Nonprofit organizations of all types and sizes should take note of the increasing regulatory and media focus on nonprofit organizations and their officer, director and spousal reimbursement policies and practices regarding travel and entertainment expenditures. Over the last several months, the topic of reimbursable travel and entertainment expenses has been raised in state compliance reviews of health systems, the IRS "soft contact review" initiative, Congressional testimony, recent IRS guidance, and inquiries by the Senate Finance Committee. The Committee is expected to include this topic in the federal oversight of charities legislation currently under consideration. Accordingly, nonprofits may wish to revisit their policies and procedures in this area for compliance with expressed policy concerns.
Business Compliance Reviews
Minnesota Attorney General Mike Hatch devoted an entire 31-page section of his Jan. 31, 2005, business compliance review of Fairview Health System to the travel and entertainment issue. This was consistent with his prior reviews of Allina Health System (2001) and HealthPartners (2003), in which he was highly critical of both organizations for an alleged pattern of inappropriate travel and entertainment spending. Attorney General Hatch's reviews typically focus on expenditures related to travel by and entertainment of board members and executives, travel by physicians, holiday parties and reimbursement for other parties, expenditures associated with retreats and other off-site activities, gifts, executive memberships and sports entertainment/golfing. In his Fairview Report, he commended Fairview for changing its travel and entertainment policy post-Allina and imposing a series of new restrictions, which included the following: (a) a requirement that employees must exercise both "good judgment" and "fiscal responsibility" to the charitable mission in making travel and entertainment decisions; (b) no further reimbursement of spousal expenses; (c) increased expense reporting requirements; (d) cessation of reimbursement of credit card receipts that do not specifically itemize expenses; (e) increased approval requirements for travel outside of the 48 contiguous states and (f) increased limitations on reimbursement for out-of-town travel. Nonetheless, Attorney General Hatch criticized Fairview for its failure to adopt a formal policy relating to travel by its board of directors.
Congressional Hearings and Testimony
Attorney General Hatch continued to express his concern regarding travel and entertainment reimbursement procedures in his testimony to the Senate Finance Committee hearings on April 5, 2005. In extensive (and colorful) written and oral testimony, he referred to his business compliance reviews of Minnesota health systems. In these reviews, he criticized charities for authorizing what he views as wasteful expenditures on travel and entertainment activities. He attributed much of the problem to the failure of their governing boards to exercise effective oversight with respect to corporate expenditures. He argued for strong federal legislation that would ensure accountability in charity expenditures, including those related to travel and entertainment. Specifically, he recommended that Congress limit amounts charities may spend on travel, meals and accommodations to the federal government rate. (In our view, this proposal seems most unreasonable, given that nonprofits cannot avail themselves of the steeply discounted rates hotels and airlines offer to governmental employees.)
IRS Soft Contact Reviews. As part of its review of executive compensation in the nonprofit sector, the IRS recently initiated 2,000 correspondence reviews of tax-exempt organizations. As part of those audits, the IRS requested organizations to disclose any economic benefits that were not reported on their Form 990 (some letters expressly inquire about spousal travel) and to describe any use of the organization’s property that did not further the organization’s tax-exempt purposes. These questions have, in some cases, led to greater scrutiny of travel and entertainment expenses.
The Grassley Letter. Travel and entertainment expenses were also a subject of the May 25, 2005, information request letter sent by Senator Charles F. Grassley, Chair of the Senate Finance Committee, to 10 large nonprofit hospital systems. An expressed goal of the information request was to learn more about the charitable activities of nonprofit hospitals in advance of legislation he will introduce to prevent perceived abuses of federal tax laws. An example of a specific information request is as follows: "For the last three years [provide] a detailed breakdown of travel of your five top salaried employees: for trips over $1,000 please provide receipts for hotel; meals; airfare and all other reimbursed items as well as the purpose of the trip."
Pending Federal Legislation
It is well known that the Senate Finance Committee is developing legislation that would dramatically increase federal oversight of the operation and governance of nonprofit organizations. Greater board oversight of travel and entertainment expenses has clearly been a topic of discussion as part of legislative development. Furthermore, draft legislative recommendations dated May 10, 2005 and prepared by the Panel on the Nonprofit Sector (empaneled by the Independent Sector to advise the Senate Finance Committee) specifically address travel expenditures and prohibit reimbursement of spousal expenses (or, if deemed necessary to the conduct of the charity, should be treated as taxable income to the employee).
IRS Recent Guidance
On May 27, 2005, the IRS issued Notice 2005-45, which provides guidance regarding deductions for entertainment use of business airplanes. While the guidance primarily relates to for-profit organizations, some aspects apply to nonprofits as well.
Given these developments, tax-exempt organizations (whether they are hospitals and health systems, trade associations, labor organizations, social welfare organizations or other types of exempts), may wish to confirm the existence and adequacy of an institution-wide policy on the incurrence and reimbursement of travel and entertainment expenses. Such a policy, and related policies and procedures, might logically incorporate the following considerations:
- Apply policies to members of management and to other senior executives, as well as to board members and their spouses (even if the rules differ slightly by category).
- Establish a clear approval mechanism for the incurrence of all material expenditures and a plan of post-expenditure reporting to enhance the institution's related degree of oversight.
- Incorporate clear guidelines on the circumstances under which spousal travel will be approved and on the approved length of stay for overnight travel, particularly to resort destinations.
Nonprofits may also wish to consider the following actions:
- In consultation with tax counsel, ensure the proper individual income tax treatment of all expenditures reimbursed to executives and to board members and their spouses, and confirm that adequate tax planning information is provided to all involved parties.
- Ensure that all travel and entertainment expenses are reported properly on all tax information returns (particularly Forms W-2, 1099, and 990).
- Recognize that some entertainment activities -- for example, golf, sports events and other similar forms of entertainment and "networking" activities -- by their very nature are "red flags" to regulators and the public and require greater substantiation and documentation of a valid business purpose before being approved.
- Substantiate expense reports related to travel and entertainment with detailed information, including copies of related receipts wherever possible and a narrative discussion of the specific business purpose of the activity. Enhance board oversight of such expenses by reviewing expense reports and giving periodic reports to the board.
- Recognize that as valuable as they may be, off-site board retreats and continuing education programs at resort destinations will be subject to close regulatory and media scrutiny. Document the benefit to the organization of participating in such activities, regardless of how self-evident the benefit may seem.
- Educate board members and executives who incur travel and entertainment expenses about the special substantiation rules under Section 274 of the Internal Revenue code and the tax treatment rules of Sections 132 and 274 of the code.
- Monitor other areas of law concerning the reimbursement and reporting of travel and entertainment expenses (e.g., state wasting of charitable asset laws, Securities and Exchange Commission reporting rules, if applicable, and valuation and security concern rules under Section 132 of the code).
- For Section 501(c)(3) and 501(c)(4) organizations, ensure that travel and entertainment advances and reimbursements, if not excluded from compensation under the intermediate sanction rules, are intended to be treated as compensation at the time the benefit is provided in order to avoid imposition of automatic excess benefit transaction excise taxes.
- In connection with corporate counsel, monitor continuing state and federal legislative and regulatory developments in this area.