2005 Spring, 34. Practical Guide to Major Changes Now Under Discussion in the Nonprofit Sector.

Author:Bar Journal Author - Attorney Michael S. DeLucia(fn1)
 
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New Hampshire Bar Journal

2005.

2005 Spring, 34.

Practical Guide to Major Changes Now Under Discussion in the Nonprofit Sector

New Hampshire Bar Journal Volume 46, No. 1, Pg. 34 Spring 2005 Practical Guide to Major Changes Now Under Discussion in the Nonprofit Sector Bar Journal Author - Attorney Michael S. DeLucia(fn1)

". . . those who turn a blind eye to the problems in the charitable sector, or seek only a fig leaf of reform, potentially cause real long-term damage to nonprofits."

- Senator Charles Grassley

Chair, Senate Finance Committee

April 5, 2005

". . . the vast majority of America's 1.3 million charitable organizations are now, and have always been, responsible, ethical and accountable. . . "

- Diana Aviv, President

Independent Sector

April 5, 2005

INTRODUCTION

Major changes are now being proposed for governance and oversight of the charitable sector on the national level. If enacted, those changes will impact every New Hampshire charitable entity in significant ways. This article addresses the proposed changes, which include, among others, mandatory financial audits for larger charitable entities, mandatory certification of the Form 990 by senior executive officers of charitable entities, increased penalties on foundation managers engaged in self-dealing, and prohibitions of certain transactions of donor-advised funds.

This article is intended to alert New Hampshire attorneys who provide legal advice to charitable entities, to inform New Hampshire accounting firms that prepare audited financials statements for charitable organizations, and to educate New Hampshire citizens that serve on nonprofit governing boards. It should also be of use to New Hampshire citizens who seek reassurance on the integrity of the charitable sector.

This article draws from a variety of sources: (i) the testimony before the Senate Finance Committee on April 5, 2005;(fn2) (ii) the Interim Report (the "Report") that was prepared by the Panel on Nonprofits (the "Nonprofit Panel");(fn3) (iii) the work of the New Hampshire "Excellence in Governance Project;"(fn4) (iv) the discussions held at the New York University School of Law, led by Professor Harvey Dale;(fn5) and (v) the commentary by advocates within the charitable sector, including the National Center for Responsive Philanthropy (NCRP).

There are many divergent voices with profoundly differing perspectives on how the nonprofit sector should be regulated, on what specific reforms are needed to curb the documented abuses, and how to achieve good governance. There is, however, no consensus. On April 5, 2005, divergent visions and different roadmaps were placed before Senator Charles Grassley's Finance Committee. As a result of the Finance Committee's hearings in 2004 and 2005, there has been more intense discussion of "good governance" and "accountability" in the past 10 months than was seen in the prior 10 years, with unique and interesting suggestions being offered.(fn6) The Senate Finance Committee is expected to propose legislation later this year.

The purpose of this article is not to endorse any of the specific reforms being considered, but rather to present a brief snapshot of what the differing roadmaps and recommendations are at this mid-point in the national discussion. A second article will appear later to describe the final resolution, if indeed there is finality or consensus on these issues. Because this article is brief, interested readers are urged to access the full testimony, reports and commentary referenced in this article for a more complete picture.

I. THE PANEL ON THE NONPROFIT SECTOR

The Panel on Nonprofits (the "Panel") was organized in 2004 to propose recommendations for changes in the charitable sector to the U.S. Senate Finance Committee, which had held Committee hearings and had begun scrutiny of the sector. The Panel is composed of 24 leaders in the charitable sector and was supported by a coalition of some 500 charities and foundations.(fn9)

The Panel solicited suggestions from organizations throughout the United States,(fn10) posted its Interim Report on the internet and presented its findings to the Senate Finance Committee Chair Charles Grassley on March 1, 2005.11 The Panel should be congratulated on its willingness to wrestle with such complex issues in such a compressed period of time; and Diana Aviv, the President of Independent Sector, deserves special note for the energy and skills that she brought to the task.(fn12)

The Report is a two-sided coin. It contains recommendations that charities should voluntarily adopt to improve governance and recommendations for legislation that would, among other things, increase funding of the IRS. The Panel's goal is to ensure continued public trust in the sector. The Report contains approximately 24 recommendations; and a Final Report will deal with the most difficult issues.(fn13)

At the April 5th hearing, the Senate Finance Committee heard testimony on many issues, including abuses involving tax-exempt organizations. According to estimates, abuses in the nonprofit sector cost the U.S. Treasury some $15 billion per year in losses;(fn14) and that is of great interest to both the Senate Finance Committee and the Joint Committee on Taxation.(fn15) The website for the U.S. Senate Finance Committee addresses the tax consequences of charitable abuses, with statements by Senators Grassley (R-Iowa) and Baucus (D-Montana).(fn16)

It was neither Federal nor State regulators that crafted the proposed changes found in the Report.(fn17) On the contrary, it is leaders of the charitable sector who crafted the recommendations.(fn18) The fact that nonprofit organizations themselves have taken the lead of this "reform" movement is important. Leaders of the charitable sector are attempting to offer a coherent plan with specific ideas to increase transparency, improve governance, and strengthen government oversight.(fn19) In doing so, the Panel tried to strike the right balance "between a self-regulatory system for charitable organizations. . . and vigorous governmental oversight and enforcement."(fn20)

Impetus for Reform:

The Cabot Charitable Trust

The front-page revelations about the Cabot Trust in Massachusetts served as a wake-up call for reform.(fn7) Paul C. Cabot, Jr., a trustee, had taken excessive compensation from the Paul and Virginia Cabot Charitable Trust to make payments on homes in Florida and Massachusetts, on yacht club fees and golf club fees, and to pay for a lavish wedding (estimated cost: $200,000) for his daughter.(fn8) Although the Cabot Trust distributed less than $500,000 in charitable grants in 2001, Paul C. Cabot's trustee fees were $1,000,000 in 2000. In 2001, his fees were increased to $1.4 million. During a nine-year period, Paul Cabot took approximately $7.5 million in trustee fees from the Trust.

Jamie Katz, the Director of Charitable Trusts in Massachusetts, took enforcement action, forcing Cabot to disgorge approximately $4,000,000 in fees paid to him by the Trust. In addition to restitution, Cabot is also prohibited for life from playing any role with any Massachusetts charity. Since IRS regulations prohibit excessive compensation, Cabot may face additional scrutiny and penalties on the federal level.

A. Voluntary Steps

The Report encourages charities to adopt voluntarily the following recommendations. First, all charities should adopt conflicts of interest policies. (In 1997, the New Hampshire Legislature required that all charities adopt such policies.(fn21) See Attachments A and B to this article. ) Second, all charities should make certain that individuals with financial literacy skills are included on their governing boards. (In 1997, the New Hampshire Legislature required "diversity" on all nonprofit boards.(fn22)) Third, all charities should adopt policies and procedures to "encourage and protect whistleblowers." This last recommendation addresses the need to reassure staff members that there will not be retaliation against them for alerting senior officials in a charity to suspicions of wrongdoing within the organization.

B. Enforcement Steps

The Report recommends stronger disclosure rules and greater funding for the IRS. First, there is a recommendation that the chief executive officer of the charity (or a senior official) be required to certify that the Form 990 report is correct and complete. Second, there is a recommendation that electronic filing of the Form 990 be made mandatory.(fn23) Third, there is a requirement that all charities with revenue in excess of $2,000,000 have an independent audit conducted annually. (In New Hampshire, the Legislature required such independent audits for all charities with income in excess of $1,000,000, effective in 2004.(fn24)) Fourth, the Panel recommends that a charity's tax-exempt status be suspended if that charity fails to file its Form 990 with the IRS for two or more consecutive years (after notice from the IRS).

C. Detailed Provisions

1. Stronger Penalties.

The Panel recommends stronger enforcement where financial matters are concerned. These include recommendations (i) to "fully enforce existing financial penalties" for failure to file accurate returns and (ii) to "extend penalties imposed on preparers of personal and corporate tax returns for omissions or misrepresentations of information" on the forms filed by charitable entities. The Panel also advocates increasing the tax penalties on managers of foundations and others who...

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