Part 2 - Noncompliant Activities: How to Make Sure You Stay on the Right Side of the Issue

Issues related to the governance of Non-Profits have intensified -- just as we anticipated 3 years ago.

However, our commitment to you is not focussed on the Past, but focussed on the Future. In this post, we will continue our discussion about regulatory expectations and your ability to keep your organization in a proactive mode.

Specifically, this post follows Part 1, where we examined the issues related to Executive Pay and the long-standing IRS regulations for documentation that supports decisions of the board.

So, what is a 'non-compliant' activity?

Let's start at the beginning...

When any non-profit applies for its tax exemption, the organization is required to specify the activities it plans to conduct and to make the case that their mission qualifies for charitable, tax-exempt status. Upon review, the IRS either grants or denies the application and issues its 'exemption letter'.

If your planned activity falls outside of the specified mission of your non-profit, then the activity may be non-compliant. Non-compliant? With what? Your IRS-approved exemption! How do you know, for sure, if your planned activity is within your compliance parameters? Easy...just ask! Who? The IRS (your regulatory reference)!

Please ponder the following hypothetical example: a local community Food Bank is deciding whether or not to purchase a national fast-food chain restaurant adjacent to its main food bank facility.

It sounds like a great idea when presented to the board for approval:

• the fast-food restaurant brings in lots of customers who would learn that the food bank is located right next door;


• the profitability of the restaurant could subsidize the operations of the food bank

Good idea? Bad idea? How would you vote if you were on the board?

This is a good example of the challenges of a non-profit board. Let's take this scenario a step further before we try to deal with the dilemma.

This Food Bank was organized 30 years ago and received its IRS approval as a charitable, tax-exempt organization serving the public good. The founding executive director (ED) led the organization for 20 years until he retired.

Following the retirement of the founding ED, the board conducted a search and hired a replacement ED. Unfortunately, their new ED left after just one year, accepting an opportunity at a larger food bank. Since that time, the organization has suffered rapid turnover among four EDs, but the board believes the tide has turned: the current ED is an experienced manager, who was looking for a career change, and is committed to remaining in this position for quite a few years.

The idea for the purchase of a fast-food restaurant took shape during a scheduled fund-raising call between the new 'out-of-the-box' ED and the owner of the fast-food chain. The owner, a former board member of the Food Bank, suggested the purchase as a mechanism for alleviating the ongoing financial challenges of the Food Bank and as part of his estate planning. The deal was a gracious opportunity; the owner would even provide the financing. To answer any questions, the owner offered to attend the board meeting with the ED.

Okay.

An opportunity presents itself: a former board member offers to be unbeliveably philanthropic and an excited ED presents the idea to the board at its regular meeting. You are a board member. You hear the presentation. The opportunity sounds great! What should the board do?

(We could spend quite a bit of time strategizing, but that is beyond the scope of this post.)

Question #1: Yes, you are a board member; however, are you qualified to analyze the deal and make an informed decision? Would you be willing to be that 'lone voice in the wilderness' that dares question the deal? Are you willing to admit your lack of knowledge?

Question #2: Did your ED research the language in your original IRS determination letter as a guide for what your scope of services can be? Did your ED consult with legal and accounting counsel?

Question #3: Are you familiar with 'unrelated business income' - whereby income-producing activities can result in taxable revenues (even for a non-profit)?

Question #4: Do you understand 'noncompliant activity'? Has your ED mentioned that issue in the board presentation?

Per usual, a lot is happening at this (hypothetical) non-profit board meeting. This seemingly good idea of purchasing a fast food restaurant is almost certainly outside the description of the activities of the food bank. The IRS could approve the deal; but, failing to request a definitive ruling would be irresponsible on the part of the board and could literally jeopardize the charitable status of the Food Bank.

A lot to worry about? Nope. Not really. Just remember to ask the right questions. If you do not know the right questions, you are probably on the wrong board.

NEXT: We will talk about the proper balance between contributions spent on charitable needs versus all other expenses of the organization.

Part 1 - Big Opportunity for Non-Profits: The Issue of Executive Pay

This blog post follows the previous "INTRODUCTION", whereby it is suggested that Non-Profit Organizations can distinguish themselves and gain a competitive fundraising advantage from their peers by proactively complying with the key issues of the Sarbanes-Oxley Act (SOX) to demonstrate organizational excellence.

While SOX does not (yet) apply to the Non-Profit Sector, the IRS has taken an aggressive position (in keeping with recommendations from the U.S. Senate Finance Committee - please see the "Introduction" post below) by enacting changes to its Form 990 (the annual filing by all Non-Profits) regulations.

Readers should remember that the IRS is tasked with (a) 'collecting taxes' from individuals, corporations, and other for-profit entities; but, (b) it is also tasked with 'regulating' the non-profit sector (in keeping with the determination issued by the IRS that the organization serves a charitable purpose and is, therefore, exempt from taxation).

Important point: as a Non-Profit, your regulatory agency is the IRS. (Remember that your grant applications require a copy of your 'IRS Determination Letter'?) And, most states now have non-profit regulatory requirements and annual filings as well.

Enough background.

On to the topic of this blog post: Executive Compensation.

In addition to being the #1 issue identified by Senate Finance, the determination of Executive Compensation for Non-Profits has previously required analysis, comparison, and justification for the pay rates and benefits of top executives (and independent contractors). As with most IRS compliance issues, documentation is advised.

So, can your non-profit organization justify its executive pay with studies, comparisons, and peer-benchmarking? Is that justification on file and ready for inspection?

If your organization does not have proper compensation documentation, it is already at risk, and will be at further risk with the implementation of the revised Form 990 requirements for Fiscal Year 2008 being filed in calendar year 2009.

Is the IRS 'boogey man' out to get your organization? Not at all. Provided you are in compliance. Or, as suggested by our organization (CGEA) you become proactive, document your compliance, or (better still) exceed both current and future compliance regulations. This approach will ensure you have (1) nothing to fear; and, importantly, (2) an opportunity for 'competitive advantage' in fundraising by demonstrating to donors that the Governance, Ethics, and Accountability regulations are of fundamental importance to the operation of your organization.

Remember, the point is to be proactive -- to go the extra mile -- to take seriously and truly demonstrate your understanding of the responsibility that comes with your charitable status as a non-profit.

Is the issue of Executive Compensation a problem? It does not have to be! Actually, it's quite an opportunity; especially for small non-profits, where compliance can be easily achieved if you take the time to do your homework.

Regulatory compliance offers a competitive advantage that is well worth your investment of time and energy. And, this is an opportunity for the Non-Profit Sector to demonstrate leadership in the aftermath of numerous scandals that have led to increased regulation in the for-profit, government, and non-profit sectors.

Please don't miss this opportunity.


NEXT: the challenges of 'non-compliant activities' will be explored...

INTRODUCTION - Big Opportunity for Non-Profits: Making the Case for Voluntary Self-Audits for Regulatory Compliance

Increasing scrutiny by the IRS among large non-profit organizations provides smaller non-profits with an opportunity to proactively model successful Governance, Ethics, and Accountability initiatives on a voluntary basis.

This blog post -- an Introduction -- will set the stage for a series of related blog posts in the coming days and weeks.

A bit of background will be helpful:

• Concerned about the lack of reporting and transparency among non-profits, the United States Senate Finance Committee began to look at revisions to non-profit reporting and regulation a number of years ago. The IRS Form 990 had not been revised in decades.

• Note that this review is relatively coincident with the enaction of the Sarbanes-Oxley Act on July 30, 2002. Commonly referred to as 'SOX', this legislation followed the corporate scandals involving Enron and others.

• The Finance Staff Discussion Draft was released on June 21, 2004. The Committee heard testimony from a number of non-profits prior to the Draft and again after its release.

• The Committee issued a press released on June 14, 2007 announcing the intention of the IRS to amend its Form 990. The amended Form 990 is scheduled to take effect in 2009 for fiscal years ending in 2008.

• On May 29, 2007, the Committee Chair and its Ranking Member co-signed a letter to the Secretary of the Treasury Department requesting that particular attention be paid to the operational complexities of non-profit hospitals and universities and the critical need of greater reporting and transparency among non-profits.

• That same letter outlined seven specific areas of concern: (1) Executive Pay; (2) Endowments; (3) Related Organizations; (4) Joint Ventures; (5) Governance; (6) Dollars Raised vs. Dollars for Charity; and (7) Hospitals.

The question that must be answered is clear: can the non-profits, particularly the small to medium ones, adopt self-audits and regulatory oversight before (and if) Congress decides to include non-profits in the SOX regulations?

Maybe the better question is: why would the small to medium non-profit NOT be proactive in its attempt to avoid costly regulatory oversight?

Since the enactment of SOX in 2002 for ALL publicly traded companies (large and small), much concern has been expressed by the small for-profit firms about the costs of compliance with SOX while, arguably, the large companies have been able to absorb the additional compliance costs more easily.

I would suggest that this dilemma can and should be avoided by the non-profit sector; excepting, however, that it seems clear that the hospitals and universities are so large and complex that they will not likely be off the radar screen in the near future.

I will continue the discussion on this issue in the days to come. In the meantime, please feel free to participate. Let us know how you feel. The purpose of our Center is to give the Non-Profit Sector a competitive advantage, so your thoughtful feedback is invited.