1. Current Nonprofit Tax, Corporate, and Compliance Issues
2017 NCHER Winter Legal Meeting
March 24, 2017
Janice M. Ryan
Venable LLP

2. Today’s Discussion Nonprofit Corporate Fundamentals and Trends
Sources and Hierarchy of Governing Rules
Board Roles and Responsibilities
Duty of Care
Duty of Loyalty
Duty of Obedience
Key Governance Policies
Tax-Exempt Status Fundamentals and Trends
Sources of Tax-exemption
501(c)(3) Fundamentals
Lobbying and Political Activities Restrictions

3. Nonprofit Corporate Fundamentals and Trends

4. What is a Nonprofit Organization?
Governed by state law (statutes and common law)
Nonprofit Corporation Laws
Unincorporated Association Laws
Non-distribution constraint is fundamental characteristic
Nonprofit status is not synonymous with tax-exempt status

5. Governance—State Nonprofit Corporation Law
State nonprofit corporation statutes set forth:
Requirements for maintaining corporate status
Rights and obligations of board
Rights and obligations of members, if any
Default provisions if not self-addressed
Internal affairs of a corporation are governed by the law of the state in which the corporation was formed
Registration as a “foreign corporation” may be required in other states where the corporation does business

6. Governance—Sources and Hierarchy of Rules
State Nonprofit Corporation Law
Articles of Incorporation
Bylaws
Policies & Procedures
Articles
Filed with the State
Include only the most basic provisions necessary to form a nonprofit corporation because cumbersome to change
Full legal name
Statement of purposes
Whether the entity will have members
Registered agent/office
Provision for disposition of assets on dissolution
Provisions limiting the activities of the organization to qualify for tax-exempt status
Bylaws
Internal governance document
Not required to be filed with State
But must be submitted to the IRS with the Form 990 when significant changes are made
Subordinate only to the articles of incorporation and state law
Usually more easily revised than articles of incorporation
Include core rules governing:
Organizational structure
Rights and obligations of participants in the structure
Essential procedures by which participants’ rights can be exercised
Policies
Board-approved policies supplement the core governance rules of the articles and bylaws in greater detail; set parameters governing operational matters or programs as needed
Subordinate to the bylaws, articles of incorporation, and state law
Most easily revised

7. Governance—Role of the Board of Directors
Board of directors is the ultimate decision-making body under state law
Board sets the mission and policy of the organization and exercises strategic direction and oversight, not day-to-day management
Delegation to officers, committees, or staff is permissible (and important!), but oversight is required
Boards generally are only allowed to act in a meeting or by unanimous written consent

8. Board Member Fiduciary Duties
Authority to govern the corporation comes with duties
State statutory and common law requires that corporate board members fulfill:
Fiduciary duty of care
Fiduciary duty of loyalty
Fiduciary duty of obedience

9. Fiduciary Duty of Care
Standard is that of “ordinary and reasonable care” – what would an ordinarily prudent director do in the same or similar circumstances?
Business judgment rule – bad decisions are more easily defended than ignorance
Courts will not view decisions from benefit of hindsight, but, rather, from the perspective of the directors making the decisions at that time (was it an informed, reasoned decision?)
Due diligence process matters most

10. Fiduciary Duty of Care Compliance with fiduciary duty of care:
Attend meetings
Review all materials provided to you in advance of meetings
Ask questions
Be familiar with the organization’s articles, bylaws, and policies and procedures
Maintain confidentiality of information and documents
Rely on experts when appropriate (but such reliance does not excuse willful ignorance)
Review all meeting minutes (particularly recorded votes) to ensure accuracy
Insist on legal/accounting/other expertise when necessary and appropriate

11. Fiduciary Duty of Loyalty
Duty of undivided allegiance to the corporation
Duty to avoid conflicts of interest (actual, potential and apparent)
Examples:
Business dealings with the corporation
Dealings with competitors
Corporate opportunities doctrine
Remedies:
Disclosure; recusal or resignation
Confidentiality

12. Fiduciary Duty of Loyalty
Compliance with fiduciary duty of loyalty:
Adhere to written conflict of interest policy
Disclose actual, apparent and potential conflicts of interest, both annually and as they arise during the year
Deliberate as a board or through a committee of the board to determine appropriate responses to and management of actual, apparent and potential conflicts of interest (conflicts policy process)

13. Fiduciary Duty of Obedience
Articles of incorporation, bylaws, and other governing documents and policies and procedures must be followed
Applicable laws and regulations must be followed
Be faithful to the organization’s mission

14. Governance Summary—Keys to Fulfilling Board Responsibilities
Meet and deliberate
Be prepared
Actively participate
Ask questions
Act in the best interest of the organization at all times
Provide strategic direction and oversight
Set direction, but delegate execution
Engage in strategic thinking and planning
Tend to the mission
Provide oversight and accountability

15. Governance Trends Form 990 Focus on Governance (2008)
Increased charitable sector enforcement and oversight by states
Charitable fundraising/consumer protection
Protection of charitable assets for public purposes
Legislation
California Nonprofit Integrity Act (2004)
Audit and audit committee requirements
Executive compensation review
New York Nonprofit Revitalization Act (2013)
Conflict of interest policy requirements
Whistleblower policy requirements
California—applies to domestic charitable organizations and foreign corporations doing business or holding property in California for charitable purposes
Audit: charitable organizations with annual revenues of more than $2 million must have an audit prepared by an "independent" certified public accountant using Generally Accepted Accounting Principles (“GAAP”). The audited financial statements must be made available to the public.
Audit Committee: the audit and any non-audit services provided by the auditing firm must be overseen by an audit committee. The audit committee cannot be combined with the finance committee. The chairperson of the audit committee cannot be a member of the finance committee, and the audit committee’s membership must not constitute more than half of the organization’s finance committee or include staff members, such as the president or chief executive officer and the treasurer or chief financial officer
Executive Comp: requires a nonprofit’s governing board or authorized board committee review and approve the compensation and benefits of the President or Treasurer, or any person holding functionally equivalent positions regardless of their title. The Board or Board Committee must determine that the compensation is just and reasonable.
New York—applies primarily to nonprofits incorporated in New York, though some of the financial and auditing provisions apply to nonprofits that are registered to conduct charitable solicitations in New York, regardless of where they are incorporated
Audit: Organizations with gross revenues greater than $500,000 must file annual financial statements accompanied by an independent certified public accountant’s audit report with an opinion that the financial statement and balance sheet fairly present the financial operations and position of the organization.
Audit Committee: Covered organizations must have a designated audit committee of the board comprised of independent directors responsible for retaining an independent auditor and reviewing the results of the audit. Alternatively, the delineated tasks must be performed by the independent directors on the board. Further. the audit committee of an organization with gross revenues in excess of $1,000,000 that is required to file an independent certified public accountant’s audit report with the Attorney General, is subject to more extensive duties relating to the audit, including reviewing the scope and planning of the audit with the auditor prior to commencement of the audit, discussing any significant disagreements between the auditor and management after the audit, and annually considering the performance and independence of the independent auditor.
Conflict of Interest Policy: must have one with specific statutory elements. Prior to the initial election of any director, and annually thereafter, directors must complete, sign, and submit a written statement identifying any potential conflict, as defined in the Act. The board or designated audit committee of the board must oversee the adoption, implementation of, and compliance with any conflict of interest policy if this function is not otherwise performed by another committee of the board consisting solely of independent directors
Whistleblower Policy: Nonprofits with 20 or more employees and annual revenue in the prior fiscal year in excess of $1,000,000 must institute a whistleblower protection policy. The whistleblower policy must protect from retaliation any director, officer, employee, or volunteer who in good faith reports an action or suspected action that is potentially illegal, fraudulent, or in violation of any adopted policy of the corporation. The policy must include procedures for reporting violations; a designated employee, officer, or director tasked with administering the policy and reporting to the audit committee or other committee of independent directors or, if there are no such committees, to the board; and a requirement that the policy is distributed to all directors, officers, employees, and volunteers.

16. IRS Form 990 and Governance
Questions Regarding Board and Management
Are minutes taken at board and board committee meetings?
Does the board receive a copy of Form 990 before filed?
Questions Regarding Governance Policies
Maintain a written conflict of interest policy
Maintain a compensation review policy—follow the procedures for the “rebuttable presumption”
Maintain a written whistleblower policy
Maintain a written document retention and destruction policy
Maintain a joint venture policy to govern transactions with taxable entities

17. Key Governance Policies
Conflict of interest policy
Why?
Facilitates tax compliance, according to IRS
Facilitates compliance with corporate duty of loyalty
Key elements are:
Defining a conflict
Defining who is covered
Creating a disclosure and resolution process
Annual disclosure of conflicts form
Form 990 asks in particular about annual disclosure of conflicts by directors, officers, and key employees

18. Key Governance Policies
Whistleblower policy
Sarbanes-Oxley has limited application to nonprofit organizations, but the whistleblower protection provisions do apply
Important to have a process for receiving, investigating, and resolving whistleblower claims
Document retention and destruction policy
Considered a best practice and asked about on the Form 990
Can help manage risks associated with not having records that are legally required to be retained or maintaining records that could have been destroyed or deleted

19. Key Governance Policies
Compensation policy
Excessive compensation=private inurement
IRS rebuttable presumption of reasonableness

20. Tax-Exempt Status Fundamentals and Trends

21. Sources of Tax Exemption
Federal Tax Exemption
Internal Revenue Code provides exemption from federal income tax to qualified nonprofit organizations
Recognition by IRS obtained through application (Form 1023)
State Tax Exemption
State statutes may provide exemption from state income or franchise tax, as well as state property, sales, and use taxes
May be conditioned upon recognition of federal tax exempt status but not always tied together or automatically granted—application to state revenue agency may be required

22. Section 501(c)(3) Tax-Exempt Status
Tax-exempt purpose—educational, scientific or charitable
Contributions tax-deductible by donors as charitable contributions (minus value of benefits received in return)
No “private inurement” or impermissible “private benefit”
No “substantial” lobbying
No political campaign activities
Taxation of unrelated business income (“UBIT”)

23. 501(c)(3) Lobbying and Political Activities—Basic Do’s and Don’ts
A 501(c)(3) may not
Support or oppose candidates for public office (absolute prohibition); or
Lobby on legislation in substantial part or, under Section 501(h), beyond a certain percentage of its expenditures
A 501(c)(3) may
Lobby on legislation within the Code’s lobbying limits
Conduct certain non-partisan, unbiased election-related activities
Get-out-the vote and voter registration drives
Legislative voting records, provided not limited campaign season
Candidate debates

24. Section 501(c)(3) Lobbying Rules
What is Lobbying?
Basic general concept—attempts to influence legislation at the federal, state, or local levels through direct or grassroots communications
Two options for measuring compliance with (c)(3) limitation on lobbying activities:
No substantial part test
501(h) expenditure test

25. Section 501(c)(3) Lobbying Rules
No substantial part test:
Vague, facts and circumstances test
Strict sanctions
revocation of exempt status
excise tax on organization and its managers (5% of lobbying expenditures)
501(h) expenditure test:
Lobbying activity measured solely by the amount of money spent on lobbying
Lobbying will not be considered “substantial” provided organization does not exceed expenditure cap
Clear definitions of lobbying and exclusions for specific activities
Must affirmatively elect to use by filing IRS Form 5768
Flexible sanctions
25% tax on amount spent over the cap
No tax penalties imposed on organization managers for exceeding the limits
Revocation of exempt status results only if the organization exceeds 150 percent of the cap over a 4-year consecutive averaging period

26. Section 501(c)(3) Lobbying Rules—501(h) Caps
NOTE: Grassroots lobbying expenditures limited to no more than 25%
of the total amount permitted for lobbying in a year.

27. Definition of “Lobbying” under 501(h) Election
Direct Lobbying: attempts to influence legislation through communications with covered officials that refer to specific legislation and reflect a point of view on the legislation
any member or employee of a legislative body
any government official or employee who may participate in the formulation of legislation
the public in a referendum, initiative or constitutional amendment
Grassroots Lobbying: attempts to influence the general public through communications that refer to specific legislation, reflect a point of view on the legislation, and include a “call to action”

28. Definition of “Lobbying” under 501(h) Election
Specific exclusions from the definition of lobbying:
Communications with members regarding specific legislation
Point of view okay
No call to action
Nonpartisan analysis, study, or research
Discussions of broad social and economic problems
Efforts to change regulations
Requests for technical advice
Conducting self-defense activity
Volunteer time
The excluded activities are not counted against a 501(h) electing organization’s annual lobbying expenditure cap

29. 501(c)(3) Lobbying Rules—Form 990 Reporting
Tax-exempt organizations report lobbying activities on Form 990, Schedule C
Effective compliance requires careful tracking of time and money spent on lobbying
Include allocable staff time and compensation, overhead, and administrative costs
Time and money spent on research, planning, drafting, reviewing, publishing, and mailing in support of lobbying is included

30. Lobbying Activities—Other Applicable Laws
Lobbying registration and reporting laws
Federal, state, and local
Different definitions of lobbying may apply (e.g., lobbying may include attempts to influence not just legislation but also executive branch activities)
Ethics laws for public officials and employees
Federal, state, local, and agency governing acceptance of gifts, etc.
Restrictions on use of federal funds

31. Tax-exempt Status Trends
IRS oversight capacity is limited
Streamlined determinations
Low audit rates
Tea Party scandal repercussions
Proposed repeal of “Johnson Amendment”
Tax reform may affect charitable deduction
Over $1 billion in budget cuts since 2010, and loss of thousands of employees, including in the exempt organizations division

32. Questions and Discussion
Janice M. Ryan, Esq.
Venable LLP
600 Massachusetts Avenue, NW
Washington, DC 20001 t
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