Panel On The Nonprofit Sector Issues Report

Nonprofit leaders recommended sweeping charitable reform in a new report, even as others in the sector questioned the handling of its release and scope.

The Panel on the Nonprofit Sector’s report is meant to be an initial response to federal proposals circulated last summer and aimed at improving charitable governance and accountability. The panel, convened by Washington, D.C.-based Independent Sector, gave its recommendations to the U.S. Senate Finance Committee March 1.

The 72-page interim report provided suggested actions for the Internal Revenue Service (IRS), legislators, and charitable organizations.

If followed, the proposals would affect charities of all sizes. Among the suggested changes:

  • Charities with at least $2 million in total revenue and filing a Form 990 or Form 990PF would be legally required to conduct a yearly financial audit;
  • Organizations with $500,000 to $2 million in total revenue would be required to have an independent public accountant review financial statements; and,
  • Charities with less than $25,000 in revenue would face automatic suspension of tax-exempt status if they fail to file an annual notice with the IRS for three consecutive years.

The proposals come at a time when many nonprofits are facing reduced funding and more costs for compliance and regulation. Debra Rex, CEO of Cleveland, Ohio-based Beech Brook, a children’s mental health organization, said her nonprofit has seen dramatic increases in compliance and regulation costs during the past five years. “Nonprofits are struggling with the burden of overhead costs we didn’t used to have,” Rex said.

The report’s release also ignited some controversy within the sector.

A few nonprofit leaders were upset that they were unable to review a final version before its delivery to Capitol Hill, yet were asked to support it.

One person familiar with the panel’s procedure, who requested anonymity, was uncertain how changes occurred between an earlier version posted for public comment and the final version of the interim report.

Gary Bass, executive director of OMB Watch in Washington, D.C., said he was “mystified” by the panel’s process. Bass recalled scrambling to get comments to the panel just days after a conference call explaining preliminary recommendations only to discover that the panel was already meeting. His group also didn’t receive any feedback on submitted comments, Bass said.

“We as a community would scream bloody murder if our government operated in this manner,” Bass said.

He acknowledged that it’s easy to take “potshots” at the process, but said the processes get in the way of constructive involvement.

The interim report, while based on issues raised by work groups and an expert advisory committee, reflected the opinions of the national panel, according to Diana Aviv, executive director of the panel and of Independent Sector.

She added that all national panel members signed off on the report. “I’m aware that some organizations felt that they wanted to have another chance to have input for what the panel was planning to recommend,” Aviv said. “If it’s possible for us to build it into the next process, then we will do that. It all depends on the time available to us.”

Projected audit costs

The report attempted to provide ballpark figures for audit costs.

Preliminary United Way of America (UWA) statistics show UWA agencies with $4 to $9 million annual revenue paid an average of $15,795 for audits. Agencies with $2 million to $3.8 million annual revenue spent, on average, $10,440 for audits. Agencies with annual revenues less than $500,000, spent an average of $3,475, according to the report.

Of course, audit costs vary based on a nonprofit’s location, size and type. Smaller charities in New York would pay roughly $5,000 for an audit, one nonprofit expert said.

Other recommendations

Elsewhere, the report recommends that the IRS:

  • Require chief executive officers, chief financial officers or the highest-ranking officer to sign tax and information forms;
  • Suspend tax-exempt status of organizations that fail to comply with federal filing requirements for two or more consecutive years;
  • Extend penalties imposed on individual and corporate tax preparers for omission or misrepresentation of information, disregard of rules and regulations to preparers of Form 990s;
  • Move forward with requiring e-filing of Form 990s and allow for separate attachments;
  • Coordinate federal e-filing efforts with states;
  • Require e-filing of applications for tax-exempt status;

The report urged charities to:

  • Adopt and enforce a conflict of interest policy;
  • Include people with some financial literacy on its board of directors;
  • Create whistleblower protection policies, although existing laws cover nonprofits and no new legislation is needed.

Congress should increase first-tier excise taxes imposed on foundation managers and disqualified persons knowingly involved in self-dealing transactions, according to the report.

Currently, first-tier excise taxes are equal to 2.5 percent and 5 percent of the amount of the transaction for managers and disqualified persons, respectively, according to IRS code cited in the report.

The panel also suggested Congress:

  • Define donor advised funds;
  • Prohibit charities from making grants to private non-operating foundations from donor advised funds;
  • Enact minimum activity rules for donor advised funds;
  • Prevent public charities from knowingly using donor advised funds to reimburse donors/advisers for expenses incurred by them in an advisory capacity or making grants to donors/advisers and related parties; and,
  • Increase funding for IRS enforcement of charities. The panel is “strongly supportive” of Congress earmarking funds derived from penalties, fees and excise taxes imposed on charities for improved IRS oversight.

The report encouraged states to incorporate federal tax law into state laws, and supported state attorneys general and other state officials having the same access to IRS information as state revenue officers.

Bigger issues?

John Graham, president and CEO of the American Society of Association Executives in Washington, D.C., and a member of the panel’s transparency and financial accountability work group, said the panel is a good effort to respond to potential legislation and ensure it doesn’t have unintended consequences.

But bigger issues are getting the IRS more money to enforce existing regulations, reviewing the IRS’s role in regulating exempt organizations, and dealing with Form 990 problems, according to Graham.

“The IRS needs to be enforcing the regulations that are currently on the books,” Graham said. “Once we see that enforcement in place we can then determine where the gaps are, and determine if we need additional legislation. One of the problems going forward is that the nonprofit community has assumed there will be additional legislation.”

Time constraints could keep the panel from addressing these issues.

“If we come to a consensus (in Phase II), it frees us in the final phase to deal with bigger issues,” Aviv said. If they’re not germane to the panel’s work, it’s not likely the panel would be used for that, she explained.

The panel limited its focus to responding to the staff discussion draft, and a few other issues that it thought would deal with potential legislation, Aviv said.

This spring, Sen. Charles Grassley, R-Iowa, Finance Committee chairman, plans to hold hearings and produce legislation incorporating charitable giving incentives and charitable governance reforms, a Grassley spokeswoman said in early March. The comprehensive legislation would go beyond the nonprofit panel’s report, the spokeswoman said.

While the panel’s interim and final reports “will weigh on the thinking of the Finance Committee,” the committee is also considering views of the Joint Committee on Taxation, and has asked for IRS and state officials’ perspectives, Grassley said in a written statement.

The Joint Committee on Taxation’s report raised the question of whether some of the proposals were more related to generating income than they were for good reform, Aviv said.

Indeed, there are potentially billions of dollars in federal government revenue in the Joint Tax Committee’s report. For example, reforming rules for charitable contributions of property could generate some $2.5 billion between 2005-2014, according to the report.

On a separate but related note, panel officials said they expect the U.S. House of Representatives Ways and Means Committee to continue its review of hospitals, universities, and profit-making activities of nonprofits. A Government Accountability Office (GAO) report addressing the House committee’s questions is expected to be released early this summer, according to panel officials.

The panel’s final report is scheduled for late spring. It will touch on additional issues, such as valuation of non-cash contributions, executive compensation, board composition, and Form 990 and Form 990PF reform, panel officials said. One nonprofit leader cautioned against making changes without considering the larger impact on the nonprofit sector. Rex, of Beech Brook, said: “I really am concerned about overreacting and doing things that we wake up one day and realize we fundamentally changed the complexion of the nonprofit sector and eliminated its unique value.”