Recommendations and Emerging Tax Issues for the Not-for-Profit Organization

“Accountability is crucial to our sector. Charitable organizations are an indispensable part of American society, offering relief from disasters, nurturing our spiritual and creative aspirations, caring for vulnerable people, protections our natural and cultural heritage, and finding solutions to medical and scientific challenges. But they can fulfill these missions only by maintaining the trust of the public."

Recommendations for Not-for-Profit Organizations

Initially intended to be applicable only to for profit corporations, the spirit of the Sarbanes-Oxley Act of 2002 is quickly spreading to the not-for-profit industry. In June of 2005, the Panel on the Nonprofit Sector released its final report, “Strengthening Transparency, Governance, Accountability of Charitable Organizations”. In order to secure the role of the charitable organization in American life, the Panel outlined the responsibilities of the charitable community and the need for balanced government oversight. The recommendations include:

Certification of the Form 990 - The IRS should require the Organizations highest ranking officers to sign and certify the Form 990. The Board of a Charitable Organization should also review the Form 990.

Audit requirement - Congress should require all charitable organizations with at least $1 million or more in annual revenues to conduct an audit and attach audited financial statements to their Form 990 and those with annual revenues between $250,000 and $1 million to have their financial statements reviewed by an independent public accountant.

Separate Audit Committee - Every charitable organization that has its financial statements independently audited, should consider establishing a separate audit committee of the board. The Board of Directors should include individuals with some financial literacy.

Review of governing documents - Boards of Directors are encouraged to undertake a full review of their organizations’ governing documents and polices at least once every five years.

Compensation guidelines - Compensation to board members is discouraged and Congress should increase penalties on board members of charitable organizations who receive or approve excessive compensation. Compensation to executives, other “disqualified persons’ and to the five highest compensated employees should be disclosed within the financial statements. The full board of charitable organizations should approve any change in compensation of the CEO annually and in advance and review the organization’s full staff compensation program periodically.

 Travel expense policy - Charitable organizations that pay for or reimburse travel expenses of board members, officers, employees, consultants, volunteers, or other traveling to conduct the business of the organization, should establish and enforce polices that provide clear guidance on their travel rules. Whether the organization has a travel policy should be required to be disclosed on the organizations Form 990 and the IRS should provide information about travel costs that are not permitted or that should be reported as taxable income.

Conflict of Interest Policy - Each organization should develop and adopt a conflict of interest policy and this should be disclosed in the annual information return.

Donor Advised Funds – The Panel recommended stronger government oversight and increase penalties for misuse of donor-advised funds to make sure that they are used to further the organizations charitable objectives.

The above recommendations, while not currently authoritative, are a statement on the current environment in which we do business. It is important to ‘take stock’ of your organization, its goals and the polices and procedures in place to ensure that the Board of Directors, management and the organization as a whole are all held accountable.

Emerging Tax Issues for the Not-for-Profit Organization

Reportable Transactions - The American Jobs Creation Act of 2004 added substantial penalties (up to $200,000) that generally cannot be waived for failure to comply with the Treasury Regulations (§1.6011-4) reportable transaction provisions. In January of 2005, an announcement was released that stated a failure to file a required disclosure cannot be cured by filing an amended return. Due to the magnitude of an error under these provisions, it is critical that tax-exempt organizations are educated about the categories of reportable transactions contained within the regulations. The IRS created a website on which current reportable transactions are summarized. (www.irs.gov/businesses/coporations, click on Abusive Tax Shelters and Transactions).

Compensation Related Issues - Executive compensation at tax-exempt organizations that is deemed to be excessive can be subject to scrutiny by both the public and the IRS. The Tax-Exempt Compensation Enforcement Project was announced in August 2004 by the IRS in an effort to identify and curtail abuse by tax-exempt organizations that pay excessive compensation and benefits. It is important for organizations to ensure that they meet the IRS “rebuttable presumption of reasonableness”. This threshold can be achieved if the following requirements are met:

1) the compensation is approved by the Board of Directors, when no conflict of interests exists;

2) the Board of Directors must utilize comparable data when determining whether to approve the compensation; and

3) all actions by the Board of Directors surrounding the approval of the compensation must be documented.

While the majority of the impact of the American Jobs Creation Act was felt by the for-profit community, it has some effect on tax-exempt organizations including rules surrounding the ‘substantial risk of forfeiture’ and vesting dates in nonqualified deferred compensation plans. The rules under new IRC §409A may be more restrictive than what is current in place at your organization. Additionally the Act contains other operational and documentation requirements for nonqualified deferred compensation plans. Failure to satisfy these additional rules may result in imposition of penalty taxes in the amount of 20 percent of the compensation includible.

Electronic Filing Required for Exempt Organization Tax Returns - On January 11, 2005, the IRS released temporary and proposed regulations that require certain tax-exempt organizations to electronically file their annual information returns beginning in 2006. For tax year 2005 returns that are due in 2006, the regulations require that corporations with total assets of $50 million or more file their Forms 1120 and 1120S electronically. In addition, tax-exempt organizations with total assets of $100 million or more will be required to file their tax year 2005 Form 990 electronically.

Beginning in 2007, the electronic filing requirement will be expanded to include the tax year 2006 tax returns of corporations and tax-exempt organizations with $10 million or more in total assets. In addition, private foundations and charitable trusts will be required to electronically file their Form 990-PF electronically regardless of their asset size.