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Texas C-Bar Pro Bono Week Dallas Volunteer Attorney Project Critical Compliance and Ethics Issues for Nonprofit Tax-Exempt Organizations Darren B. Moore.

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Presentation on theme: "Texas C-Bar Pro Bono Week Dallas Volunteer Attorney Project Critical Compliance and Ethics Issues for Nonprofit Tax-Exempt Organizations Darren B. Moore."— Presentation transcript:

1 Texas C-Bar Pro Bono Week Dallas Volunteer Attorney Project Critical Compliance and Ethics Issues for Nonprofit Tax-Exempt Organizations Darren B. Moore Bourland, Wall & Wenzel, P.C. Attorneys and Counselors 301 Commerce Street, Suite 1500 Fort Worth, Texas (817) (817) (facsimile) ©Bourland, Wall & Wenzel, P.C.

2 Governance; State Standards of Care; Attorney General Oversight Prepared By: Darren B. Moore Bourland, Wall & Wenzel, P.C. 301 Commerce Street, Suite 1500 Fort Worth, Texas (817) (817) (facsimilie) ©Bourland, Wall & Wenzel, P.C. Nonprofit Organizations – 2012 Class #2

3 Charitable Trust – Texas Trust Code; Common law Nonprofit unincorporated association –Texas Business Organizations Code; Common law Nonprofit Corporation – Texas Business Organizations Code; Common law Limited Liability Company – Texas Business Organizations Code; Common Law What Law Applies?

4 Who Owes the Duties? Directors At least 3 Voting rights carry responsibility Largely charged with making strategic decisions, evaluating, reviewing, overseeing and approving corporate actions Officers May hold multiple offices but same person may not be both President and Secretary Owe duties within the scope of implementing decisions and policies established by the Board Member In instances in which the organization is member-managed by a sole member, the member takes on the duties of a director

5 Both trustees and directors owe basic fiduciary duties Duties owed by directors are not those owed by trustees (BOC ) In reality, it is a matter of the degree of strictness to which the fiduciary is held All fiduciaries arent created equally

6 Fiduciary Duties 1.Duty of Care 2.Duty of Loyalty 3.Duty of Obedience Additional duties may apply related to investment of assets

7 Exercise care and skill of person of ordinary prudence in dealing with persons own property Liable for simple negligence Administer the trust in good faith according to its terms, the Trust Code, and where not inconsistent, the duties imposed on trustees at common law (Tex. Trust Code ) Duty of Care - Trustees

8 Administer trust property solely for the benefit of beneficiaries Avoid conflict of interest transactions even if fair to beneficiaries absent full disclosure and consent of beneficiaries If trustee cannot demonstrate full disclosure and consent, transaction may be set aside regardless of fairness Certain transactions may be set aside irrespective of disclosure Duty of Loyalty - Trustees

9 Act in good faith Use care that a person of ordinary prudence would use in same or similar circumstances (reasonable skills) Make decisions reasonably believed to be in the best interest of the corporation Reasonableness based on objective facts available to the decision maker Duty of Care - Directors

10 Directors of nonprofit corporations are not liable where they exercise their business judgment in making decisions on behalf of organization. Parameters not clearly defined (compare for profit context) Statutory law governing nonprofit corporations simply refers to the duty of care Essentially means directors are not liable for simple negligence absent fraud, illegality or a disabling conflict of interest Duty of Care: Business Judgment Rule and Directors

11 Investment: Uniform Prudent Investor Act Consider investment portfolio as a whole Diversify investments Delegate decisions

12 UPMIFA Uniform law governing management, investment, and expenditure of funds held by charitable organizations within its scope. (Replaces UMIFA) Intended to modernize the rules for expenditures from endowment funds and update provisions governing the release and modification of restrictions on charitable funds. Standard of Care: Ordinary business care and prudence under the facts and circumstances prevailing at the time of the action/decision Prudence standard consistent with the UPIA Permits expenditure of net appreciation in FMV of endowment assets over historic dollar value Sets certain rebuttable presumptions of imprudent spending Allows for delegation of investment authority so long as prudent under the circumstances Allows for release of donor restrictions when donor consents in tangible or electronic writing or court grants permission

13 Duty of Loyalty Exercise an extreme measure of candor, unselfishness and good faith Dont usurp corporate opportunities Transactions with organization must be fair to the organization Maintain appropriate confidentiality

14 Corporate Opportunity Prohibits a director from usurping corporate opportunities (i.e. opportunities in which the corporation has a legitimate interest or expectancy and the financial resources to exploit) Where closely related to corporate operations, must disclose (timely) Defenses where no disclosure: Not same line of business Corporation abandoned opportunity Corporation lacked financial resources to pursue the opportunity

15 Before a director engages in a transaction which he or she reasonably should know may be of interest to the corporation, the director should disclose the transaction to the board in sufficient detail (all material facts) and adequate time to enable the board to act or decline to act with regard to such transaction. Corporate Opportunity

16 Interested Transactions Not inherently unethical or a violation of law Note: Loans to directors are a statutory violation Key is disclosure and how the director and board then deal with a disclosed conflict (i.e. upon disclosure the board should provide a disinterested review of the matter) Decision makers should consider adopting a conflict of interest policy

17 Interested Transactions An officer of director is interested if he: makes a personal profit from the transaction with the corporation; buys or sells assets of the corporation; transacts business in the officers or directors capacity with a second corporation of which the officer or director has a significant financial interest; or transacts corporate business in the officers or directors capacity with a member of his family.

18 Dealing with Disclosed Conflict Interested transactions are presumed unfair on the part of the decision maker, fraudulent on the corporation and generally voidable. Safe Harbor Interested decision maker discloses material facts Majority of the disinterested directors, in good faith and the exercise of ordinary care, authorize the transaction

19 Conflict of Interest Policy If an organization chooses to adopt a policy, the policy should consider the following: 1. Identification of the class of individuals covered by the policy; 2. Definition of "actual" and "potential" conflicts of interest; 3. Articulation of the duty of disclosure of officers and directors; 4. Appropriate "trigger" mechanisms to help identify potential conflicts; 5. Annual, episodic disclosure obligations of individuals covered by the policy; 6. Written conflicts disclosure questionnaires; 7. A process for review of disclosed potential conflicts by a committee of disinterested directors with outside counsels input; 8. The applicability of the corporate opportunity doctrine to the board; 9.Disclosure obligations regarding outside board service of officers and directors; and 10. Disclosure obligations regarding outside business activities of senior executive leadership.

20 Duty of Obedience Remain faithful to and pursue the goals of the organization Follow the governing documents of the organization, laws applicable to the organization (including reporting and regulatory requirements), and restrictions imposed by donors Ensure charitable assets are not diverted to non-charitable uses Liability requires personal participation or actual knowledge of the wrongful act

21 Permissive Director in good faith Director reasonably believed she acted in the best interests of the corporation (or, if not conduct in official capacity, not in opposition to corporations interests) Criminal: no reason to believe conduct was unlawful Indemnification Precluded Found liable for receiving personal benefit improperly Found liable to the corporation But: Can still be indemnified for reasonable expenses incurred in connection with proceeding so long as not found liable for willful or intentional misconduct in performing corporate duties Must have a provision in the governing documents to provide for indemnification during litigation

22 Nonprofit must reimburse reasonable expenses incurred by a director after a court order and the exhaustion of all appeals where the director is successful in defending the lawsuit Mandatory Indemnification

23 Standing to Bring a Complaint Nonprofit Corporations: Organization (and/or its members where applicable) OAG Donors in very narrow circumstances (must retain a special interest in the donated gift) Note: Venue for breach of fiduciary duty claims brought by the OAG lies in Travis County

24 Common Law Authority Constitutional Authority Statutory Authority Authority of AG as to Charitable Organizations

25 Representative of the public interest in charity (standing) Duty to ensure charity assets used for appropriate charitable purposes Broad authority to carry out duty Power and Duty derived from Statute of Charitable Uses (cf. Tex. Civ. Prac. & Rem. Code s 5.001) Common Law Authority of the AG

26 AG shall perform such other duties as may be required by law. [The AG] shall represent the state in all suits and pleas in the Supreme Court of the State in which the State may be a party, and shall especially inquire into the charter rights of all private corporations and from time to time, in the name of the State, take such action as may be proper and necessary to prevent any private corporation from exercising any power... Not authorized by law. Article IV, Section 22 Texas Constitution Constitutional Authority of the AG

27 Chapter 123 of the Texas Property Code Defines charitable trusts to include virtually all charitable entities AG is a proper (although not necessary party) to proceedings involving charitable trusts (must receive notice and have right to intervene on behalf of public) Doesnt provide any substantive rights (builds on common law authority) Statutory Authority of the AG

28 Bingo Enabling Act Charitable Raffle Enabling Act Solicitation in the name of veterans organization Solicitation for Public Safety Organizations Telephone Solicitations by Charitable Organizations Duties of Nonprofit Hospitals Statutory Enforcement Authority

29 Texas Business Organizations Code (Ch. 12, 22, Ch. 252) Deceptive Trade Practices & Consumer Protection Act (17.61, Tex. Bus. & Commerce Code) Provides AG authority to present a written request to examine the operations of the corporation (without notice) Failure to comply with the AG can result in forfeiture of right to do business in Texas and fines for the corporations officers Statutory Investigative Authority

30 Provides AG various powers and investigative authority over nonprofits Many powers implied from provisions of the Act which require corporate compliance (eg keeping accurate books and records) Authority to apply for involuntary dissolution (and liquidation) Authority to apply for appointment of a receiver Statutory Investigative Authority (con.)

31 Authorizes pre-suit investigations Authorizes suits for enforcement Imposes penalties for noncompliance Enhanced penalty in the event AG determines act or practice seeking to acquire or deprive money from a consumer 65 or older AG Authority Under the DTPA False, misleading, or deceptive acts or practices in the conduct of any trade or commerce Applies to nonprofits even if they dont charge Applies to fraudulent solicitations regardless of whether goods or services are offered as part of the solicitation

32 1.Constructive trust (really a remedy) 2.Breach of fiduciary duty (venue in Travis County) 3.Violations of various statutes (see above) 4.Fraud 5.Other Common Causes of Action by AG

33 Removal of trustees or board members Money damages Appointment of a receiver Injunctive relief TROs, asset freezes, orders of attachment Attorneys Fees and court costs Remedies Commonly Sought by the AG

34 Hardt v. Vitae Foundation, Inc. (Missouri) Gift: Cash grant from estate (2 grants of approximately $4 Million each) Terms: To be used as matching grant for specific purpose detailed in written grant agreement Deviation: Used for other purposes; used without first getting matching grants Relief sought: accounting, restoration, injunction, alternatively transfer to another charity of Plaintiffs choice Appellate court held no standing after rejecting arguments: Missouri Uniform Trust Code UPMIFA Public Policy Cy Pres

35 Smithers v. St. Lukes – Roosevelt Hospital Center (New York) Gift: $10 Million cash grant over time Terms: Build free-standing alcoholism treatment center; donor had to approve various decisions Deviation: After being operated for a number of years and one year after donor died, hospital decided to transfer center to hospital ward and sell building Relief sought: accounting, injunction, restoration of lost income, specific performance, declaratory relief Appellate court held Executrix had standing noting donors may be in a better position than the attorney general to be vigilant and enforce conditions public policy basis for standing

36 Howard v. Administrators of the Tulane Educational Fund (Louisiana) Gift: Ms. Newcomb made gifts during life and at death to Tulane Terms: The gifts were made for the purpose of establishing a separate college for women within Tulane Deviation: After 199 years, and as a result of the financial impact of Hurricane Katrina, Tulane decided to merge Newcomb College into a single undergraduate college at Tulane for consistent experience Relief sought: Collateral heirs of Mrs. Newcomb sought injunctive and declaratory relief Appellate court determined Louisiana law allowed heirs to seek enforcement of a conditional donation; remanded to determine if Plaintiffs were heirs Subsequent development: In new suit filed by great-great-niece, trial court ruled Mrs. Newcombs will did not contain an enforceable conditional obligation on the use of the donation; upheld 3-2 on appeal; LA Supreme Court denied writ

37 Tennessee Division of the United Daughters of the Confederacy v. Vanderbilt (Tennessee) Gift: UDC gifted $50K to Peabody College for the construction of a dorm between Terms: 2 floors dedicated to women descendants of civil war vets for rent-free housing; dorm named Confederate Memorial Hall Deviation: After Peabody merged with Vanderbilt in 1970s, rent-free housing phased out; in 2001 Vanderbilt renamed the dorm Memorial Hall Relief sought: injunction, declaratory judgment, damages Appellate court held UDC made a donation with restrictions (implicit right of reverter); court rejected various contractual defenses and held Vanderbilt had to keep the name or pay back donation as adjusted by CPI Vanderbilt chose to keep the name by keeping it inscribed on the pediment though changed on maps, etc.

38 Cornyn v. Fifty-Two Members of the Schoppa Family (Texas) Gift: Individuals donated DNA samples, brain tissue and medical records for a research project examining certain genetic factors in development of certain medical conditions Terms: Consent forms named specific individual as head of research and that donors could discontinue their participation Deviation: Specified head of research removed from her position; University threatened destruction of donors samples if new consent forms not signed Relief sought: Plaintiffs sought an injunction and declaratory relief – return of samples or transfer to trustee Appellate court held donors had standing -- taking allegations as true -- fact-finder could find that the donors had an implied reversionary interest following termination of program (analogous to resulting trust following failure of express trust)

39 Dodge v. The Trustees of Randolph-Macon Womens College (Virginia) Gift/Terms: College established in 1891 with primary purpose of educating women in liberal arts setting; gifts made in furtherance of that purpose throughout its history Deviation: College made the decision to provide a co-educational undergraduate experience Relief sought: alleging breach of fiduciary duty sought injunction and declaratory relief (argued Colleges assets deemed to be held in trust in furtherance of Colleges purposes and a change in purposes would constitute a breach of fiduciary duty) Appellate court held no relief available even if plaintiffs had standing (without deciding) because Uniform Trust Code and Virginia Nonstock Corporation Act did not impose trust duties on directors no duty to refrain from changing purpose; gifts given with no express conditions

40 Bases for Standing Conditional gift with right of reverter or gift over Retained special interest separate and distinct from interest of general public Donor who is a member of the charity or serves on the board (alleging ultra vires act)

41 Other Claimed Bases for Standing Charity is deemed to be a charitable trust and holds assets in trust; plaintiffs are beneficiaries of trust Texas law does not impose trust duties on directors Is the beneficiary actually a named charity or the public interest in charity? The Uniform Principal Management of Institutional Funds Act confers standing No express grant of standing – look to the Hardt analysis Public policy supports a finding of standing: Texas follows the majority rule and has never recognized a public policy exception like the one in Smithers

42 No common law charitable immunity Historically immune TSC abrogated in 1971 Pendulum swung back in 1987 with passage of Charitable Liability and Immunity Act of 1987 (Section et seq Texas Civil Practice & Remedies Code) Charitable Immunity: Texas

43 Governance (contd) (pp ); Charitable Orgs. (Ch. 4) if using 2 nd Edition, also read: 1.Caracci v. Commissioner, 456 F3d Spitzer v. Grasso, 893 N.E.2d Vision Service Plan v. U.S., 2005 W Next Week

44 Prepared By: Darren B. Moore Bourland, Wall & Wenzel, P.C. (817) (817) (facsimile) ©Bourland, Wall & Wenzel, P.C. Federal Standards of Conduct; Charitable and Social Welfare Organizations

45 Federal Standards of Conduct Self-Dealing Excess Benefit Transactions

46 Private Foundation Per § 509(a): Organization described in § 501(c)(3) other than the following: Traditional public charities Publicly supported charities Supporting organizations Public safety testing organizations (i.e. § 501(c)(3) is a private foundation if it fails to qualify as a public charity)

47 Public Charity Traditional charities (hospitals, churches, etc.) Publicly supported (aka gross receipts) charities (receive substantial amount of support from public or governmental agencies) Supporting Organizations (take status from supported organization)

48 Self-Dealing (PF) § 4941 – Any conflict of interest transaction between an insider (disqualified person) and the organization Fairness to organization irrelevant Awareness by person involved that the acts constituted self- dealing irrelevant Consequence is excise tax

49 Self-Dealing (Insiders) 1.Foundation Managers (officers, directors, trustees) 2.Substantial contributors (greater of 2% of total contributions for tax year or $5000) 3.20% Owners (owner of 20%+ power of organization that is a substantial contributor) 4.Family Member of (1), (2) or (3) (spouses, ancestors, children, grandchildren, great grandchildren) 5.35% owned entities (organizations more than 35% controlled by any of the above)

50 Self-Dealing Transactions 1.Sale, exchange or leasing of property (unless leased to PF free of rent) 2.Lending of $$ or extension of credit (unless lent to PF interest free) 3.Furnishing of goods, services or facilities (unless provided on same basis as to general public) 4.Payment of compensation or reimbursement of expenses that are not reasonable and necessary to accomplish an exempt purpose 5.Transfer to or use by or for the benefit of a DQP of any of the income or assets of PF 6.Certain agreements to pay a government official

51 Self-Dealing Consequences Two tier excise tax on DP 1.10% of amount involved for each year (5% on foundation manager participating unless unaware act was self-dealing and not willful) - a DP who is also a Foundation Manager can be subject to both 2. If not corrected in a timely manner, second-tier tax of 200% on DP and 50% on foundation manager)

52 Self-Dealing Consequences Amount involved: the greater of the amount of money and the fair market value of the property given or the amount of money and fair market value of the other property received (§ 4941(e)(2)) First tier tax cannot be abated by IRS even for reasonable cause (§ 4962(b))

53 Self-Dealing (Estate of Reis) Courts have consistently held that statutory scheme of excise taxes is a valid legislative response to perceived abuse in use of PFs Interest of PF in property of an estate (as a beneficiary of the estate) is an asset of the PF for self-dealing purposes (prohibits indirect self-dealing) Benefit to the DP doesnt have to be pecuniary but must be significant as opposed to tenuous

54 Excess Benefit Transactions Applies intermediate sanctions (excise taxes) on DPs who benefit improperly and on organization managers who participate in such transaction Applies to public charities and social welfare organizations Overlaps concepts of private inurement discussed later in course

55 Excess Benefit Transactions § 4958(c)(1): Any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any DP if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

56 EBT: Disqualified Persons 1.Any person who was in a position to exercise substantial influence over the affairs of the TE organization at any time during a 5 year period ending on the date of the transaction 2.A family member of a person of substantial influence 3.An entity that is 35% controlled by (1) or (2) **Beware: this is a different definition from PF DPs.**

57 Substantial Influence President, CEO, COO Treasurer, CFO Voting member of the governing body Persons with a material financial interest in a provider- sponsored organization (e.g. nonprofit hospitals)

58 Persons Deemed Not to Have Substantial Influence § 501(c)(3) organizations Certain § 501(c)(4) organizations Employees receiving economic benefits of less than a specified amount in a taxable year

59 Facts & Circumstances Tending to Show Substantial Influence Founder of organization Substantial contributor Compensation primarily based on revenues derived from activities of the organization Has or shares authority to control/determine substantial portion of the organizations capital expenditures Managerial authority or key advisor to person with managerial authority Has controlling interest in a corporation, partnership or trust that is a DP

60 Facts and Circumstances Tending to Show No Substantial Influence Person is an independent contractor Person has taken a vow of poverty Preferential treatment offered to all making comparable donations Direct supervisor of the person is not a DP

61 Excess Benefit Transaction Consequences Two tier excise tax on DP 1.First tier tax of 25% of the excess benefit - can be abated under certain circumstances 2.If not corrected in a timely manner, second-tier tax of 200% of the excess benefit Organization manager who knowingly participates pays a tax of 10% of the excess benefit not to exceed $10,000

62 Correcting an Excess Benefit Transaction An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the applicable tax- exempt organization involved in the excess benefit transaction in a financial position not worse than that in which it would be if the DP had been dealing under the highest fiduciary standards. (Treas. Reg. § (a))

63 Practical Correction 1.Return the correction amount (the excess benefit plus interest) 2.Return the specific property where excess benefit was transfer of property (organization must agree) - DP (and family members) cannot vote on whether to accept the property as correction

64 Unreasonable Compensation as an Excess Benefit Compensation must be reasonable in relationship to the value of the services rendered Compensation paid by similarly situated organizations for comparable positions Availability of similar services in geographic area Current compensation surveys by independents firms Written offers from competitors for the employee

65 EBT: Compensation Organization must clearly indicate intent to treat the economic benefit as compensation when the benefit is paid Written contemporaneous substantiation Employment contract W-2, 1099, 990 DP reports on 1040 Exception: amounts excluded from gross income (e.g. employer- provided health benefits)

66 EBT Compensation: Rebuttable Presumption of Reasonableness Transaction approved by an authorized body of the organization composed of non-conflicted individuals Prior to making determination, authorized body obtained and relied upon appropriate comparability data Authorized body adequately documents basis for determination concurrently with making decision

67 Excess Benefit Transactions (Misc) Applies to churches (although IRS must still follow church audit act) Applies only to post-September-1995 transactions Does not replace revocation of exemption Has organization been involved in repeated excess benefit transactions? Size and scope of excess benefit transaction Safeguards implemented following transaction Compliance with other applicable laws

68 Registered Nonprofit Organizations by IRC Subsection (National)(2003) Source: National Center for Charitable Statistics, Urban Institute Doesnt include most religious congregations.

69 Charitable Organizations § 501(c)(3) Why choose to be a 501(c)(3)? Not required to pay income taxes May elect not to pay federal unemployment taxes Ability to attract deductible contributions State tax exemptions

70 § 501(c)(3) Elements 1.Proper organizational structure 2.Organized exclusively for charitable purposes 3.Operated exclusively for charitable purposes 4.No part of net earnings inures to benefit of private individual 5.Not an action organization 6. > - not violative of public policy

71 Organizational/Operational Tests Organizational Look to enabling documents Must be organized exclusively for charitable purpose(s) May be general or specific Operational Look at actual activities of organization Must be operated exclusively for charitable purpose(s) May not engage in substantial activities that fail to further charitable purposes More often the basis for revocation

72 Charitable Purpose Primary purpose must be charitable (exclusive doesnt mean sole) Charitable purposes: Relief of poverty Advancement of education & religion Promotion of health Governmental purpose Social welfare BBB v. United States

73 Social Welfare Organizations [c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare... exclusively again means primarily

74 Social Welfare Organizations: Can qualify as exempt under § 501(c)(3) or (c)(4) with purposes to further common good and benefit community § 501(c)(3) Contributions are deductible Cannot be involved in political campaigns Cannot have a primary purpose of lobbying § 501(c)(4) Contributions not deductible Can have some involvement in political campaigns (not a primary purpose) Can have as a primary purpose lobbying Regan v. Taxation with Representation

75 Social Welfare Organizations 1.Commensurate with the common good and general welfare of the community 2.Doesnt include activities that primarily constitute carrying on business with the general public in a manner similar to organizations operated for profit 3.Must benefit community as a whole rather than merely benefiting the organizations membership or other select group of individuals or organizations What is community???

76 Advocacy Groups Attempts to influence legislation May operate to inform public on controversial subjects even though advocating a particular viewpoint Q: Why is this beneficial to the community? Cannot have as a primary purpose intervention on behalf of or in opposition to a candidate for public office.

77 Next Week Obtaining and Maintaining Tax-Exempt Status (Ch. 5)

78 The information set forth in this outline should not be considered legal advice, because every fact pattern is unique. The information set forth herein is solely for purposes of discussion and to guide practitioners in their thinking regarding the issues addressed herein. Non-lawyers are advised to consult an attorney before undertaking any issues addressed herein. Unless otherwise stated herein, pursuant to requirements prescribed by the Internal Revenue Service under Circular 230 for tax practitioners, Bourland, Wall & Wenzel P.C. must inform you that any U.S. federal tax advice or opinions contained in this paper are not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter addressed in this communication.

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