Lessons for Charity Boards from AG Audit of CSU Stanislaus Foundation

In April of this year, the California Attorney General launched an investigation into the California State University Stanislaus Foundation. The probe followed upon the Foundation's refusal to turn over records to Senator Leland Yee that he requested under the California Public Records Act. Lee began his inquest after it was reported that the Foundation has engaged Sarah Palin as an fundraising event speaker. Since the Foundation is not an entity covered by the CPRA (Yee's pending legislation may change this), it was not required to provide records to Senator Lee, and so, thwarted by the Foundation, he requested the Attorney General investigate it.  Under the broad authority given to the AG under California law for the oversight of organizations holding charitable assets, the AG sought to determine whether the foundation, which has assets of more than $20 million, has spent its money to benefit CSU Stanislaus, as it has promised donors, the university and the public.

Based upon the limited review conducted, the AG found no diversion of charitable assets by the Foundation. Nevertheless, the Closing Letter (pdf) by Belinda Johns, Senior Assistant AG to the Foundation's counsel points out that the Board did not always exercise adequate fiscal oversight.  This Closing Letter is instructive for understanding what the duties of directors of nonprofit charitable organizations are with regard to adequate fiscal oversight, especially under California law.

The underlying principle of law is that the Board of Directors of an organization holding charitable assets in California has the ultimate responsibility for those assets and must manage and protect them from being diverted from the charitable purposes of the organization or, if applicable, the specific purposes for which the assets were given.  The Board must see to the "protection of charitable assets" under its control. As the AG's letter points out, among other things, that means that the Board is responsible for:

• Comparing and analyzing revenues and expenses on a periodic basis to determine if the organization is meeting its budgetary goals.

• Reconciling endowment accounts and correctly identifying restricted and unrestricted funds. Board members may be personally liable for restricted funds which are incorrectly released.

• Reviewing budgets for special events. "Assessing the effectiveness of a fundraising event is essential to avoid waste of charitable assets."

• Managing fundraising activities administered by outside groups. "The board must exercise control over the representations made by fundraisers in order to assure those representations are accurate and to determine whether they include language that may restrict donations for a specific purpose."

Johns also pointed out that the Board "does not appear to fully understand its duties and responsibilities under applicable law." Of how many other charitable organizations could this also be said? In particular, these duties and responsibilities are found in the following statues:

• Supervision of Trustees and Fundraisers for Charitable Purposes Act (Gov. Code section 12580 et seq)
• California Public Benefit Corporation Law (Corp. Code section 5000 et seq.)
• Uniform Prudent Management of Institutional Funds Act (UPMIFA) (Prob. Code section 18501 et seq.)

Note that these are all California state laws controlling nonprofit organizations, and not the federal tax code. While the IRS is an important regulator of charities, state laws have traditionally determined most of the governance for nonprofit organizations and the safeguards on charitable assets.

As part of the closing of the investigation, the Board of CSU Stanislaus Foundation agreed to undertake "'board training' to assure they fully understand their fiduciary duties" under these laws.  Boards of other organizations that find themselves not fully understanding their fiduciary duties could probably do no better than to initiate a similar board training by reviewing the Closing Letter and discussing how and where they can improve their management and protection of charitable assets.

IRS Offers Relief for Failure to File Form 990-N or 990-EZ

As discussed previously on this blog, the 2009 tax year is the first year for which the filing provisions of the Pension Protection Act of 2006 come into effect. Specifically, exempt organizations that have not filed a federal informational tax return (Form 990) for three consecutive years are now subject to automatic revocation of their exempt status.

Even small organizations with annual income less than $25,000 are required to file the Form 990-N, the "e-postcard" for exempt organizations. This filing requirement for small organizations represents a change in the law and, despite considerable publicity and outreach by the IRS, many organizations may not yet be aware of their need to file, or they were not aware of it before the filing deadline of May 17, 2010.  In fact, it is estimated that nearly 300,000 organizations are in danger of losing their exempt status as a result of their failure to file a return.

In light of this, the IRS has announced today that it is offering a one-time relief program to small organizations. Organizations can preserve their exempt status under this program by filing past due returns, either Form 990-N or Form 990-EZ by October 15, 2010. Organizations required to file Form 990 or Form 990-PF are not eligible for relief under this program. If these are subject to the automatic revocation of their exempt status, they will have to re-apply for exemption using the Form 1023 or Form 1024 applications. 

The IRS has posted the names and addresses, listed by state, of those organizations that are at risk of losing exemption for failure to file returns for the past three consecutive years. Every organization manager - president, CEO, board member, treasurer, secretary, CFO, etc - should take a look at this list and confirm that their organization is not listed, regardless of how certain they are of the filing status of their organization.  A cursory review of the list suggests that there are many entities here that may be related to larger organizations as affiliates, subsidiaries or chapters, which nevertheless have independent exempt status. Also, there appear to be listed organizations that are, in fact, churches. While these organizations may not be required to file an informational return, they should contact the IRS and confirm their status as churches so as to avoid future confusion and potential loss of exemption.

Florida's Philanthropic Freedom Legislation: A Reaction to California's AB 624

If there is a legislative equivalent to Newton's third law of motion, the recently enacted Florida legislation, SB 998 (pdf -begin page 10, line 288) (signed by Governor Crist on May 27, 2010) must be the equal and opposite reaction to the California legislature's AB 624 (2007-2008 Legislative Session).

AB 624 was a bill proposed in 2007 by Assembly Member Joe Coto and vigorously promoted by the Greenlining Institute. AB 624 would have required a nonprofit corporation or trust, deemed to be a "private, corporate, or public operating foundation," with assets over $250 million, to collect and disclose the racial, gender, ethnic and sexual orientation statistics about its board members and staff, and those of its grant recipients.  FL SB 998, on the other hand, prohibits the government from requiring charitable organizations to collect and disclose such information, or make distributions based upon it. It was the result largely of the legislative advocacy of  the Alliance for Charitable Reform.

In California, many organizations and advocates were taken by surprise by the proposed AB 624. It took some time to understand how this legislation could seriously impact the operation of philanthropic organizations in California. After several months of discussion and analysis, the Nonprofit and Unincorporated Organizations Committee of the Business Law Section of the California State Bar (made up of lawyers who work with nonprofit organizations) voted to oppose AB 624, and expressed its opposition in a letter to the State Bar Office of Governmental Affairs (March 27, 2008). In that letter, the Committee expressed the reasons for its opposition:

The proposed bill would not advance governance of foundations. On the contrary, the bill is unconstitutionally and impermissibly intrusive at many levels, to foundations, their grantees, grantees’ beneficiaries and businesses with which foundations interact, as well as to the boards of directors and employees of each of the foregoing... Even if a foundation and its grantees could lawfully obtain, assemble and make public the data the bill requires, the lack of clarity as to who and what are described...and the immensity of the task (if made clear) would burden nonprofits well out of proportion to any benefit that might result...Many of the key terms purporting to describe data to be assembled are so vague, undefined or ambiguous as to defy collection... As a result, the bill, if enacted, is likely to adversely impact the efforts of California charitable foundations in making, as well as the ability of worthy beneficiaries in receiving such grants.

Clearly, AB 624 was poorly drafted legislation and would have been highly intrusive and burdensome. In addition to the State Bar's NPO Committee, the bill was opposed by many philanthropic organizations and others who recognized that such an overreaching piece of legislation would impede charitable and grant-making activities. In light of the mounting opposition, the bill was eventually withdrawn. An agreement was also made between the Greenlining Institute and some of the large foundations to direct $30 million in grants to diverse communities and organizations. Nevertheless, the promoters of AB 624 have promised to pursue similar legislative efforts in other states, and this appears to have spurred Florida legislators on to take the proactive step of enacting SB 998. 

The "Nonprofit Sector and Community Solutions Act of 2010"

Representative Betty McCollum(D-MN) introduced the Nonprofit Sector and Community Solutions Act of 2010 (H.R. 5533) on Wednesday, June 16.  The bill has the support of several nonprofit advocacy groups, including the National Council of Nonprofits, Independent Sector and America Forward. The purpose of the Act is to research, report on and coordinate the federal government's interaction with nonprofit organizations. The Act promises to do so by facilitating better communication of the nonprofit sector with the federal government, better coordination between the government agencies, and enhanced data collection about nonprofit organizations.

The Act authorizes the creation of a bipartisan, 16-member “ U.S. Council on Nonprofit Organizations and Community Solutions” which would be tasked with considering the relationship between the federal government and nonprofits and making recommendations based upon its findings to the President and Congress. The Council would also be mandated to host an annual summit to inform Congress and the public on its solutions and progress.

The Act would also create the “Interagency Working Group on Nonprofit Organizations and the Federal Government,” to be composed of Cabinet Secretaries, White House officials, and the heads of agencies that interact with nonprofits. The Working Group would convene and engage a coordinated process to achieve better outcomes in addressing federal priorities on national and community challenges.

Finally, the Act authorizes the Department of Commerce to coordinate data collection on nonprofits and the National Science Foundation to engage research on nonprofit organizations.

Part of the rationale for the Act to move the federal government towards an agency for nonprofits analogous to the Small Business Administration. The bill's authors lament that "no Federal agency has responsibility for evaluating, building, or maintaining the capacity of the nonprofit sector." Should there be one? Strikingly absent from the discussion is recognition of the substantial oversight and regulation of nonprofits that the IRS already does and which promises to increase under the new Form 990 and the Service's governance initiatives.

The nonprofit sector is enormously diverse. It is difficult to see how this proposal will lead to a more vibrant nonprofit community as a whole. Rather, it seems directed primarily at entrenching the relationship between the federal government and large nonprofit organizations. This is good for two groups: the federal government and large nonprofits. Perhaps it will also create more efficiencies in the delivery of goods and services to those who rely on these entities. Beyond that, I am skeptical that a large political and bureaucratic endeavor on the federal level offers much benefit to the sector as a whole.

IRS Cyber Assistant Program Delayed

The IRS has been developing a web-based software program called the Cyber Assistant. Honestly, it sounds cooler than it really is - that is, unless you are a 501(c)(3) geek like we are. In any case, this program is designed to help 501(c)(3) applicants file for exemption (Form 1023)as well as improve the quality and consistency of exemption applications.The program was scheduled to be rolled out this year, but the IRS recently announced that software testing has revealed some problems requiring correction prior to public launch, and so the release of the Cyber Assistant will be delayed beyond this calendar year. The IRS will continue to accept exemption applications using the existing processes and the current user fees will remain in effect for the 2010 calendar year.When the Cyber Assistant is released, the user fee will be reduced to $200 for applications filed using the program.

Exempt Organizations Need to File Form 990/990-EZ/990-N/990-PF by May 17

Most tax-exempt organizations must file an annual return or notice with the IRS. The Pension Protection Act of 2006 provided that if an organization does not file as required for three consecutive years, it automatically loses its tax-exempt status, effective the due date of the filing. The 2009 filing is the first year that the provision will come into effect. The due date for exempt organization returns is May 17th this year.

The IRS has posted new FAQs and an audio interview discussing the automatic revocation of tax-exempt status for failure to file. Also, the Urban Institute's National Center for Charitable Statistics has a searchable database available online to see if an organization is at risk of losing its tax-exempt status. This is a useful tool for checking to see if your organization needs to file a return.

IRS Report on College and Universities Released

The Internal Revenue Service has released an interim report summarizing responses to compliance questionnaires sent to 400 public and private colleges and universities in October 2008. The interim report contains preliminary information on the respondents’ organizational structures, demographics, exempt and unrelated business activities,endowments, executive compensation and governance practices. The survey divided the organizations into three categories: Small (under 5,000 students), Medium (5,000 to 14,999 students) and Large (15,000 or more students). The focus of the report is on UBIT, investments, and executive compensation.

Together with the recently released CBO report on arbitrage by exempt colleges and universities, there is good reason to think that the regulatory winds are blowing for the nonprofit higher education sector. There will likely be new legislation at some point affecting colleges and universities, if not the whole exempt sector, as a result of these reports. A similar IRS study of nonprofit hospitals was begun in 2006 and was directed at community benefit and compensation issues, and there was also a CBO report on tax arbitrage by nonprofit hospitals. The recently enacted of IRC 501(r) as part of the health insurance reform legislation requires that exempt hospitals conduct a community benefit assessment every three years and make fee assistance programs more accessible, among other things.

Tax Tips from the IRS about Exempt Organizations

As part of its series of Tax Tips for 2010 aimed at taxpayers, the IRS has issued a short list of tips on exempt organizations called Six Important Facts about Tax-Exempt Organizations (IRS Tax Tip 2010-29). These tips are directed at informing donors about exempt organizations. Here is the list:

1. Annual returns are made available to the public. 
2. Donor lists generally are not public information.
3. How to find tax-exempt organizations.
4. Which organizations may accept charitable contributions.
5. Requirement for organizations not able to accept deductible contributions. 
6. How to report inappropriate activities by an exempt organization.

The notice also includes links to IRS forms and publications that can assist donors in learning about the destructibility of their contributions and the organization to which they are donating.

California Use Tax Registration - Qualified Exempt Organizations Must Register

As part of the emergency budget legislation last year, the California legislature added section 6225 to the Revenue and Taxation Code.  This new law requires a "qualified purchaser" to register for reporting its use tax with the Board of Equalization (BOE) by April 15, 2010.  Under this section, “qualified purchaser” means a person that meets all of these conditions:

1. It is not required to hold a seller’s permit pursuant to this part.
2. It is not required to be registered pursuant to Section 6226 (a retailer)
3. It is not a holder of a use tax direct payment permit as described in Section 7051.3.
4. It receives at least one hundred thousand dollars ($100,000) in gross receipts from business operations per calendar year.

Exempt organizations are not excluded from this requirement. BOE staff have indicated that they will look to Form 990, Item G Gross receipts in the heading section to determine if an organization has the requisite gross receipts. Organizations, such as churches, that don't file Form 990 would still have to register and report if they meet the qualified purchaser conditions above.

Although the BOE has sent out notices and automatic registration letters, an organization that is a qualified purchaser but has not received notice from the BOE must still register by the April 15 deadline. Another area of concern is that the BOE is asking for past due use tax returns for 2007 and 2008 to be filed as well, along with penalties and interest. The compliance burden could be quite significant.

It is difficult to say how this will affect nonprofits, but they need to be aware of the issue. A series of answers to Frequently Asked Questions regarding the use tax registration requirement is available on the Board of Equalization's website.

SB 218 - CA Law Affecting State University and College Related Nonprofits Vetoed

SB 218 was a bill that would have amended the California Education and Government Codes to treat certain nonprofit auxiliary organizations, such as alumni groups, student associations, faculty organizations, and supporting organizations associated with the University of California (UC), the California State University (CSU), and the California Community Colleges (CCC), as state and local agencies under the California Public Records Act (CPRA), Government Code section 6250 et seq. The legislative intent was to reject court interpretation of state law regarding the application of CPRA to auxiliary organizations, in particular CSU Fresno Association, at issue in California State University, Fresno Assn., Inc. v. Superior Court (2001) 90 Cal.App.4th 810, which excluded these organizations from CPRA requirements.The bill was vetoed by the Governor because he felt it would "result in a loss of private donations and volunteer activities supporting California public institutions of higher education."