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 Issues(2) Specific Governance Practices Should Be Mandated Only In Rare AndLimited Circumstances. We do not believe specific governance standardsshould be a per se prerequisite to the granting of tax exemption. There arenonprofit organizations with model governance practices that fail to serve theircharitable purposes, comply with the requirements for exemption, or abide bylegal obligations, just as there are nonprofit organizations with minimal formal“good governance” practices that perform in an exemplary manner. While our“gut” may tell us that organizations that have adopted “best” practices are morelikely to be compliant, as discussed at length previously, this is not supported byempirical evidence. Further, even conceding the big picture proposition, which“best” practices are really “best” also remains an open issue. To the extent thatthe IRS is reflecting a congressional finding, it is on safer ground. In enactingsection 4958, Congress found that organizations are more likely to make betterdecisions about the fairness of insider compensation and the fairness of certaintransactions involving insiders if those decisions are made by independentdirectors or committee members who rely on comparability data and whocontemporaneously document their decisions. However, Congress rewarded,but did not require, independence, use of comparability data, andcontemporaneous documentation. Thus, it is likely that the IRS would be goingbeyond what Congress thought was appropriate if it sought to mandate eventhese governance practices with congressional imprimatur.We believe that no mandated governance practice ensures compliance with therequirements for tax exemption and that various approaches may give sufficientcomfort that an otherwise qualifying organization is unlikely to violate theproscriptions against private inurement or more than incidental private benefit.Mandating such governance practices usurps the proper role of the governingbody to choose from among a wide variety of suitable governance practicespermitted under state law based on the distinctive aspects of the organizationand also has the greatest potential for harm to the diverse, vibrant, and flexiblecharitable sector, particularly when there is little or no empirical supportsupporting specific nonprofit governance practices. Moreover, should the IRSseek to implement specific governance standards as a condition for exemption,we urge it do so through the regulatory process, thereby ensuring an opportunityfor public comment.As discussed previously, 143 there are only a limited number of situations wherethe IRS has issued precedential or non-precedential guidance to the effect that itis mandating specific governance practices as a condition for exemption. Weappreciate the reasons that the IRS has sought to create governance litmus testsin complicated areas such as health care, and we agree, for example, that anindependent governing body can be viewed as a favorable factor indeterminations, but we encourage the IRS to utilize more flexible standards thatallow for consideration of all the facts and circumstances in determining whether143See supra notes 107-09 and accompanying text.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 48
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesthe standards for exemption have been met. In addition to these documentedattempts by the IRS to mandate specific governance practices, there issignificant anecdotal evidence that the IRS is requiring new organizations toadopt a conflict of interest policy as a condition for exemption. There even arereported instances where the IRS required its form of conflict of interest policy tobe adopted. Again, while the existence of a conflict of interest policy mayappropriately be viewed as a favorable factor on determination, we do not believeit should be a per se requirement.The one situation where we believe it is appropriate for the IRS to have latitude inseeking to impose specific governance practices is where the IRS has identifiedan organization that has committed one or more grievous violations of thestandards for tax exemption. One example is an organization that violates theinurement proscription and where the IRS has the right to revoke exemption inaddition to imposing section 4958 excise taxes. 144 In such a case, and subject toour recommendations with respect to consistency and fairness below, we believethe IRS should have discretion in determining whether to propose revocation ofexemption of a culpable organization or to allow the organization to undergosufficient changes that its charitable mission can be preserved in a context thatmakes future violations highly unlikely. In fact, we hope that where there issufficient charitable mission to preserve that the IRS will seek to createconditions that allow the organization to continue. In this regard, we think it isappropriate for the IRS, in its judgment, to seek to condition continued exemptionon the adoption of extensive governance changes that are reasonably implicatedin the charity’s wrongdoings. These could include, for example: requiring achange in directors, officers and/or senior managers; imposing independencerequirements for the board as a whole and/or in connection with variousdecisions of the organization such as executive compensation, joint ventures,and financial oversight; mandating approval processes that assure involvementof directors or key employees; requiring adoption of various policies such as aconflicts of interest policy and/or whistleblower policy; requiring the governingboard and senior managers to undertake training on their respective roles andresponsibilities; and requiring greater transparency. In making its determination,we believe the IRS should take into account self-initiated changes theorganization has voluntarily undertaken, particularly when undertaken beforegovernment contact. Of course, if the organization does not voluntarily agree tomake the changes, the IRS cannot force it to do so; it can instead revoke theorganization’s exemption, and the organization, in turn, has the right to challengethat determination in court.A more challenging situation for us is where the compliance initiative showsevidence of operational concerns but not at a level that would result inrevocation. This might include, for example, an instance where there was apurchase of property from a person involved with the organization who was not adisqualified person at a price just in excess of fair market value, without a formal14470 Fed. Reg. 53599 (March 27, 2008).ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 49
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