Non-Profit Legal Matters

The Blog of the Law Firm for Non-Profits®

Seven-Figure Salaries at Nonprofits

Executive compensation at nonprofits is on the rise, according to a recent article by the Wall Street Journal. New data from the IRS shows that the number of seven-figure salaries at charities tripled between 2011 and 2014. The organizations that are paying their employees in the millions range from major hospitals and universities to small online ministries.

So why are salaries rising? Many charitable nonprofits struggle to bring in and retain executives who can help the organization navigate complex challenges. Offering more money may attract much needed talent to these organizations. Some experts say that compensation packages at nonprofits are beginning to mirror corporate CEO contracts. These packages can include bonuses and deferred-compensation arrangements.

When boards do their due diligence, such compensation often can be justified. However, there also are greedy nonprofit executives who abuse their authority to demand large compensation packages from their unsophisticated boards.

Whether these corporate-style compensation packages are offered to bring in the talent that a nonprofit needs or the result of greedy executives, high paydays can come with consequences to the organization if the rules governing “excess benefit transactions” (and the laws of some states) are not followed.

Paying compensation that is not “reasonable” is a type of an excess benefit transaction. Compensation is considered reasonable if it is the amount that would ordinarily be paid for like services by like organizations under like circumstances. In other words, the nonprofit organization must look at what similar executives at similar organizations of a similar size in a similar geographic area are being paid. If an executive is getting paid much more than executives in similar situations, that is red flag that can trigger an IRS audit of a potential excess benefit transaction.

The executive, as well as board members, face potential tax penalties if these rules are not followed. If the IRS audits a 501(c)(3) organization and determines that executive compensation amounts to an excess benefit transaction, the executive may be liable for excise tax penalties up to 225% [sic] of the excess benefit. A nonprofit’s board members face a penalty of up to 10% of the excess benefit. Some states, such as California, also impose penalties on participants in excess benefit transactions.

A board that becomes aware of an excess benefit has a duty to try to “correct” it. Correction takes place when the overpaid executive returns the excess benefit to the nonprofit and otherwise restores it to the same position it would be in had the excess benefit transaction not occurred. That means the high-paid executives may be a position where they must pay back any compensation that is not considered reasonable in addition to tax penalties.

To avoid these pitfalls, nonprofit organizations’ board members and high-paid executives should take care to review all aspects of their compensation agreements. This includes obtaining salary comparisons and careful consideration by the board before its votes to approve six- and seven-figure deals.

For more information, contact the Law Firm for Non-Profits.

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The Non-Repeal of the Johnson Amendment

Lyndon Johnson

Lyndon Baines Johnson

Much brouhaha has been made over President Trump’s May 4 Executive Order claiming to “totally destroy” the Johnson Amendment. The Johnson Amendment is a 1954 law that bars 501(c)(3) organizations from supporting or opposing candidates for public office. As with much in politics, this is truly much ado about nothing. The Executive Order may serve the President’s political purposes, but at least in so far as the Johnson Amendment is concerned, it does nothing but create headlines.

Trump does not have the power to repeal the Johnson Amendment (only Congress does). The May 4 Executive Order, titled “Promoting Free Speech and Religious Liberty,” is touted as repealing the Johnson Amendment. It directs the Treasury Department (of which the IRS is a branch) to not take “adverse action” against tax-exempt religious organizations that campaign for politicians. The White House has previously said that Trump was planning to direct the IRS to “exercise maximum enforcement discretion” over laws regulating religious organizations. But the Order is mum on that point.

The Order has prompted much hype. However, the Order has no binding effect on the IRS. The Internal Revenue Code contains a prohibition on the executive branch influencing taxpayer audits and investigations. That means the IRS, by law, may not follow the Order.

Even if the Order had any legal effect, California law prohibits 501(c)(3) organization that are tax-exempt under the similar state law from supporting or opposing political candidates and engaging in more than insubstantial lobbying. Officials in California are likely to enforce restrictions on nonprofits. For example, California’s new Attorney General, Xavier Becerra plans to target political nonprofit organizations. Becerra says certain nonprofits mislead donors and influence campaigns. He intends to investigate big-spending nonprofits to make sure they are complying with California law.

So what would happen if the Order actually had any legal effect? Churches would become a loophole in campaign finance laws. They would be able to accept untold and unreported amounts of “dark money” to influence elections. As churches do not file information returns with the IRS like other nonprofits, secret donors would be able to pour money into churches without worrying about disclosure of their identities.

At least for now, despite all the hysteria, the valve of dark money has not been opened by Trump’s Order.

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Are Nonprofits “Follow the Money” Obsessed?

Are Nonprofit follow the money obsessed?Have the leaders of nonprofits been overly incentivized to “follow the money,” resulting in a troubling shift in the composition of boards? The answer is yes according to a recent article in the Stanford Social Innovation Review. The trend may be “distort[ing] organization priorities” and may “dilute charitable values.”

According to the author, Garry W. Jenkins, nonprofits board are becoming overly reliant on financial industry executives. Among organizations surveyed in New York, they comprise just under 40% of board members, and between 44% and 56% of board officers. Anecdotal experience suggests this trend, while perhaps not as pronounced elsewhere, is national.

“Boards and board governance are inevitably shaped by the identify and background of those who make up the boards themselves.” Thus, the large portion of financial industry executives on boards has at least two effects feared by the author. Groupthink is dangerously prevalent among nonprofits boards according to some. As The Board Book suggests, lack of “industry diversity” among a nonprofit’s board squashes discussion. By way of example, it holds that the best boards “take care that there is ample inclusion and weighty voices of” diverse values “to ensure that those values are woven into the guts of the institution.

Groupthink exacerbates another alleged ill effect, a board that increasingly incorporates “finance practices” into decision making. These include “data-driven decision-making, an emphasis on metrics, prioritizing impact and competition, managing with three- to five-year horizons and plans, and advocating executive style leadership . . .”

As one who advises hundreds of nonprofits annually and also sits on boards, I see both merits and problems with Prof. Jenkins’ concern. I am a firm advocate that entrepreneurial thinking has a place in almost every nonprofit, especially when it comes to good management technique. Notwithstanding, too much emphasis on entrepreneurship, especially when it translates to building earned revenue programs rather than good management practice, can result in a emphasis on earning and raising money. A focus on recruiting finance executives (because of the money they presumably will bring to the organization) both overtakes the charitable purpose of the organization and can even threatened exemption.

Many factors are constantly shaping and reshaping the nonprofit sector. If the trend Prof. Jenkins and others report on is real, should we be concerned? Share your thoughts.

What has been your experience as a nonprofit board member, advisor, or otherwise? Is there overrepresentation of finance executives on nonprofit boards. Is that bad or good? Does it depend? And has the emphasize of some boards shifted too much from mission in order to “follow the money”?

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Form 990 Due Friday!

IRS/Form 990Form 990 is due this Friday (May 15) for all nonprofits that have a January to December tax year (other than churches, which are not required to file). If your nonprofit is not able to file a version of Form 990 by Friday, be sure it files for an automatic three-month extension instead. Then be sure it files its Form 990 by the extended deadline.

Late filers can be penalized $100 per day until their returns are filed. Note that if you are a board member of a nonprofit that files late, in some states such as California you can be held personally liable for the late filing penalties! A nonprofit that fails to file Form 990, 990-EZ or 990-N three years in a row will have its tax-exemption automatically revoked.

Apply for Form 990 Extension

Extensions can be filed online at http://efile.form990.org/. A fillable version of the form can be downloaded from the IRS website.

Remember that Form 990 and extensions for calendar year organizations must be filed or postmarked by Friday May 15. If a hardcopy is submitted, be sure to use certified mail or FedEx or UPS overnight or 2nd day air. Your receipt is the only proof acceptable to the IRS that the organization filed its return or extension on a timely basis.

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990s to Get Greater Scrutiny

Ferret

IRS to Ferret Out Inconsistent and Error-Laden 990s

Late last month, the IRS announced enhanced electronic processing of Forms 990 that will result in their getting greater scrutiny to ferret out inconsistencies and missing information. According to IRS tax law specialist (and former Los Angeles-based colleague of The Law Firm for Non-Profits) Elaine Leichter, exempt organizations should fill out form 990 as completely as possible and according to the instructions in order to avoid being flagged by new automated processes that may result in an audit.

What is an organization to do to avoid having their 990 flagged? Simple – avoid inconsistencies. Also, filers are warned to not include or omit information the IRS can easily find on public websites.

The new scrutiny will apply to electronically filed 990s. However, Ms. Leichter assured filers that electronically filed returns will not automatically have a greater chance of being audited.

Given the IRS’ recent track record, do you trust the IRS to maintain a level playing field between paper and electronic returns? If your organization has filed an electronic return and been audited would love to know about it. Please add a comment telling us what happened.

Form 990 Filing Site Hacked

Form 990 Filing just got more complicated. The online service where 990s are filed electronically has recently been hacked.

The Urban Institute, which operates the online filing site for the annual returns nonprofits must file, announced that it “recently discovered that an unauthorized party or parties have gained access to the Form 990 Online and e-Postcard filing systems for nonprofit organizations.”

Form 990 Filing Site Hacked

On the FAQ pages of its website, it also noted that: “Based on current information, we believe no information from the filings themselves was compromised. These forms do not contain Social Security numbers or individual tax filer information, so such sensitive information was not available to the hackers.” The Urban Institute states that the information compromised was usernames, first and last names, email addresses, IP addresses, phone numbers, and passwords were accessed. Credit card and social security numbers were not obtained by the intruders.

Users of the system will be required to create a new password next time they log on. However, all users are urged to visit the website to create new passwords right away. Form 990 online filers can do so by clicking here. E-Postcard (990-N) filers can click here.

Many Form 990 and 990EZ filers must file online, as must all filers of the Electronic Postcard.

 

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IRS Targets Nonprofit Self-Declarers

It’s official. IRS targeting of nonprofit self-declarers will begin this year.

Most organizations that qualify for federal tax-exemption other than non-church 501(c)(3) charities do not need to apply for tax-exemption. Whereas may do, they can simply self-declare that they are tax-exempt.

When such nonprofit organizations complete their Forms 990 they need only identify their 501(c) category. That will change in 2015.

Last week the IRS announced that starting next year, self-declIRS Targets Nonprofit Self-Declarersared exempt organization will be required to check a box on their Form 990 that they are self-declared. While the IRS is coy about what it will do with this information, it is likely they will use is to target organizations for possible audits. This seems to be a follow-up to an IRS study commenced two years ago.

Is your nonprofit organization’s exemption self-declared? Do you think this new rule will result in more organizations applying for tax exemption instead of self-declari

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WATCH OUT! Phishing Remains a Threat for Taxpayers

phishingThe IRS is warning taxpayers to watch out for fake emails and websites trying to steal personal information that can be used to commit identify or financial theft. The IRS is listing this type of “phishing” scheme on its list of the top tax scams for the 2015 filing season, the typical time when scams peak as people prepare their returns.

IRS Commissioner John Koskinen explains that the “IRS won’t send you an email about a bill or refund out of the blue. Don’t click on one claiming to be from the IRS that takes you by surprise.” The IRS generally does not initiate contact with taxpayers by electronic communications, such as email, text message, or social media channels, to request personal or financial information.

If you receive an unsolicited email from the IRS, report it by sending it to phishing@irs.gov. Get more information about reporting phishing and other online scams here.

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For-Profit College Converts to 501(c)(3)

In recent years we’ve converted a university and other 501(c)(3)s into for-profit corporations. But is the trend now reversing? Last year, the Law Firm for Non-Profits helped a for-profit private school become a nonprofit. And at the beginning of 2015, Herzing University, one of Wisconsin’s oldest and largest for-profit career colleges, was converted to 501(c)(3) status.

Why is this occurring? In the case of Herzing, it appears to be a combination of economics and changes in the law. For example, the federal rules now require for-profit colleges to demonstrate that they are preparing students for “gainful employment.” This includes setting a cap on annual student loan payments to the colleges at 20% of the student’s discretionary income or 8% of their total earnings. Failing to keep to these caps may result in a college being ineligible for federally funded student aid. Such aid is crucial to the financial success of most for-profit colleges.

It could have also helped that students of 501(c)(3) colleges in Wisconsin are able to tap into state financial aid that is not available to for-profit schools in that state.

Does Herzing’s conversion herald a new trend? For-profit colleges currently enroll 13% of all U.S. college students and take in more than a quarter of federal aid – over $30 billion a year. Unless the new law is reversed (it’s been challenged by the Association of Private Sector Colleges), we believe it will.

In the meantime, if your nonprofit school or college is considering converting to or from nonprofit status, call on the Law Firm for Non-Profits to successfully guide you through this process.

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Telephone Townhall for Nonprofit Organizations

TownhallDo you have questions about the sales and use taxes that affect nonprofits organizations? Here is your chance to ask your questions directly to the California Board of Equalization.

On February 19, 2015 at 10AM, California Board of Equalization member George Runner and the California Association of Nonprofits are hosting a live telephone townhall titled “How Tax Laws Affect You.” The purpose of the townhall is to provide nonprofits with information about common tax concerns, including the sales and use tax issues that affect them. During the event, callers will have an opportunity to ask questions.

Get more information here and register online here. If you attend the townhall, let us know what you learn in the comments section below!

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