DATELINE: December 14, 2009, Chicago
The IRS recently issued a Governance Check Sheet and a Governance Guide Sheet for completing the Check Sheet. The Check Sheet is to be completed by IRS agents during audits of tax-exempt organizations. As its name suggests, the check sheet focuses on the organization’s governance. This can be taken as an indication that the IRS is not backing off its focus on nonprofit governance. This is not surprising given the fact that IRS officials have said that a well governed organization is more likely to be a tax-compliant organization.
Although a good portion of the checklist focuses on factual matters that are now answered by the Form 990, the Check Sheet and guidelines suggest that agents will be asking for...
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additional details during examinations. Agents are being asked to go behind and beyond the Form 990 responses. To a certain extent, some of the questions can be viewed as outtakes that did not make the final Form 990 for one reason or another. Question 1 through 6 ask basic identification information, which should be available from the fact of the tax return. Here is an overview of the remaining portions of the Check Sheet: A. Mission Statement: The Form 990 asks the organization to describe its mission. Question 7 of the Check Sheet goes further, asking whether the organization has “a written mission statement that articulates its current I.R.C. Section 501(c)(3) purposes.” Those organizations that responded to the Form 990 changes by putting in place conflicts of interest, whistleblower, and record retention policies may want to consider adopting a written mission statement in light of the Check Sheet. Agents will be looking for another piece of paper. G. Financial Oversight. Part 6 (Questions 19 through 23) asks about financial oversight. There are a number of questions should be viewed as Form 990 outtakes. Agents are asked to identify the systems and procedures in place that are intended to make sure assets are properly used, consistent with the mission (Question 19). They also are asked how often the board reviews written reports regarding financial activities (Question 20). Of even greater significance, the Check Sheet asks a number of questions about management letters, including whether recommendations were adopted. This will cause agents to carefully review the letter. Organizations should be prepared to explain why they did not implement recommendations if that is in fact the case. We can only wonder whether failure to implement suggestions will result in far closer scrutiny. H. Document Retention Policies. Part 7 (Questions 24 through 26) asks about document retention policies. There is nothing too surprising here, although the agent is asked to indicate whether the lack of documentation hindered the exam. All of these questions are important to the organization under audit, but we suspect they also are important to the organization not currently under audit. We would not be at all surprised to see the IRS develop audit selection programs that utilize the information furnished by the agent on the Check Sheet, particularly in cases where adjustments and penalties are assessed and the intermediate sanctions are invoked. One thing is for sure: Those who argued that the IRS has no business examining governance have lost the argument, at least for the time being.
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B. Bylaws. Question 8 of the Check Sheet asks whether the organizations bylaws set forth the following information regarding the governing body and officers: (i) composition; (ii) duties; (iii) qualifications; and (iv) voting rights. Bylaws drafted by knowledgeable legal counsel should contain most, if not all, of this information. Those organizations that determine that they should modify their bylaws in response to the Check Sheet should do so with caution. Make sure that duties assigned to different officers match what those officers actually do. Sometimes people use form bylaws with detailed and extensive descriptions of duties. Those descriptions might make sense for someone who holds a paid full-time position, but not for a volunteer officer. By being too inclusive when unwarranted, the organization risks placing an officer in violation of his duties even if no one really expects the officer to do what is specified in the bylaws. The classic example is the volunteer treasurer. Sometimes the bylaws will indicate that this person maintains the accounting records, bank accounts, prepares tax returns, and undertakes a host of other specific duties. In fact, all of this is turned over to an accounting firm, an employee, or a consultant. The description is inaccurate and could pose problems if the organization experienced financial difficulties.
C. Board Member Receipt of Bylaws. Question 9 of the Check Sheet asks whether all board members have received copies of the articles of incorporation and bylaws. As a matter of good practice, they should, but the organization may not do this routinely. Organizations should consider formalizing this process.
D. Quorums. Questions 11a and 11b of the Check Sheet focus on board meetings and quorums. As a matter of good practice, the meeting minutes should track board member attendance and should indicate whether a quorum was present. If an organization is not currently tracking this information, the person maintaining the minutes should modify the template used for the minutes. This will make the organization’s efforts to respond to the agent's request for information smoother.
E. Compensation. Part 3 of the Check Sheet (Questions 13 through 15) focuses on compensation. There is nothing here that should come as a surprise. The IRS does ask its agents to take a closer look at the source of any comparables. Specifically, it wants to know whether the comparables come from exempt organizations, non-profit entities not exempt from tax, governmental entities, for-profit entities, or other types of entities. Organizations should expect further questions from the agent if they indicate that the comparables come from for-profit entities. Neither the Check Sheet, nor the Guide Sheet require the agent to ask those questions, but the IRS and Senator Grassley are suspicious of for-profit comparables so we believe they are potential red flag. That doesn’t mean organizations shouldn’t use them when appropriate, but organizations should develop a sound basis and rationale for the use of for-profit comparables.
F. Organizational Control. Questions 16a through 17 of the Check Sheet ask about organizational control. Much of the requested information should come straight off the Form 990, but Question 17 has a new twist to it. Specifically, it asks the agent to make a subjective assessment rather than an object one. The Guide Sheet states, “For example, is there a single individual or small group of individuals to whom the board typically defers?” We suspect agents will be asking questions and reading minutes in an effort to answer that question. Many agents may began with the working assumption that what appears to them as a highly paid executive director is the one calling the shots. Those charged with maintaining the meetings minutes may want to keep this mind. If, for example, one or more board members object to an action proposed by the CEO, the person drafting the minutes might want to reflect that fact to dispel notions that the CEO is a Svengali-type character. Keep in mind it is illegal to create false evidence.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL.
