Sweeping Legislative Changes for Nonprofits Move Closer to Reality
Leadership of nonprofit, tax-exempt organizations should take particular notice of the tenor of many of the comments of those testifying on April 5, 2005 at the Senate Finance Committee Hearing on oversight of charities. Common themes expressed included the lack of effective enforcement vehicles available to the IRS to police tax-exempt organizations; perceived lax oversight exercised by governing boards of nonprofit organizations; concerns with respect to excessive compensation paid to executives of tax-exempt organizations; deficiencies in Form 990 reporting by tax-exempt organizations; and perceived excess in travel, entertainment and other related expenses of tax exempt organizations. The nonprofit health care industry received specific criticism at the hearings.
IRS Rebuttable Presumption
With the unmistakable focus of the IRS on executive compensation arrangements, charity leadership can expect to be both perplexed and chagrined by several requests by the witnesses to eliminate the "rebuttable presumption of reasonableness" under the IRS' intermediate sanctions rules. Since its adoption, this IRS “safe harbor” has afforded charities a meaningful way to review permissible arrangements with "insiders" if specific safeguards concerning transparency, arms-length dealing and fair market value/reasonableness have been satisfied. Testimony submitted by the Chief of Staff of the Joint Committee on Taxation suggested that the safe harbor provides charities with a procedural advantage on a matter that is already difficult to enforce. Testimony submitted by the Minnesota Attorney General suggested that the safe harbor actually has had a negative effect leading to excessive executive compensation arrangements. The elimination proposals suggest a much harsher approach to compensation and similar arrangements by the IRS and other charity officials. Both statements appear to overstate the perceived negatives. Executive compensation reviews by nonprofits will continue to be prepared by boards in accordance with their fiduciary duties and overall compliance plans. The rebuttable presumption of reasonableness sets forth guidelines which, if followed, would ensure that nonprofit boards are fully informed and, in the event of an audit, would provide the IRS with a detailed explanation as to the manner in which the compensation was reviewed and determined.
Nonprofit Health Care Organizations
Nonprofit health care organizations came under particular attack throughout the testimony. For example, the IRS Commissioner stated that "some health care providers may not differ markedly from for-profit providers in their operations,” an ominous observation when coupled with the Commissioner's call for greater oversight of tax-exempt status. Such arguments are also a slippery slope given the increased numbers of for-profit educational universities and museums. Currently, one would be hard pressed to find a nonprofit organization that does not have a commercial counterpart. In addition, the Minnesota Attorney General's testimony colorfully summarized the conclusions of several high profile and controversial business compliance reviews of Minnesota nonprofit health care providers and set forth a call for the establishment of federal guidelines/requirements with respect to the provision of charity care. For nonprofit health care organizations that have not done so, it is imperative to begin reviewing, researching and drafting “Community Benefit Studies” detailing the charitable work provided by such entities and to review their charity care collection policies and performance.
Proposed Legislation: More Overreaching
In his prepared remarks, Committee Chair Senator Charles Grassley (R-IA) expressed his intention to "move legislative reforms" in this area promptly. Based on the testimony presented to the Committee and the severity of some of the proposals submitted by the presenters, nonprofit organizations should begin to pay much closer attention to the efforts of the Committee in this regard. The ultimate legislative proposal emanating from this Committee may be far more draconian than previously thought, particularly if it removes the rebuttable presumption of reasonableness, limits travel and entertainment expenses to federal employee levels, and provides the IRS with stronger enforcement authority with respect to tax-exempt status.
Overall, the witnesses’ statements and the tone set by the Committee suggest that proposed legislation will be far more overreaching than the more reasonable, yet still extensive, proposals recently made by the independent sector at the request of the Senate Finance Committee. It also appears that the Senate Finance Committee’s proposal may extend far beyond the proposals set forth in its discussion draft issued last summer and resemble the comprehensive proposals suggested by the Joint Committee on Taxation in January 2005. For a discussion of the previous Senate Finance Committee Hearing and the initial discussion draft of proposed reforms, please see the article, “Nonprofit Governance Concerns Put Charities under the Microscope (Again)” at http://www.mwe.com/info/pubs/tax030905.pdf.
Finally, while Congress looks at new rules, the IRS continues to implement existing laws. Last week, the IRS issued a new section in the Internal Revenue Manual regarding intermediate sanctions.