least some independent board members.Similarly, despite the fact that the Form 1023 specifically states that a conflict of interestpolicy is recommended but not required, 114 reports suggest that determinationspecialists often require adoption of such a policy, occasionally the form of policyincluded with the Form 1023.There typically is no public record where taxpayers agree to make the changesrequired, strongly urged, or recommended by the IRS in the determination process andreceive an exemption; or where an application is withdrawn. The public release of IRSdenials of exemption 115 has, however, shed a little light on how the IRS focuses onspecific governance practices in the determination process. For example, in one denialof exemption involving an organization that sought to supply ski boats to tax-exempt111Schedule A inquires about a church’s religious hierarchy or ecclesiastical government, as well as whether its religious leader isalso an officer, director or trustee.112In the case of a hospital, Schedule C asks: whether its board of directors is comprised of a majority of individuals who arerepresentative of the community; with a description of the board members’ credentials and how each is a community representative;whether it will participate in joint ventures; and, if so, whether the partners are section 501(c)(3) organizations, the activities of thejoint venture, how the hospital exercises control over the joint venture’s activities and how it furthers the hospital’s exempt purpose;whether it will manage activities or facilities through its own employees or volunteers; and whether it has adopted a conflict ofinterest policy consistent with the sample health care organization conflict of interest policy attached to the Instructions to the Form1023; and, if not, a description of how it will avoid any conflicts of interest in its business dealings.113See supra notes 107-108 and accompanying text.114The Form 1023 itself (Part V, question 5a, page 4) states: “a conflict of interest policy is recommended though it is not required toobtain exemption.” The instructions to Form 1023 (Part V, question 5a, page 9) goes further and also explains how such a policymay facilitate tax compliance (although it appears to confuse inurement and private benefit and could have been written clearer):“Adoption of a conflict of interest policy is not required to obtain tax-exempt status. However, by adopting the sample policy or asimilar policy, you will be choosing to put in place procedures that will help you avoid the possibility that those in positions ofauthority over you may receive inappropriate benefit” Form 1023 (rev. June 2006).115Following a Freedom of Information suit brought by Tax Analysts, denial of exemption determinations and revocations are beingmade available in redacted form under IRC section 6110. See discussion infra at note 243 and accompanying text.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 33
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