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 IssuesThese concerns should be considered by the IRS in any instance in which the IRSinquiries or opines about matters of nonprofit governance. However, the inherent risksand the need for caution are not of equal sensitivity in all circumstances. Therefore, weoffer a framework and recommendations that take these concerns into account in ourconsideration of the appropriate role of the IRS with respect to nonprofit governance.IX. RecommendationsWe begin our recommendations by again acknowledging the IRS’s longstanding stakeand legitimate interest in governance issues as they relate directly to compliance withthe laws under its jurisdiction. As we stated in the introduction, the IRS’s view that “awell-governed charity is more likely to obey the tax laws, safeguard charitable assets,and serve charitable interests than one with poor or lax governance” 140 seems selfevident.But efforts to promote good governance are fraught with complexity. While wemay all agree that governance matters, the empirical evidence does not support theproposition that requiring specific governance practices results in greater compliancewith the tax laws. Effective governance likely is much more a question of the attitude ofresponsibility and accountability of those in charge than the adoption of specific policiesand practices. Given the diversity of the sector and the varying, and oftenunpredictable, challenges facing an organization, the organization’s governing boardgenerally is in the best position to determine what the most appropriate practices are forits organization. We are very mindful of the fact that even the most modest level ofprescription from a regulatory body such as the IRS regarding what constitutes “good”governance can undermine the fundamental and wholly legitimate authority of theorganization’s governing board and can suggest a one-size-fits-all approach that canplace undue burdens on an organization, divert the organization’s attention frommeaningful governance to polices and procedures, and do damage to the uniquelydiverse and vibrant charitable sector in this country.Accordingly, we believe that the IRS should approach the governance area with caution.We recommend that in each instance the IRS is considering involvement in a specificgovernance issue it should consider the importance of the specific governance practiceto compliance with the laws under its jurisdiction and then balance that against potentialcountervailing considerations (e.g., will it elicit or promote a meaningful responserelated to tax compliance and what harm might flow) in determining whether to proceed.We believe the context in which the IRS is operating—in creating standards forexemption; on determination of exemption; on examination or in other complianceinitiatives; in 990 reporting; and in education and outreach—is relevant to this balancing.We conclude our report with 12 recommendations we hope the IRS will find useful as aframework in helping it navigate appropriately between its mandate to ensurecompliance with the tax laws and the broader and more aspirational goal of promotinggood governance in the sector. We recognize that in a number of instances the IRSalready follows or substantially follows these recommendations, but we include all 12 toensure a complete framework.140Governance and Related Topics – 501(c)(3) Organizations, supra note 22, at Preface.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 46
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issues(1) The IRS Should Continue to Work Collaboratively With The Tax-ExemptCommunity In Connection With Its Governance Initiatives. The IRS’sapproach to the redesigned Form 990 for 2008 has been a model ofinclusiveness and collaboration. After releasing a draft redesigned Form 990 forpublic comment in June of 2007, the IRS reached out broadly to the nonprofitcommunity and the public to discuss the draft and solicit input. The IRSultimately received over 650 comments, amounting to more than 3,000 pages,much of which was reflected in the revised redesigned Form 990 released inDecember of 2007. The result is a substantially better form, including withrespect to the governance questions contained therein. In April of 2008, the IRScontinued this exemplary process, releasing draft instructions, including a draftglossary, for public comment. The “Governance and Related Topics – 501(c)(3)Organizations” materials added to the Life Cycle are useful and a significantadvancement over the earlier draft. But we believe they could have been evenbetter if they had the benefit of more input. For example, we believe thedocument structure should, with respect to each subpart, relate therecommended practice to the tax rules and state with respect to each practicethat it is not required for exemption; focus more on practices than policies; focuson charitable purposes and not “mission;” include either more explanation ordelete the recommendation to keep fundraising costs “reasonable;” and includeeither more explanation or delete the recommendations for an audit byindependent auditors overseen by an independent audit committee. We believethat the sample conflict of interest policy in Appendix A to the instructions of theForm 1023, as well as the inquiries in the Form 1023 about whether a policy“consistent with the sample conflict of interest policy” could be improved uponwith input from the tax-exempt community. 141 If IRS agents are going to utilize apost-exam checklist to assist in determining the impact of governance, we wouldhope that the IRS would seek input from the nonprofit community with respect toboth the checklist and the process employed. The desirability of bothcollaboration 142 and an opportunity for comment in the governance arena isparticularly strong because the IRS involvement in governance is discretionary,the subject is not mainstream to IRS expertise, there are a significant number ofsubstantive experts in the field, and there are numerous viewpoints reflectingboth the diversity of the sector and the dearth of empirical evidence.141The IRS does not explain in connection with the Form 1023 what parts of the sample conflict of interest policy it considers criticalor what “consistent with the sample conflict of interest policy” means. For example, unless an organization simply adopted the IRSsample policy, it would be unusual for a conflict of interest policy to call for “periodic reviews” of compensation arrangements andbenefits or partnerships, joint ventures, and arrangements with management organizations to “ensure that the Organizationoperates in a manner consistent with charitable purposes and does not engage in activities that could jeopardize its tax-exemptstatus,” and to authorize the use of “outside experts” (confusingly denominated as “outside advisors” in the immediately priorsentence). Moreover, if an organization follows the rebuttable presumption of reasonableness under IRC section 4958 it is not clearwhy such a compensation review is necessary; nor is it clear why routine management arrangements for food service, security,parking, or laundry necessarily merit such a review.142The Exempt Organizations Division may want to discuss with the Officer of Inspector General of the Department of Health andHuman Services its experiences in releasing three publications on governance jointly with the American Health LawyersAssociation. See Appendix 3.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 47
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