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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesyouth camps, the IRS determined that the activity was a commercial one, but it alsofound that because the five-person board of directors included three members of onefamily and compensation arrangements did not follow a conflict of interest policy, thiscould result in inurement. 116A recent case, Exploratory Research, Inc. v. Commissioner, 117 also is enlightening. TheIRS had advised the organization that it was unable to make a final determination andtherefore was closing the case because the organization had failed to provide sufficientinformation in connection with follow-up requests from the IRS. The court agreed thatthe organization had not described its proposed activities in sufficient detail andtherefore found that the organization had failed to exhaust its administrative remedies.Of interest is the extent to which the IRS sought governance changes:Additionally, Mr. St. Julien [the IRS determination specialist] expressed his concern thatpetitioner might act in the private interest of Mr. Anderson [the founder and sole director,who proposed to be compensated at the rate of $400 per week if and when theorganization obtained funding]. He also renewed his request that petitioner addmembers to its board of directors, asked whether petitioner had adopted a conflict ofinterest policy, and inquired as to what policies and procedures were in place to ensurethat the board of directors was not receiving benefits from petitioner’s activities. Finally,he asked petitioner to detail what internal controls on decision-making were in place toprevent petitioner from operating for the private benefit of Mr. Anderson. 118The organization refused to add additional directors, but listed several controls in placeto prevent Mr. Anderson from using the organization for his own purposes, including theorganization’s governing documents and IRS oversight. The letter from the Director ofExempt Organizations informing the organization that the IRS was closing the casebecause it was unable to make a final determination also stated that her office hadcontacted petitioner’s attorney and explained to her that the organization’s responseswere insufficient and that the organization “does not meet the operational test and116PLR 200733027 (May 21, 2007). See also TAM 200737044 (June 18, 2007) and PLR 200736037 (June 15, 2007)(both notingthat father and son were sole officers and directors and son provided most funding and almost 90% of the bank’s sperm toorganization that provided sperm without charge); PLR 200736031 (Dec. 7, 2006)(noting that married couple were sole officers anddirectors, there was no conflict of interest policy and couple did not recuse themselves when causing organization to contract formanagement services with for-profit company of which husband was sole shareholder); PLR 200535029 (June 9, 2005)(“ Finally,despite the expansion of your governing board from three (3) to five (5) members, and the enactment of a conflict of interest policy,we still have some concern that your actual operations will be controlled and directed by B and his daughter C. We acknowledgethat there is no evidence of any inurement to the benefit of these individuals, but then there has been no financial activity on yourpart to date.); PLR 200514021 (Jan. 13, 2005)(“There seems to be great likelihood of inurement to these individuals in that they allserve on the Board of Directors, and have a vote on compensation arrangements, leasing arrangements, and other financial mattersthat would affect the organization’s financial interests as well as their own. This situation gives rise to an inherent conflict ofinterests that would potentially, adversely impact the financial well being of the organization. Thus, you have failed to show that B,C, D and E, through their positions on the Board, would not benefit from inurement….); PLR 200510031 (Nov. 15, 2004)(“There isnot even one outside, disinterested board member to speak for the community. We must conclude that you violate the secondfundamental rule for exempt organizations, and operate for private, not public benefit.)117TC Memo 2008-89 (April 8, 2008).118Id. at 6.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 34
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesappears to be control [sic] by and for the one person board, officer, researcher andstaff.” 119We appreciate we have only anecdotal evidence regarding governance issues in thedetermination process. It is, however, our impression that the “when” and “what” areunclear and not uniformly applied. We are concerned about the IRS having this level ofdiscretion in cajoling or requiring specific governance process, particularly in thedetermination phase, where there usually is no track record evidencing operationalfailures.D. Governance Issues Involving Form 990 DisclosureThere has been an evolution over the last 66 years in the IRS’s interest in what wewould today characterize as nonprofit governance as evidenced in the Form 990,Return of Organization Exempt from Income Tax. The Form 990 has grown from twopages (1942 Form 990) to an eleven-page core form with Schedules A through R for2008. On the 1942 Form 990, two officers were required to sign an affidavit. Thisversion of the form contains only three questions about the exempt organization,including “have your articles of incorporation or by-laws or other instruments of similarimport been amended since your last return was filed, if so attach a copy.” In reviewingthe Forms 990 since 1960, we see increased inquiry in areas directly related toinurement and the operational test. Over time, these governance-type inquiries havebecome more attenuated to the tax laws, presumably on the assumption that goodgovernance practices in a general sense result in more likely tax compliance. Appendix5 summarizes our analysis of the changing nature of the Form 990. We agree with theconclusion in the 2006 ACT report that the Form 990 should be “designed primarily toassess whether the filer is complying with federal tax requirements.” 120The draft redesigned Form 990 for 2008 includes numerous governance questions,principally in the Part VI “Governance, Management and Disclosure” section of the coreform. The Commissioner for TE/GE has, in fact, characterized this governance sectionas “the crown jewel” of the IRS’s activity in the nonprofit governance area over the pastyear. 121 The principal governance additions in the redesigned Form 990 include (butare not limited to) disclosure of the following:119Id. at 8. After discussing the absence of concrete activities disclosed, the court stated: “Because petitioner’s application lackedproposals for tangible facilities, detailed plans, and criteria for selecting activities, and because petitioner was controlled by Mr.Anderson, respondent rightfully concluded that he required additional information before issuing a determination….” Id. at 13-14.120Policies and Guidelines for Form 990 Revision, June 7, 2006, http://www.irs.gov/pub/irs-tege/tege_act_rpt5.pdf, at 1, 23. Whilewe believe that governance questions on the Form 990 are appropriate subject to the limitations set forth in the 2006 ACT reportand this report, we are mindful of GuideStar’s comments about the draft redesigned Form 990: “The redesigned Form 990,however, goes beyond information required by the Internal Revenue Code or the underlying regulations. Although tax-exemptorganizations should certainly be cognizant of best practices, what an organization does with regard to them is a business judgmentmatter for the organization—and its donors—rather than an issue for tax administration. Devoting space on the Form 990 toimmaterial information diverts attention from true issues of tax compliance.” Letter from Robert Ottenhoff, President and ChiefExecutive Officer, GuideStar to Lois Lerner, Director, Exempt Organizations Division, Sept. 14, 2007, http://www.irs.gov/pub/irstege/redesignedform990commentsgeneral_9_14_07_i.pdf,at 106, 107.121Remarks of Steven T. Miller, supra note 24.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 35
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