Delaware Valley GrantmakersJanuary 14, 2010

Abigail R. Mulligan

Good Governance for Nonprofits:IRS Rules, Guidance, and Best

Practices

Roadmap Overview of Attendees Governance Discussion: Events that have shaped the governance

discussion Sources of Governance

Legal SourcesLegal GuidancePeer Organization Practice Guidance

The IRS and GovernanceDiscussion: IRS’s entrance into the arenaACT Conclusions and Recommendations IRS Reports, Announcements and Speeches IRS Guidance: Life Cycle, Check Sheet, Forms, Training

MaterialsThemes Discussion: IRS’s place in Governance Discussion and its next

steps Other Guidance and Best Practices Final Comments Resources

Governance“The Exercise of authority and control over

an organization”IRS Governance Training Materials

ManagementEngagementAwareness SkillKnowledge Accountability

ControlsIndependence

Discussion: Events That Have Shaped the Governance Landscape Sarbanes Oxley Charitable Organization Scandals: Smithsonian, Red Cross,

American University, Stevens Board not engaged in setting strategic direction Not monitoring conflicts of interest Excess executive compensation

Pension Protection Act of 2006 Revised Form 1023 (2004) Revised Form 990 (2008) ACT Report (2008) Madoff and Other Ponzi Schemes Economic Downturn In what ways has your organization acted/reacted?

Create or rethink policies? Implement previously created policies? Create or rethink practices? Seek consultation of advisors: attorney, accountant, investment

advisor or otherwise?

Smithsonian Background

Smithsonian is a trust instrumentality of the U.S. that has a private endowment, but with approximately 2/3 of its operating revenues in FY 2008 originating from federal appropriations

Board of Regents 2007: Lawrence Small (Smithsonian Secretary) and Shelia Burke (Deputy

Secretary and COO) resign after compensation package of each draws Congressional attention

Issues Lax governance by Board of Regents Lack of transparency Excessive compensation of top executives Lack of internal controls

Reform Recommendations made Board of Regents adopts new set of governance practices to ensure

more active role in organization and in setting “direction” of Smithsonian Government Accountability Office recommends 4 reforms and Regents’

Governance Committee (an independent review committee chaired by Patty Stonesifer) recommends 42 reforms As of December 2009, Board of Regents has adopted 1 of 4 recommended GAO

reforms and 39 of Governance Committee reforms

Legal Sources of Governance State Corporate and Trust Law

Governing Instruments: Certificate of Incorporation and Bylaws Powers, duties and responsibilities of officers and directors Voting rights Election of officers and directors

Policies and Procedures Board Requirements

Size Term limits Meetings and notice thereof

Duties of Loyalty, Care, Obedience Business Judgment Rule Investment and Accounting Rules (UPMIFA, UPIA, etc.)

States Attorney General and Charity Officials of Individual States Stewards of charitable funds Regulate fundraising, registration and reporting Enforce nonprofit corporate and trust law

Legal Sources of Governance (cont.) Sarbanes-Oxley

Criminal liability for retaliation against whistleblowers reporting a federal offense

Criminal liability for destruction of records with intent to obstruct a federal investigation

IRS Code and RegulationsProhibition Against Self Dealing (Section 4941)

Financial transactions with disqualified person using foundation assets Investments Jeopardizing Charitable Purposes (Section 4944)

Certain asset investments subject to additional scrutiny: futures, oil and gas wells, puts, calls, and the like

Program-related investments as an exceptionTaxable Expenditure (Section 4945)

Application of charitable assets to non-charitable/impermissible useExcess Benefit/Private Inurement (Section 4958)

Organization provides an excess economic benefit to a person who is in a position to exercise substantial influence over its affairs (e.g., unreasonable compensation)

Other Sources of GovernanceAttorney General and State Charity

Regulator GuidanceIRS GuidancePeer Organization Guidance

Discussion: The IRS Enters the Governance ArenaIs the Charitable Organization Community

aware of the IRS’s entrance into the governance arena?

Is the IRS’s entrance into the governance arena appropriate?

What is the IRS’s role and extent of authority with respect to governance issues?

IRS Enters the Governance Discussion Background:

IRS believes good governance and tax compliance are linked and has set out to develop the objective data to prove its theory Examination Check Sheet Form 1023 Form 990

Collaboration with Guidestar to make 990s publicly available to promote transparency and accountability

Determination Stage (Form 1023) and development of Cyber Assistant Tool (due to go online presently)

ACT (TE/GE Advisory Committee) report on “The Appropriate Role of the Internal Revenue Service with Respect to Tax-Exempt Organization Good Governance Issues” (June 2008)

Discussion: Why isn’t compliance with the “law” enough? For organizations: good governance as tool to reduce risk of non-compliance (?) For IRS: IRS cannot delegate its duties to enforce conditions of tax-exemption to states

and to the sector itself Good governance derives from tax code?

The “key organizations and operating principles that the IRS has already articulated, and that find their origin in the Code. They are not expressly laid out in the Code…but the principles of governance that are of concern to the IRS should derive from the requirements for tax exemption, and should aid an organization in meeting them”

New Compliance Measures for the IRS Review of Organizations Unit Exempt Organizations Compliance Area

ACT Report: The Appropriate Role of the Internal Revenue Service with Respect to Tax-Exempt Organization Good Governance Issues Issued June 2008 by Advisory Committee on Tax Exempt and

Government Entities (ACT) Summary of Conclusions

Empirical evidence is lacking to support the effectiveness of specific governance measures

Exempt organizations are governed by boards, not the IRS IRS should continue to collaborate with tax-exempt

community on governance issuesSpecific governance measures should be mandated only in

rare circumstances IRS should explain relationship between tax compliance and

each practice it wishes to addressConsistent and fair treatment is critical Education is more appropriate than pressureGovernance inquiries should be made in a neutral mannerCompliance questions may be more appropriate than

governance questions IRS should acknowledge expressly when a practice is not

required

Remarks by Sarah Hall Ingram Commissioner Tax Exempt and Government Entities,

June 23, 2009: “Nonprofit Governance – The View from the IRS”

“The IRS has a clear obligation to see that the tax subsidy that the tax-exempt community enjoys – estimated by the Office of Management and Budget to be billions of dollars per year – is used properly, for the purposes and within the parameters the Congress has laid down.”

“adherence to principles of good governance is entirely consistent with both [charities’] task to accomplish…charitable objectives, and [the IRS’s], to see that the tax-exempt sector complies with the Code. …[G]ood governance helps advance these goals.”

Hall Ingram Remarks (continued)Meaning of “Good Governance” to the IRS:

The “key organizations and operating principles that the IRS has already articulated, and that find their origin in the Code. They are not expressly laid out in the Code…but the principles of governance that are of concern to the IRS should derive from the requirements for tax exemption, and should aid an organization in meeting them”

Internal Controls appropriate to the organizationElements of Good Governance

MissionEngaged, informed, independent boardProper use and safeguarding of assetsTransparency

IRS Guidance, Governance and Related Topics

“The IRS is dedicated to ensuring that charities operate exclusively for charitable purposes and use their assets to accomplish charitable ends. Good governance is important to increase the likelihood that organizations will comply with the tax law, protect their charitable assets and, thereby, best serve their charitable beneficiaries. …Current IRS positions on nonprofit governance are best reflected in the reporting required by the revised Form 990, effective beginning with 2008 tax years, and the governance and related topics components included in the Life Cycle.”http://www.irs.gov/charities/article/0,,id=178221,00.html

IRS Guidance on GovernancePublished on IRS’s Web site at

http://www.irs.gov/charities/article/0,,id=178221,00.html

Charitable Organization “Life Cycle”MissionOrganizational DocumentsGoverning BodyGovernance and Management PoliciesFinancial Statements and Form 990

ReportingTransparency and Accountability

Mission Statement“The Internal Revenue Service encourages charities to establish and review regularly the organization’s mission. A clearly articulated mission, adopted by the board of directors, serves to explain and popularize the charity’s purpose and guide its work. It also addresses why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.”

Organizational DocumentsOrganizational documents provide the

framework for governance and management

State law will dictate the form of the document (i.e., Trust Agreement, Articles of Incorporation, Bylaws, etc.)

IRS requires organizational documents to be submitted in connection with Form 1023

IRS requires reporting of significant changes on Form 990

Governing Body Why is IRS interested in the governing board?

IRS believes that an active and engaged board = tax compliance Board members bring knowledge, skill and enthusiasm and fulfill need:

accounting, finance, compensation, ethics, legal Composition and size of board should be appropriate to ensure:

Compliance with tax laws Safeguarding of charitable assets Furtherance of charitable purposes Relationship between board size and compliance:

Small boards may not represent sufficiently broad public interest and lack required skills or resources to govern effectively

Large boards may have difficulty making decisions Executive and advisory committees may be appropriate with large boards

Independence of Board Members Governing board should include independent members Board should not be dominated by employees or persons related by

family or business ties IRS reviews board composition to determine:

Representation of broad public interest Identify potential for transactions (leading to misuse of charitable funds) Power of independent board members or others to elect directors and

vote on key decisions Delegation of primary board responsibilities to outside management

company

Governance and Management PoliciesExecutive CompensationConflicts of InterestInvestmentsFundraisingDocumentation of Governance DecisionsDocument Retention and DestructionWhistleblower Claims

Executive CompensationReasonable compensationSelf-Dealing and Tax Expenditure Rules (private

foundations)Private Inurement (public charities)Rebuttable Presumption of Reasonableness under

IRC Section 4948 and Corresponding Treasury RegulationsApproved in advance by knowledgeable, conflict-free

authorized bodyComparables implemented in making the decisionBasis of determination contemporaneously documented

Executive Compensation continues to be a focal point in the IRS examination program

Conflicts of InterestDuty of Loyalty mandates a director to act in

interest of charity rather than in personal interestIRS strongly encourages adoption of and

adherence to Conflict of Interest Policy and provides sample policy at Appendix A of the Form 1023

Key provisions of Conflict of Interest Policy:Requirement that directors and staff act in interest

of charity without regard to personal interestProcedures for determining existence of potential

conflicts personal, financial, business affiliations

Course of Action when conflict is identifiedPeriodic Disclosure of Potential ConflictsRegular and consistent monitoring and

enforcement of conflict policyApplication of Policy(ies) to Board and Staff

Fundraising PolicyKnowledge of and adherence to federal and

state requirementsSolicitation materials are accurate, truthful

and candidReasonableness of costs encouragedInform public and donors with information

on fundraising costs and practices

DocumentationGoverning Body Minutes and Records:

contemporaneous documentation of meetings minutes and board actions

Document Retention and Destructions: written policy regarding standards for the integrity, retention and destruction of documents, including with respect to electronic files

Ethics and Whistleblower Policy Ethics Policy: Board should establish ethical

standards and ensure compliance and dissemination within charitable organization; Policy should describe behavior Board hopes to encourage and to discourageCode of Ethics should communicate and promote

culture of legal compliance and ethical integrityWhistleblower: Board encouraged to establish

policy aimed at effective handling of employee complaints and procedures for reporting of suspected improprieties, illegalities, misuse of charitable resources and inappropriate behavior

Financial Statements and Form 990 ReportingFinancial Statements

Directors as stewards of charity’s financial and other resources

Board (or authorized committee) should conduct periodic reviews of financial statements, auditor’s letters or finance and audit committee reports

Audited Financial Statements State law may impose audit requirements Grantor organizations may impose requirement upon grantees Federal fund recipients and Circular A-133 Audit IRS encourages but does not mandate audited financial statements

for organizations with substantial assets or revenueAudit Committee: may be appropriate to ensure

independence and competence of auditor, quality of audit, and independence and competence of key personnel on audit engagement team

Form 990Dissemination of draft 990 to governance body,

management officials, board or otherwise

Transparency and AccountabilityTransparency and accountability to constituents

attained by full and accurate disclosure of:MissionActivitiesFinanceGovernance

Forms 1023 and 990 must be available for public inspection

IRS encourages adoption and monitoring of procedures designed to ensure that Forms 1023, 990, annual reports, and financial statements are complete, accurate, posted on its public Web site and made available to the public upon requestForms 1023 and 990 inquire about the availability

of key organization documents

Governance Check SheetIn December 2009, the IRS released a check

sheet to be used by IRS exempt organizations examination agents to capture data about the governance practices and the related internal controls of organizations under Examination. 

The IRS anticipates that the data collected will be included in a long-term study to gain a better understanding of the intersection between governance practices and tax compliance.

Check Sheet can be found at: http://www.irs.gov/pub/irs-tege/governance_check_sheet.pdf

Guide Sheet (for completing check sheet) can be found at: http://www.irs.gov/pub/irs-tege/governance_guide_sheet.pdf

Check sheet will be used in connection with examination of public charities.

Governance Check Sheet: Issues CoveredGoverning Body and Management:

Mission statementBylaw information on board: composition, duties,

voting rights, qualificationsAvailability of Bylaws and Articles of IncorporationFrequency of board meetings

Compensation of Board Members, Trustees, key employeesIs compensation set by conflict of interest free,

authorized body of the organizationUse of comparability data in setting compensationContemporaneous documentation of

compensation determinations

Governance Check Sheet: Issues Covered (continued)Organizational Control

Family and business relationships among board members/trustees and other board members, trustees, officers, key employees

Effective control of the organization and whether concentrated among a few individuals

Conflict of InterestExistence of policyCoverage of recusals in policyAnnual Disclosure Adherence to policy

Governance Check Sheet: Issues Covered (continued)Financial Oversight

Procedures to assure that assets used in accordance with mission

Independent review of Form 990Reporting to the Board on financial activitiesDiscussion by the Board of financial activitiesPreparation of independent accountant’s reportPreparation of management letter by independent

accountantDocument Retention

Existence of document retention policyAdherence to document retention policyDocumentation of board meetings and retention of

such documentation

Form 1023 Governance MattersRevised June 2006Available at: http://www.irs.gov/pub/irs-pdf/f1023.pdf

(form); http://www.irs.gov/pub/irs-pdf/i1023.pdf (instructions)

Compensation ProvisionsCompensation of officers, directors, trusteesCompensation of 5 highest-paid employees (receiving

more than $50,000)Compensation of 5 highest-paid independent contractors

(receiving more than $50,000)Best Practices for Compensation Determination (toward

goal of preventing excess compensation): Conflict of Interest Policy followed in setting compensation Approval of compensation arrangements Written documentation of approved compensation arrangements Documentation of vote regarding compensation Use of comparables and documentation of use of comparables

Form 1023 Governance Matters Organizational Control/Relationships

Family and business relationships between board members/trustees and other board members, trustees, officers, key employees and independent contractors

Compensation and control: disclosure of compensation received by officers, directors, trustees, highest-compensated employees, and highest-compensated independent contractors from another organization related to applicant through “common control” (i.e., overlapping boards, majority ownership interest)

Purchase of goods, services, assets and leases, contracts and agreements between organization and directors, officers, trustees, key employees and independent contractors Fair market value Arm’s length negotiation

Conflict of Interest Policy “Although a conflict of interest policy is not required as a matter of tax law,

we encourage adoption of a substantive conflict of interest policy because it makes it more likely that you will operate for the benefit of the community and not for private interests.” (Form 1023, Instructions)

Sample Policy available in Appendix A to Instructions Procedures for Addressing Conflict Situation Annual Disclosure and Acknowledgement Form Periodic Review of Compensation, furtherance of charitable purposes and financial

decisions/arrangements

Form 990 Governance Matters Revised 2008 Part VI: Governance, Management and Disclosure Instructions to Form 990: Even though governance, management, and

disclosure policies and procedures generally are not required under the Internal Revenue Code, the IRS considers such policies and procedures to generally improve tax compliance. The absence of appropriate policies and procedures may lead to opportunities for excess benefit transactions, inurement, or other activities inconsistent with exempt status. Whether a particular policy, procedure, or practice should be adopted by an organization may depend on the organization’s size, type, and culture. Accordingly, it is important that each organization consider the governance policies and practices that are most appropriate for that organization in assuring sound operations and compliance with tax law.

Governing Body Composition Independence Family and business relationships among board members Membership of organization and control thereof over board elections,

decisions Documentation of board and committee meetings

Form 990 Governance Matters Policies

Conflict of Interest Policy Existence Annual disclosure statement Compliance procedures

Whistleblower Policy Document Retention and Destruction Policy Compensation Policy Joint Venture Policy

Disclosure Availability of Form 990 for public inspection Availability of governing documents, financial statements, and

policies for public inspection Compensation of officers, directors, trustees, key employees,

five highest paid employees ($100,000+), five highest paid independent contractors ($100,000+) and former officers, directors, trustees, key employees and highly compensated employees

IRS Training Materials-Governance Prepared in May 2009 by IRS for Exempt

Organization examination agents, determinations specialists, tax law specialists and managers

Provides overview of IRS positions on governance issues, background and history of IRS involvement in governance debate

Reviews IRS areas of interest: Board: active and engaged; appropriate size;

independence, knowledge, and skill of directorsDocumentation of actionsPolicies and practices: conflicts, whistleblower,

document retention and destruction, compensation, and investments

Themes that Emerge from IRS Governance Materials and GuidanceTax Compliance and Good Governance are connectedThe IRS has no intention of walking away from

governanceThe IRS wants the nonprofit community to succeedOne size does not fit allTransparency of policies, practices, goals, finances,

etc.The IRS cannot mandate most governance practicesThe IRS can recommend governance practices and

will seek explanation when governance practices are either not implemented or not followed

The IRS is continuing to develop its information and material on governance issues

This is only the beginning of the IRS’s interest in governance issues

DiscussionDoes the IRS belong in the governance

discussion?Should governance be confined to State

Law?Do states exercise adequate control over and

provide sufficient guidance to charitable organizations?

What limits, if any, should be placed on the IRS in the governance discussion?

Other Guidance Panel on Nonprofit Sector

Convened in 2004 at urging of U.S. Senate Finance Committee

Promulgated 33 “Principles for Good Governance and Ethical Practice” in October 2007Legal Compliance and Public DisclosureEffective GovernanceStrong Financial OversightResponsible Fundraising

Issued “The Principles Workbook” in 2009Provide sector-wide guidance on governance

principles as means of supporting self regulationIndependent SectorState Attorney Generals

Other Policies Promoting Good Governances and Best PracticesFundraising and Grant-making

Pre-grant Due DiligenceGift Acceptance PolicyInternational Grants, Activities, Investments

Anti-terrorism guidelines (U.S. Department of Treasury Voluntary Best Practices)

ConfidentialityPolicies Applicable to Employees

Memorialized in employee handbook

DiscussionWhat’s Next for the IRS, the Senate Finance

CommitteeGovernance Enforcement?Private Foundation Rules Reform?

Jeopardy Investment RulesExcise Tax Rules

DAFs?Supporting Organizations?Endowment Funds?Venture Philanthropy Funds? Low-Profit Limited Liability Companies?

Resources IRS Charitable Organization Web sites

www.irs.gov/charities; www.stayexempt.org (online workshop)

Form 1023 and Instructions http://www.irs.gov/pub/irs-pdf/f1023.pdf; http://www.irs.gov/pub/irs-pdf/i1023.pdf

Form 990 and Instructions http://www.irs.gov/pub/irs-pdf/f990.pdf ; http://www.irs.gov/pub/irs-pdf/i990.pdf

Examination Governance Check Sheet and Instructions http://www.irs.gov/charities/article/0,,id=216068,00.html

IRS Remarks on Governance (Speeches and Testimony) http://www.irs.gov/charities/content/0,,id=184547,00.html

IRS Governance Training Materials http://www.irs.gov/charities/article/0,,id=208454,00.html

IRS Guidance, Governance and Related Topics http://www.irs.gov/charities/article/0,,id=178221,00.html http://www.irs.gov/pub/irs-tege/governance_practices.pdf

Resources (cont.)Panel on the Nonprofit Sector

www.nonprofitpanel.org Principles for Good Governance and Ethical Practice

Independent Sector www.independentsector.org

Council on Foundationswww.cof.orgConflict of Interest Policy: articles, samples and

analysisBoard Source

http://www.boardsource.org2007 survey of nonprofit practices and policies

http://www.boardsource.org/clientfiles/sarbanes-oxley.pdf The Sarbanes-Oxley Act and the Implications for Nonprofit

Organizations

Resources (cont.)Governance Matters!

www.governancematters.orgSmithsonian

GAO Report, December 2009 www.gao.gov/new.items/d10297t.pdf

Attorney Jack Siegel’s Web site on Charitable Governancewww.charitygovernance.com

Provides links to news articles on governanceSenator Grassley

http://grassley.senate.gov/ Provides Grassley’s public comments on governance

mattersNew York State Attorney General: “Right from the

Start, Responsibilities of Directors and Responsibilities of Not-for-Profit Corporationswww.oag.state.ny.us/bureaus/charities/about.html