Non-Profit Legal Matters

The Blog of the Law Firm for Non-Profits®

Current Challenges in the Nonprofit Sector

Nonprofit organizations in the United States constantly struggle with operational and financial challenges. Speculation about the common challenges faced by our nation’s nonprofits is abound, but what do the concrete statistics say? The BDO Institute for Nonprofit Excellence recently released a report from its survey of 105 nonprofits that reveals the current challenges nonprofits are facing. What did the report find?

One of the biggest challenges nonprofits face right now is the inability to adequately compensate staff. This problem is not new. In fact, in 2016, many nonprofits opposed new federal overtime pay rules, claiming that they could not properly function if they had to pay staff overtime. Nonprofits that cannot adequately pay staff struggle with recruiting and retention. According to the BDO report, nonprofits are using flexible work options as a solution to the problem. Many of the nonprofits surveyed are either currently offering, or expect in the next two years to offer, flexible work options to employees like part-time arrangements, telecommuting and remote work opportunities. These flexible options allow nonprofits to bring on and retain staff in a less costly manner.

Another concern in the BDO report was demand for information made by funders. Over half of the organizations surveyed reported that some of their funders required additional information during the most recent reporting cycle. Organizations whose funders want to see information on the impact of programs and activities may be under pressure to develop new ways to measure and report outcomes.

Nonprofits also reported apprehension about raising funds and fear of losing a main revenue source. As with employee compensation issues, financial concerns are not new to nonprofits. In a 2013 report, the Urban Institute surveyed over 4,000 nonprofits and found that they struggled with financial issues such as delays in payment for contracts and difficulty securing funding for the full cost of their services.

However, the results of the BDO report showed that 70 percent of the same organizations that reported being apprehensive about funding and fearful about revenue sources experienced a growth in revenue during their last fiscal year. Does that mean their financial fears are unfounded? Only time will tell.

As the Nonprofit Quarterly noted, more studies are needed to answer the questions that were raised by the BDO s report. Nonprofits should always monitor current statistics and keep an eye out for these types of studies. By comparing data from other nonprofits, organizations can see how they are doing in key areas and learn how to improve.

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Data Breaches at Nonprofits

Everyone hears about data breaches hitting large companies like Yahoo!, Home Depot, Anthem, Sony, and Target. Nonprofit organizations also have crippling data breaches.

Earlier this year, a small nonprofit in Indiana fell prey to hackers, reports KQED. The organization is Little Red Door, whose mission is to reduce the financial and emotional burdens of cancer and promote cancer prevention. According to KQED, hackers got into the nonprofit’s server because a staff member accidentally downloaded malware. The hackers demanded $43,000 in exchange for return of the client files and financial data they had stolen. When the organization refused to pay, the hackers posted on Twitter private letters that the organization sent to grieving families who lost a loved one to cancer. Also, as a result of losing all of its files, the organization lost funding because it did not have the information it needed to apply for grants.

The Little Red Door’s story could happen to any nonprofit, no matter how large or small. According to the Privacy Rights Clearinghouse’s data breach database, 110 nonprofits in the United States have reported data breaches to state authorities since 2005. These reported incidents exposed data like employee, client, and donor names, addresses, social security numbers and credit information. This number only accounts for reported data breaches in states, like California, where organizations are required to notify their Attorneys General upon discovery of a breach.

110 data breaches since 2005 may seem like a small number. However, other statistics indicate that nonprofit data breaches are much more common. A 2016 survey reports that a whopping 63% of nonprofit organizations (which equates to about a million organizations) suffered a data breach within the one year period covered by the survey. These data breaches involved hacking, physical breaches like theft of devices or stolen files, a vendor or other third party being breached, or inadvertent errors like accidentally emailing confidential information to the wrong person.

Of these types of data breaches, the California Attorney General reported that malware and hacking present the biggest threat to our personal data. This is certainly true for nonprofits. As demonstrated by the Little Red Door, a hacking incident can leave a nonprofit organization unable to function and obtain funding.

To prevent such an incident, nonprofits should take steps to protect the information they collect and store. The first step is to understand all of the sensitive and confidential data in the organization’s files. Then, the organization may take steps to secure and protect its data and to have a remediation plan in place in case a data breach occurs. This work should be undertaken by a well-qualified cyber-security consultant.

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Protecting the Public from Charity Scams

Beware of charity scams. Do your homework before donating. Those are the warnings issued to the public by CNBC in a recent report about fraudulent nonprofits.

The CNBC report focused on an unprecedented enforcement action in 2015. The Federal Trade Commission, along with all 50 states and other law enforcement authorities, filed a complaint against four cancer support nonprofits (Breast Cancer Society, Cancer Fund of America, Cancer Support Services, and Children’s Cancer Fund of America) and their executives. According to the complaint, the organizations raised $187 million from donors on the premise that the money would support cancer patients. In reality, the organizations spent the money on their employees, employees’ families and friends, and fundraisers. The organizations falsified information on public financial statements. The scheme went on for years.

Since the case was filed, the charities have been dissolved. The executives have been banned from fundraising and charity management. Judgments ranging from $30 million to $75 million have been imposed against the executives and the charities. It is clear from the CNBC report that members of the public are being told to research charities and look at organizations’ financial statements before donating. If organizations report false financial data, like the four cancer charities, then members of the public can’t really do their research.

Should the onus be on the public to ensure charities are legitimate? How come it took regulators so long to go after the cancer charities?

Some were disappointed in the Internal Revenue Service for not prosecuting the fraudulent cancer charities. Others predicted that state regulators may begin looking at fraudulent charities more closely. Nonprofit leaders used the case as a wake-up call, reminding charities to follow ethics principles.

Not all nonprofits heard the call. Politico recently published an extensive portrait of a cancer research charity that has raised legal questions over intimate ties with its founder’s for-profit entities.

Also in the news are Trump lawyer Jay Sekulow’s organizations, Christian Advocates Serving Evangelism and the American Center for Legal Justice. According to The Guardian, the nonprofits made many unusual seven-figure payments to Sekulow’s company, law firm, and family members for various services and compensation. One of the organizations reportedly used aggressive tactics to get donations from retirees on fixed incomes. Then, the organization paid Sekulow and his family members tens of millions of the donated dollars. “That kind of money is practically unheard of in the nonprofit world, and these kinds of transactions I could never justify,” said Arthur Rieman, managing attorney at The Law Firm for Nonprofits, quoted in The Guardian article. “I can’t imagine this situation being acceptable.”

As regulators do not announce their investigations, it is not known if any have gone after these organizations.

Perhaps new California Attorney General Xavier Becerra will look at the organizations in the Politico and The Guardian articles. Becerra has made it clear he will be cracking down on law-breaking charities. Whether both national and state regulators will band together again, as they did in the cancer charities case, to go after fraudulent nonprofits is unknown. Without sufficient regulatory oversight, however, the public will not be protected from charity scams.

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California’s Crackdown on Nonprofits

Nonprofits should take note that there is a new sheriff in town. California Attorney General Xavier Becerra is cracking down on nonprofits that are breaking the law.

Becerra’s public statements indicate that he will bring stronger enforcement against charities. So far, he has. Since Becerra became Attorney General, the State of California has initiated litigation against two nonprofits alleged to be engaging in illegal acts. The Law Firm for Non-Profits has also seen an increase in audits of charities.

As Attorney General, Becerra has sweeping authority to enforce rules against nonprofits that are breaking the law. During a press conference on his 100th day in office, Becerra said that he is enforcing the law against organizations falsely claiming to be supporting veterans.

Becerra was presumably referring to a recent lawsuit brought by the State of California against two nonprofits run by one family. One of the nonprofits, the Wounded Warrior Support Group, was formed to support wounded veterans and their families. The other organization, Central Coast Equine Rescue and Retirement, claims to rescue abused and neglected horses. The lawsuit claims that neither organization did anything to support those causes. According to the complaint, the officers and directors of the organizations used illegal raffles to raise funds and then spent the money on themselves at restaurants, Victoria’s Secret, Nordstrom, and Macy’s.

The Attorney General names the two nonprofits and their officers and directors as defendants. Among the litany of allegations in the Attorney General’s complaint are claims of mismanagement, misapplication of charitable assets, fraudulent abuse of corporate powers, persistent breach of fiduciary duties, and failure to carry out the charitable purposes of the organizations.

The State of California is seeking to remove the officers and directors of the two organizations, dissolve the two organizations, and recover hundreds of thousands of dollars.

Also in Becerra’s cross-hairs: political nonprofit organizations that use “benevolent” names to lure in donors who do not realize their funds are going to support undisclosed political agendas. According to the AP, Becerra plans to go after such organizations, stating, “The last thing I think most people want to find out is that all these groups that are getting tax breaks because they are not-for-profit are actually going out there and influencing our political system.”

If the lawsuit and Becerra’s public statements about political nonprofits are any indication, there is reason to believe that Becerra will be tough on all nonprofits. Indeed, nonprofits engaging in any kind of deceptive or illegal behavior (including self-dealing) should not expect to slip through the cracks in California.

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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 Johnson, author fo the Johnson Amendment

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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