The State of Nonprofit Governance “Law”

By Bruce R. Hopkins, EditorJune 22, 2012 | Print

(Originally published in the July 2012 issue of Bruce R. Hopkins Nonprofit Counsel, available electronically to subscribers on publication.)

ax Exempt and Government Entities Division (TE/GE) management continues to assert that the Division’s policy is not to dictate board composition and/or the adoption of various policies and procedures but to educate exempt organizations about nonprofit governance principles. But practices in the field continue to belie these statements. Thus, an organization was denied recognition of tax exemption, in part because it refused to expand its three-person board of directors, two of whom are related, to “place control in the hands of unrelated individuals.” This was found to be a violation of the private benefit doctrine (Priv. Ltr. Rul. 201218041). This is not the law, and the IRS continues to be wrong on the point. (A client in this position was heard to say: “What are we supposed to do? Fill the board with strangers and enemies?”)

Matters worsen. An organization seeking recognition of tax exemption failed to adopt bylaws and a conflict-of-interest policy. Despite absence of a formal requirement in the federal tax law for bylaws and this type of a policy, the IRS wrote that the fact that this organization did not have them is “problematic.” Moreover, the IRS added that the failure to adopt these documents shows that the entity “lack[s] the basic procedural safeguards necessary to prevent impermissible private benefits from flowing to your members” (Priv. Ltr. Rul. 201221022). The IRS is flat wrong in asserting that these documents are inherently “necessary” or will somehow function to prevent private benefit from occurring.

Moreover, in this ruling, the facts revealed that two of five board members are married to each other. (Not only that, but according to the ruling, these married couples “live with” each other.) This led the IRS to the conclusion that this is a “closely-related” [sic] governing body. (There is nothing inherently wrong with a closely related board; it certainly is not illegal.) Then, since the board may become compensated and will determine the amounts of compensation, this arrangement was pronounced a “conflict of interest,” which “leaves open the possibility” of private inurement. Presumably, anything is possible.

This organization was faulted for not establishing criteria to determine how compensation will be ascertained and to ensure that compensation does not exceed fair market value, the duties assigned to the individuals, and the hours they will devote to their duties.

Some of this may amount to good ideas, but it is absurd to claim these elements are required, as a matter of law, for acquisition of recognition of tax-exempt status.

This latter case, by the way, illustrates the arrogance of the IRS agents who take these positions. The ruling states that this issue of compensating the board in the absence of these procedures “was identified early in the process of developing your case, and you had ample time and opportunity to address it.” In other words, the IRS gave the organization “ample time” to expand its board and adopt the policies and procedures as a condition of exemption. The IRS agent found this unwillingness to capitulate to his or her demands “troubling.” So, here, recognition of exemption was not gained because of matters deemed “problematic” and “troubling,” not because of any law violations. Those are hardly standards on which a government agency should issue rulings. The IRS wrote, “The potential for private benefit clouds every aspect of your organization’s operations.” Not only is this an exaggeration, but it is not the law. The private benefit doctrine is implicated where there is wrongdoing; it is not to be invoked merely because some IRS representative perceives a potential for wrongdoing. [5.7(b), 20.11]

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