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 Issuesnot materialized. A number of states have, however, issued educational materials fornonprofit organizations 19 or supported such endeavors by groups within their states. 20In this environment, the Internal Revenue Service (“IRS”) similarly has been active inpromoting “best practices” for tax-exempt organizations. The IRS added a governancesection to its redesigned Form 990 for tax years beginning in 2008; it included a paperentitled “Governance and Related Topics – 501(c)(3) Organizations” in its Life Cycle onlineeducational tool; 21 and the Commissioner for Tax Exempt and Government Entities(“TE/GE”) and the Director of Exempt Organizations have spoken nationally about theimportance of tax-exempt organizations adopting good governance practices. 22 In avery recent speech, the Commissioner for TE/GE advised as follows: 23Over the past year, we have said repeatedly that we care because a well-governedorganization is more likely to be compliant, while poor governance can easily lead totrouble. Good governance also allows for self-identification and resolution of problems.Some disagree with us on this. My view is clear. Despite the absence of explicit federalstatutory provisions setting forth clear governance standards, what I am callingjurisdictional gaps, we are not interlopers trying to regulate an area that is beyond oursphere. Rather, the effects of good or bad nonprofit governance cut across virtuallyeverything we see and do in our work. It impacts whether the organization is operated tofurther exempt purposes and public, rather than private, interests. It dictates whetherthe organization’s executives are compensated fairly or excessively. It influenceswhether the organization makes informed and fair decisions regarding its investments orits fundraising practices, or allows others to take unfair advantage. The question is nolonger whether the IRS has a role to play in this area, but rather, what that role will be.Under the circumstances, we thought this was an opportune time to consider theappropriate role of the IRS with respect to good governance practices by tax-exemptentities.We begin by acknowledging the IRS’s longstanding stake and legitimate interest ingovernance issues as they relate directly to compliance with the laws under its19See, e.g., Guidebook for New Hampshire Charitable Nonprofit Organizations (New Hampshire Attorney General, Charitable TrustUnit ed., 2005), available with other resources, www.doj.nh.gov/charitable; Iowa Principles and Practices for Charitable NonprofitExcellence (Iowa Governor’s Nonprofit Task Force ed. 2006), http://www.sos.state.ia.us/pdfs/Nonprofits/IAPP4CNE.pdf; AttorneyGeneral Andrew M. Cuomo, Internal Controls and Financial Accountability for Not-for-Profit Boards (2007), athttp://www.oag.state.ny.us/charities/internal_controls.pdf; Attorney General Andrew M. Cuomo, Right from the Start (2007),http://www.oag.state.ny.us/charities/not_for_profit_booklet.pdf.20See, e.g., Colorado Nonprofit Association, Principles and Practices for Nonprofit Excellence in Colorado (2007),http://www.coloradononprofits.org/PandP/PandP.pdf ; Maine Association of Nonprofits, Guiding Principles and Practices forNonprofit Excellence in Maine (2008), http://www.nonprofitmaine.org/documents/PandP_2008.pdf.21See http://www.irs.gov/charities/article/0,,id=178221,00.html and http://www.irs.gov/pub/irs-tege/governance_practices.pdf.22See, e.g., Remarks of Steven T. Miller, Commissioner, TE/GE, IRS, Georgetown Tax Conference (April 26, 2007), The ExemptOrganization Tax Review, Vol. 56, No. 3, 256 (June 2007), and The IRS Role in an Evolving Charitable Sector, PhilanthropyRoundtable (Nov. 10, 2007), http://www.irs.gov/pub/irs-tege/philanthoropy_roundtable11.pdf. See also the letter of June 28, 2007from IRS Acting Commissioner Kevin M. Brown to Senator Grassley as to the importance of “an independent, empowered andengaged board of directors. . . .” http://www.senate.gov/~finance/press/Gpress/2007/prg072307a.pdf.23See Remarks of Steven T. Miller, Commissioner, TE/GE, IRS, Georgetown Tax Conference, (April 23, 2008),http://www.irs.gov/pub/irs-tege/gulc_governance_speech_042308.pdf.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 10
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesjurisdiction. Charitable governance issues arise from section 501(c)(3)’s operationaltest and inurement proscription; 24 section 4958’s imposition of excise taxes on excessbenefit transactions between public charities 25 and those in a position to exercisesubstantial influence over them (particularly the procedures set forth in the regulationsto section 4958 regarding how to obtain the rebuttable presumption ofreasonableness); 26 the limits on transactions involving private foundations and theirinsiders, including directors, trustees, their family members, and other related parties; 27and the statutorily mandated public disclosure of the Forms 1023 and 990. 28Governance is an issue in each of the IRS’s five points of contact with the tax-exemptsector: in creating standards for exemption; on determination of exemption; onexamination or in other compliance initiatives; in 990 reporting; and in education andoutreach.The IRS’s view that “a well-governed charity is more likely to obey the tax laws,safeguard charitable assets, and serve charitable interests than one with poor or laxgovernance” 29 seems self-evident. At the same time, efforts to promote goodgovernance are fraught with complexity. There are over 1.2 million organizationsdescribed in section 501(c)(3) today. 30 Effective governance practices among theseorganizations will vary depending on numerous factors, including size, sophistication,location, available resources, and activities. 31 Moreover, while we may all agree thatgovernance matters, it is not at all clear that requiring specific governance practicesresults in greater compliance with the tax laws. In fact, superior board governance mayhave much more to do with the values, active engagement, and accountability of thosein charge than with the adoption of procedures and policies. Yet, the IRS merely askingabout specific governance practices is a powerful force that can drive behavior.Charities can feel pressured to adopt the specified practices even where it isinadvisable in their situation because they believe the IRS or others will consider thempoorly governed if they fail to do so. This can effectively usurp the judgment of thegoverning board in determining what governance practices make sense in its specificcontext, place undue burdens on organizations, divert their attention to proxies forgovernance instead of actual governance, and adversely impact the unique, diverse,24All references to “section” are to the IRC unless otherwise indicated. Inurement also is proscribed by IRC sections 501(c)(4),501(c)(5), 501(c)(6), 501(c)(7), 501(c)(9), and 501(c)(10), inter alia.25IRC section 4958 also regulates excess benefit transactions involving IRC section 501(c)(4) organizations.26Treas. Reg. § 53.4958-6.27See IRC sections 4946 (defining disqualified persons to private foundations), 4941 (self-dealing), and 4945 (taxableexpenditures).28See discussion infra at notes 104-06 and accompanying text.29Preface to Governance and Related Topics – 501(c)(3) Organizations, supra note 22.30See Remarks of Steven T. Miller, Commissioner, TE/GE, IRS, Georgetown Tax Conference (April 24, 2008),http://www.irs.gov/pub/irs-tege/represent_manage_speech_042408.pdf.31See Panel Principles, supra note 13, at 5: “[G]iven the wide, necessary diversity of organizations, missions, and forms of activitythat make up the nonprofit community, it would be unwise, and in many cases impossible, to create a set of universal standards tobe applied uniformly to every member. Instead, the Panel commends the following set of principles to every charitable organizationas guideposts for adopting specific practices that best fit its particular size and charitable purpose”ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 11
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