The Shifting Landscape for American Not-for-Profit Organizations

Governance Is Key Issue in Regulating Charities, IRS Official Tells State Leaders

The International Journal
of Not-for-Profit Law

Volume 10, Issue 1, December 2007

Grant Williams1

A top official of the Internal Revenue Service says the tax agency is sticking with its plan to ask charities a series of questions about their management and governance policies and practices on the IRS’s new version of its Form 990 informational tax return, the primary tax document charities file each year.

“Some folks would argue that we have gone beyond where we should be going” with such questions, Lois G. Lerner, director of the Exempt Organizations Division of the IRS, told the annual meeting in Denver of the National Association of State Charity Officials on October 15.

“We disagree; we think that governance is a very big part of accountability,” said Ms. Lerner. “There is some argument that this is only the purview of the states. The IRS believes it is your purview but it is also of interest to us.”

The Internal Revenue Service in June released a new draft version of its Form 990 and is attempting to finish its overhaul of the form by the end of the year so that a final version can be used by charities by the beginning of 2009.

In Part III of the draft form, the IRS asks such new questions as:

  • “Does the organization have a written conflict of interest policy? If Yes, how many transactions did the organization review under this policy and related procedures during the year?”
  • “Does the organization have a written whistleblower policy?”
  • “Does the organization have an audit committee?”

Ms. Lerner said governance policies are one factor that figure into “risk models” that the IRS uses to help decide “which organizations we should use our scarce resources on” when selecting charities for review.

“The IRS has been involved in governance for a long time,” Ms. Lerner said. “When you talk about charities operating in a charitable manner, you are talking about governance.”

How Is Compensation Set?

Ms. Lerner referred to a law enacted in 1996, in Section 4958 of the Internal Revenue Code, that gives the IRS the authority to fine charity officials for receiving salaries and other benefits that are deemed excessive, as well as to penalize trustees who approve the compensation. The law is known as the intermediate-sanctions statute because it gives the government an alternative to revoking a charity’s tax-exempt status.

“When you talk about 4958 sanctions, you are talking about governance: How are people setting compensation, who is involved, are there conflicts going on?” said Ms. Lerner. “That is governance.”

To the regulators, Ms. Lerner added: “We just want to use governance as one piece of a larger picture of what we do when we are looking at organizations. We understand that the main purview of the states is the actual day-to-day governance of the organizations. We aren’t trying to take over your job, we’ve got a big enough one ourself.”

Ms. Lerner said the governance part of the final version of the new Form 990 would “clarify whether the requested information pertains to policies that are legally required” or are simply “good practices” of well-run organizations.

Meaningful Questions

But taking such an approach will not be easy, said other people at the meeting. Jack B. Siegel, a Chicago lawyer who was the keynote speaker at the
conference of state regulators, said he believes “there are problems with formulating meaningful questions” about governance on the Form 990.

“I’m not necessarily opposed to having governance questions on the form,” he said. “As someone who looks at charities, that’s useful information.”

But Mr. Siegel said the IRS’s question about whether a charity has a conflict-of-interest policy “carries the implicit judgment that Yes is the right answer and you are bad if you answer No.”

Said Mr. Siegel: “There are going to be some organizations out there that are smart and say Yeah, we better answer Yes to that. So what are they going to do? They are going to on the Internet and grab one and throw it in the drawer and never look at it — but now they have one.”

Mr. Siegel said “at one point there was a suggestion that these questions were aspirational or educational” on the part of the IRS. “And I know you folks get into that business, too, and that’s fine,” he told the state regulators. “But you have to then decide what you are going to tell your auditors if you are the IRS and your staff regulators when they review these forms, so that what becomes an aspirational or an educational question does not become a rule of law.”

Accounting and Legal Expenses

Ms. Lerner said that the IRS has been informed by lawyers for some nonprofit organizations that filling out the new form and its attachments “is going to cause a significant increase in the accounting fees — the preparation — depending upon the organization. Some are estimating a 50- to 200-percent increase.”

“I can’t speak to that,” Ms. Lerner continued. “I’ve heard that; I don’t know. But we do think about those things as we go through this, because remember one of our guiding principles in this form was reducing or at least keeping the burden the same.” Ms. Lerner said IRS officials “still believe that most organizations” will not face new steep costs.

In the end, Ms. Lerner said, the new Form 990 will be “much easier” for the IRS to change and update in future years than the current form has been.

“We do not believe that the form that is going to come out at the end of 2008 for the 2009 filing will be the form for the next 30 years,” she said. “We think it is a continuing, evolving form. So there will be some things that you will be unhappy with, there will be some things you will really like, there will be some things that we will learn don’t really work. We will be able to adjust it because we have designed it in a way that the cost factor will not be so great if we need to make incremental changes. And that’s a good thing because we’ve never been able to do that before, which is why [the current form] is such a mess.”

The new flexible form will allow the IRS to adjust quickly to any “flavor-of-the-month abuse that we will not have thought about” that some nonprofit organizations may engage in, said Ms. Lerner. “We want to be able to change the 990 quickly so that we can deal with that.”


1 From The Chronicle of Philanthropy, October 16, 2007. Reprinted with permission.