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 Issuespractices and policies are not useful for organizations in providing a structure thatassists them in their decision-making and operational processes. Rather, we believethat respect for the diverse and evolving nature of the nonprofit sector requires that wecontinue to value flexibility in our expectations of the specific governance practices thatmay be essential to the health of the sector. Thus, we support the autonomy of anorganization’s governing body and its exercise of its business judgment as to what bestreflects the needs of its organization.Regulation and Self-Regulation of Nonprofit Governance Outside of the IRS. Oneof the issues that arises is whether there is a need for the IRS to be more involved innonprofit governance beyond the specific statutory requirements in the tax laws.Nonprofit organizations can be regulated by many—and sometimes conflicting—authorities. Because nonprofit organizations are established under state law, stateshistorically have had the principal responsibility and greatest authority to regulate in thearea. Organizations with offices in more than one state or that solicit contributions inmultiple jurisdictions may be subject to the laws of a number of states. There also areindustry-specific accreditation agencies, standards relating to participation in particularmembership groups, and innumerable voluntary standards and publications fromleading organizations regarding nonprofit governance. Because large, sophisticated,and 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 case. 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 adopting certainpractices simply may not be worth the benefits, and the reality that the costs ofgovernance will consume charitable assets that could otherwise be devoted to theorganizations’ programs. Finally, while disclosure and transparency, facilitated by thepublic availability of Forms 990 and 1023, undeniably play an influential role inencouraging appropriate nonprofit governance, they have limitations.Role of IRS/Treasury in Governance Involving Tax-Exempt Organizations. TheIRS has sought, to varying extents, to promote good governance practices in each of itsfive points of contact with tax-exempt organizations: in creating standards forexemption; on determination of exemption; on examination or in other complianceinitiatives; in 990 reporting; and in education and outreach. Our report reviews each inturn to identify how governance is involved and to highlight some concerns.Governance Issues on Standards for Exemption. While Congress has not required theadoption of specific governance practices as a condition for exemption under section501(c)(3), there are a limited number of situations where the IRS has mandated specificgovernance practices as a condition for exemption in precedential (sometimes nonprecedential)rulings and other documents. Most of these arise in the health care arena,although the IRS requires a conflict of interest policy in certain low-income housing jointventures. We appreciate that in the quickly-changing field of health care it can, in someinstances, be difficult to distinguish a health care organization that qualifies forexemption from one that is merely the for-profit practice of medicine or a health-relatedADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 2
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesbusiness. In various contexts, as the IRS has labored to draw that line, it has created aper se requirement for exemption that requires the organization be governed by anindependent body. The IRS’s position, however, has not always been sustained by thecourts and we are concerned about per se requirements.Governance Issues Involving Determinations. Both stages of the determinationprocess—the completion and submission of Form 1023; and the administrative processwhere the IRS determines whether exemption is merited—address governance matters.We 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. We certainly appreciate that governance canbear on the operational test, among other issues. Our personal experience andresearch for this report suggest, however, that the IRS may require specific governancepractices on an ad hoc and inconsistent basis. For example, determination specialistsmay require organizations seeking exemption to have independent boards or at leastsome independent board members. Similarly, despite the fact that the Form 1023specifically states that a conflict of interest policy is recommended but not required, ourexperience and interviews suggest that determination specialists often require adoptionof such a policy, and occasionally require adoption of the sample form of policy includedwith the Form 1023 instructions. We appreciate we have only anecdotal evidenceregarding governance issues in the determination process. It is, however, ourimpression that the “when” and “what” are unclear and not uniformly applied. We areconcerned about the IRS having this level of discretion in cajoling or requiring specificgovernance process, particularly in the determination phase, where there usually is notrack record evidencing operational failures.Governance Issues Involving Form 990 Disclosure. The addition of a number ofgovernance-related questions to the recently redesigned Form 990 serves as furtherdemonstration of the IRS’s growing involvement in the area. The IRS’s approach to theredesigned Form 990 for 2008 has been a model of inclusiveness and collaboration.We believe in large part the governance questions on the redesigned Form 990 for2008 are appropriate and formulated in a relatively neutral manner, recognizing that trueneutrality is an unattainable goal. The inclusion of the questions, however, inherently(and intentionally) suggests that the IRS supports adoption of specific governancepolicies and practices. The danger then is that organizations will take the path of leastresistance and adopt the policies and practices whether or not they are appropriate forthem, or effective in their context.Governance Issues in the Examination or Other Compliance Initiative Context. As withdeterminations, the IRS considers an organization’s governance in the context of anaudit or other compliance initiative. However, the audit context differs significantly fromdeterminations in that the organization has a track record and the IRS is, or should be,considering the organization’s actual operations in ascertaining whether theorganization qualifies for exemption. Thus, where there are violations of the standardsfor exemption, the IRS rightfully has a greater interest and duty and correspondinglyincreased latitude to address misbehavior. However, we were not able to findADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 3
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