Friday, September 12, 2014

Who “Owns” a Nonprofit?


Nonprofit “ownership” can be a confusing, counterintuitive concept.  It can implicate both financial and control issues for stakeholders.  Consider the following scenario.

            Jack founds Nonprofit Beanstalks with two supportive friends to improve the environment.  The first week, Jack contributes $20,000 to launch Nonprofit Beanstalks and otherwise invests extensively through volunteer service as its President, focusing on eco-friendly gardening as the first initiative.  One year later, Jack is worn out and grumpy, and Jack’s friends aren’t so friendly to him anymore.  Thinking that they can run Nonprofit Beanstalks much better than Jack, they vote him out of office and ask their new friend Jill to take over as its President.  Jill is delighted.  With her friends’ support, she will carry the organization up the environmental hill through a new clean water project.   Jack is furious.  He demands repayment of his $20,000 contribution and tells his former friends that they better focus on gardening.  

            May he get the funds back?  And can he insist that Nonprofit Beanstalks return to its roots?  No, and no!   

            No founder, director, or officer of a nonprofit corporation has any ownership interest in the nonprofit.  Nor can he or she control the nonprofit corporation after being removed from office.  This lack of private ownership and control is the key distinction between nonprofits and private businesses such as sole proprietorships, partnerships, and for-profit corporations,

So, who does own a nonprofit?  The answer is “Nobody and everybody!”  Unlike these other types of business organizations, a nonprofit is not privately owned by anyone.  The organization’s assets are held in trust for the use and benefit of the beneficiaries in accordance with the purposes for which it is organized.  The nonprofit’s directors are legally responsible as fiduciaries to ensure that the corporation’s assets and operations are used properly for nonprofit purposes.  They are accountable to governmental authorities such as the IRS and state Attorney General offices (as well as to donors and other stakeholders, albeit on a more practical level).  This trust concept is central to nonprofit law, and raises important issues for nonprofit leaders.

An example is evident in a recent Nonprofit Quarterly story about the potential sale of a nonprofit hospital in Missoula, Montana.  (For the article, click here.)  According to the article, the nonprofit hospital, “built by local donations and taxpayer-supported bonds, may soon be sold to the for-profit Regional Care Hospital Partners of Brentwood, Tennessee.  Some community members are crying foul…”  Essentially, they want a stronger voice to determine what will happen to the nonprofit hospital.  But the donors can neither get their donations back nor - absent their own board membership - control what happens to the nonprofit hospital.  Their influence can only be through community pressure and calls for governmental accountability. 

In the case of Jack and Jill, Jack must accept his losses and move on to hopefully greener pastures, perhaps with new friends.  In the case of the Montana hospital, the result could be that the nonprofit hospital continues as is, thanks to community pressure.  Alternatively, its assets could be transferred to a new nonprofit organization, to start a new era of charitable activities through a different nonprofit.  In no event, however, could the nonprofit’s assets simply be given to any private person or divided up among the donor base.  Another option, which is sought in the Montana case, is for the nonprofit’s assets to be sold at a fair market value.  In such event, a high-quality appraisal will be essential for the board directors to ensure that they have fulfilled their fiduciary duties to protect the organization’s charitable assets.  The money from the sale, however, would still have to be put to charitable use, most likely by transferring the funds to another nonprofit organization.

For further information concerning nonprofit governance and related considerations for legal compliance, please contact one of our attorneys at 312.626.1600 or info@wagenmakerlaw.com, or visit us on the web at www.wagenmaker law.com.

Friday, September 5, 2014

Diverse Religious Groups Unite on Clergy Housing Allowance Appeal


What will become of the clergy housing allowance?  We have been following the legal developments a 2013 Wisconsin federal district court case, which struck down the venerable income tax benefit as unconstitutional.  The case is now on appeal before the Seventh Circuit Court of Appeals.  See Freedom from Religion Found., Inc. v. Lew, 983 F. Supp. 2d 1051 (W.D. Wis. 2013).  This decision stands in stark contrast to other decisions, including a 2014 Kentucky federal court case, that have rejected such challenges creating disagreement among the courts as to whether the tax benefit is constitutional.  If upheld on appeal, the Wisconsin case thus could result in a drastic sea change for clergy tax benefits.

            Not surprisingly, the Seventh Circuit appeal continues to generate much interest.  As of September 3, 2014, six briefs have been filed with the Seventh Circuit Court of Appeals.  Two of the briefs are from the parties themselves.  Four, however, have been filed by amici curiae -- “friends of the court.”  The friends of the court are interested parties who feel they have important information for the court to consider.  The parties provide such information to the court in amicus curiae briefs.

            Three of the amicus curiae briefs argue the housing allowance is constitutional and should not be disturbed.  Remarkably, these briefs, together, represent more than ninety American religious groups.  These groups span much of the American religious landscape:  Jewish, Protestant, Islamic, and Catholic.  The groups’ broad support underscores the critical nature of the issue under consideration.  The remaining brief has been filed on behalf of two small organizations arguing for abolition of the housing allowance.

            Copies of the four briefs are located here:


            If the Seventh Circuit affirms the Wisconsin district court and the IRS implements such decision, the financial impact on clergy and the religious institutions they serve could be massive.  Our law firm will continue to monitor developments from the Seventh Circuit and report updates to the status in this crucial case.  In the meantime, should you or your religious group have questions concerning the case, or have general questions concerning the clergy housing allowance, please contact one of our attorneys at 312.626.1600 or info@wagenmakerlaw.com, or visit us on the web at www.wagenmakerlaw.com .

Interested in learning more?  Click for our other posts on the clergy housing allowance exemption

Friday, August 29, 2014

Nonprofit Payroll Tax Alert


A recent federal government report shows that thousands of nonprofits are not meeting their payroll tax obligations.  Though it may be tempting for nonprofits to avoid payroll tax responsibilities, especially when facing cash flow challenges, such avoidance is extremely risky. 

Payroll Tax Primer

            All organizations with employees owe taxes to the government, in substantial part to pass along tax dollars owed by the employees.  Payroll taxes cover both employees’ income tax obligations, and their employees’ 7.65% portion of FICA taxes for social security and Medicare taxes.   In addition, employers are separately responsible for paying the employers’ other 7.65% portion of FICA taxes.  Essentially, employers hold  employees’ tax obligations in trust and must remit them to the government taxing authorities, as well as pay the employers’ share. 

            The financial cost of each employee thus includes all tax-related costs, not just the net compensation each employee receives.  Even the most worthy charitable causes are responsible for withholding and paying their employment taxes – no excuses, no exception.   What’s the key lesson here?  Pay your taxes!

The TIGTA Report

            The U.S. Treasury Inspector General for Tax Administration (“TIGTA”) recently released a report showing that a shockingly high number of tax-exempt organizations have not been paying employment taxes.   Specifically, the TIGTA report found that 64,200 tax-exempt organizations owed almost $875 million in unpaid taxes.  According to the report, 1,200 of these organizations owed more than $100,000 each, and five owed more than $10 million each.  The rest owed varying amounts. 

            The TIGTA report recommended that the IRS more seriously address nonprofits’ delinquent payroll taxes practices.   In particular, TIGTA recommended that the IRS’s Exempt Organizations (“EO”) unit coordinate with the IRS’s payroll tax collection division to identify nonprofit organizations that may not be complying with other legal requirements regarding tax-exempt status.  In other words, payroll tax problems may indicate other tax-related malfeasance.

            The IRS’s EO unit rejected this recommendation, stating that data from collections is not useful in indicating other tax-related compliance issues such as private inurement or operation for a non-exempt purpose.  Of course, the EO unit has the flexibility to later decide that unpaid payroll taxes may point to other issues warranting IRS examination.  Notably, failure to pay payroll taxes – by itself – at this point would not constitute legal grounds for revocation of tax-exempt status.

            The IRS’s EO unit indicated that it will act upon one recommendation in the TIGTA report – that the EO unit “work with the Department of Treasury to evaluate whether a legislative proposal is warranted to strengthen the IRS’s ability to enforce payroll tax non-compliance by tax-exempt organizations.”  As such, we may see the IRS pushing for legislative action to allow the agency to address nonpayment of payroll taxes more aggressively.

What Could Go Wrong?

            1.         Penalties.  If payroll taxes are paid late, significant penalties may be owed to the organization.  While penalties may be decreased when the organization had “reasonable cause” for the late payments, this standard is extremely high.  The organization must show that the lateness was due to circumstances outside the control of the directors, rather than due to any oversight by the board.  It is also important to show that the organization has taken corrective measures to ensure that payroll taxes will be timely paid in the future.  Obtaining an abatement (i.e., reduction or elimination) of penalties based on a reasonable cause determination may be very challenging.  Organizations should instead establish payment procedures early on to help avoid late payments and the associated penalties.

            2.         Frozen/Taken Assets.  IRS has the power to freeze and levy (i.e., take from) organizational assets like bank accounts.  In that way, the IRS can ensure that the employer makes payroll taxes a high priority, albeit involuntarily.

            3.         Personal Liability for Leaders.  Unpaid payroll taxes may result in personal liability for the organization’s leaders who are responsible for overseeing timely payment.  The board of directors has a general responsibility to make sure payments are made.  Other individuals may have a more specific responsibility to ensure timely payment, and may be more likely to be held personally liable for such payments and late penalties.  This often includes the Treasurer, the Executive Director, or a director or officer who is aware that the payments are not being timely made.   Because of serious responsibility associated with payroll tax liability, both civil and criminal liability may be imposed.  Serious business indeed!

            With the recent spotlight on payroll tax noncompliance by nonprofits as shown by the TIGTA report, we may see the IRS increase penalties, more aggressively attempt to collect from officers and directors, or even press for legislative action allowing revocation of income tax exemption for organizations that have unpaid payroll taxes.  Nonprofits should thus be aware of their employment tax liability and extremely diligent in paying taxes as they are due.

            For questions regarding tax-exempt nonprofits, payroll tax requirements for nonprofit organizations, or legal issues pertaining to nonprofits generally, please contact one of our attorneys at info@wagenmakerlaw.com or 312.626.1600, or visit us at www.wagenmakerlaw.com.

Wednesday, August 27, 2014

Is the IRS Back in Church?


With fall approaching, the next election cycle is just around the corner – just in time for new IRS developments affecting churches and other religious institutions.  As with all section 501(c)(3) organizations, religious institutions are prohibited from engaging in “political campaign activities.”  That is, they may not advocate for or against a particular candidate for office, or otherwise seek to influence an election.  For many, such restriction seems like a constitutional violation of First Amendment free speech and religious liberty protections.  In recent years, IRS officials have refrained from auditing religious institutions and thereby have avoided this issue.  But recent court and IRS activity this summer begs the question:  Until now?

A.        IRS Background

Some legal and historical background is in order.  Due to constitutional safeguards for religious institutions, the law imposes heightened restrictions and procedures as to when and how the IRS may audit them.  In particular, Section 7611 of the Internal Revenue Code requires “an appropriate high-level Treasury official” to “reasonably believe” that a religious institution is engaged in improper activities before the IRS may commence an audit.  The regulations accompanying section 7611 designate such official as a “Regional Commissioner” – that is, the head of an IRS region.  As a result of the IRS’s 1998 internal reorganization, however, IRS “regions” no longer exist, making this regulatory definition obsolete. 

In 2009, a Minnesota church challenged an IRS audit, arguing that the IRS’s reworked definition of “high-level Treasury official” was legally deficient.  Therefore, as the church claimed, its alleged political campaign activity could not be investigated.  The federal court agreed, finding that the subject IRS official in that audit was only a “mid-level” employee.  In doing so, the court recognized that Section 7611’s intent is to protect religious institutions from overly aggressive IRS examinations and other government intrusions into religious liberty.   Since then, the IRS has neither conducted any new audits of religious institutions nor corrected the Section 7611 regulatory language.

B.        Fallout from Freedom From Religion Foundation

This summer, however, new information surfaced as a result of the Freedom from Religion Foundation’s settled lawsuit against the IRS.  The lawsuit challenged the IRS’s perceived policy of selective non-enforcement of the section 501(c)(3) political campaign prohibition. In connection with the settlement, and apparently in response to such challenge, an IRS letter penned by Mary Epps (acting director of IRS’s Exempt Organizations Examinations) was issued to the U.S. Department of Justice and then became publicly available.  In the letter, Ms. Epps states that the IRS has actually processed several alleged church violations of the political campaign prohibition.  Specifically, the IRS’s Political Activities Referral Committee (“PARC”) now has a list of 99 churches that it believes merit a “high priority examination” for such violations, dating from 2010 to 2013.  (click here for a copy of the letter.)

C.        What Lies Ahead?

Some believe that by Ms. Epps’s letter, a clear signal has been sent:  the IRS is ready to resume scrutiny of churches and other religious institutions.  This would mean not only enforcement of political campaign intervention prohibitions, but also other areas of potential trouble for churches such as unrelated business income tax (“UBIT”), which may affect certain fundraising activities, as well as employment tax liability (e.g., clergy tax, independent contractor versus employee distinctions, excessive compensation issues). 

Others are concerned that such stepped-up scrutiny also may lead to governmental abuse and other inappropriate treatment of religious institutions, in violation of their First Amendment protections.  The IRS’s recent conservative-targeting scandal, as well as the fact that current IRS regulations allow for viewpoint discrimination in politically related areas, are certainly dangerous portents in that regard.  (See also “Speak Up: Issue Advocacy in Increasingly Politicized Times.”) In the meantime, as has also occurred in recent years, religious institutions may attempt to provoke a constitutional showdown on the political campaign ban itself.   For example, the “Pulpit Freedom Sunday” annual campaign, sponsored by the Alliance Defending Freedom, advocates religious freedom for church pastors to speak out on abortion, marriage, and other topics in the crosshairs of politics.  The next Pulpit Freedom Sunday is right around the corner – on October 5, 2014. 

D.        What should responsible religious institutions do now? 

First, make sure that your organization’s operations and procedures are fully compliant with tax-related requirements.  This review should include a wide range of income-generating activities and clergy employment tax practices.  Second, the board and executive staff should have a thorough understanding on what the organization and its representatives may and may not do with respect to politically related activities.   Third, keep up with evolving legal developments, as applicable requirements and standards can change.  Fourth, remember that our country’s religious institutions serve critical roles for our society’s well-being and betterment and therefore are to be honored and respected. 

For more information regarding compliance with laws and regulations applicable to religious institutions or nonprofits generally, contact one of our attorneys at 312.626.1600 or info@wagenmakerlaw.com, or visit us on the web at www.wagenmakerlaw.com.