Adopting Robert’s Rules of Order Thursday, Sep 10 2009 

In a recent article by nonprofit attorney Jack Siegel of Charity Governance Consulting entitled “Disorder From Robert’s Rules of Order” (http://www.charitygovernance.com/charity_governance/2009/08/disorder-from-roberts-rules-of-order.html), he reiterated his position that nonprofit boards should never assign blanket allegiance to the Robert’s Rules of Order in their bylaws.  In an effort to adopt all the policies considered proper for governance, new boards may be tempted to throw in a line encapsulating the whole of Robert’s Rules – without realizing the full extent of the 600+ page document to which they are committing themselves.

Although many people are familiar with the Robert’s Rules of Order by name, the vast majority of board members are not familiar with the complete compilation.  A board’s willingness to commit to an unknown document is often a hasty action to embrace standard practices for meetings that may not have been originally listed in the governing documents.  Most organizations, however, will never adhere to the level of detail and formality spelled out in the Rules.  Despite general impressions to the contrary, an adoption of these provisions can, if fully implemented, affect more than the efficiency of a meeting.  The last provisions of the Rules, for example, address the punishment of members – giving instructions for trying members, right down to the details for ejecting members from a meeting place.

The article cited above reviews the case of an organization that, having adopted Robert’s Rules, regretfully learned in more detail of its requirements when one of the board members engaged in improper behavior, meriting his removal.  The article explains:

What the organization apparently failed to recognize when they adopted Robert’s Rules of Rule is that Chapter XX (starting on page 624) outlines disciplinary proceedings.  The rules are themselves ambiguous as to whether they need only be adhered to if specifically adopted by the organization, or whether a blanket adoption of Robert’s Rules of Order requires these rules to be followed.  Whatever the intention, the rules provide the offender with the opportunity to argue that the specific disciplinary procedures must be followed if the organization adopted Robert’s Rules of Order.  The outlined disciplinary procedures contemplate a confidential investigation, notice to the offender, a trial with specific procedures, the group’s review of the trial, a report, and the implementation of remedies.

The board in this case did not follow the procedure of the Rules, rather threatening a lawsuit instead.  The offending member in turn was able to use the forgotten Robert’s Rules to gain an advantage in the situation.

The article concedes that most organizations adopting Robert’s Rules will usually manage to function without a mishap.  But when circumstances arise, as in the example above, Robert’s Rules can work to the detriment of the organization.  Unless board members have read, fully understand, and mean to practice the Rules, it is best not to adopt them in their entirety.   One feasible approach may be to adopt only those sections of the Rules that are thought appropriate.  Alternately, an organization’s own bylaws may be sufficient for the purposes at hand.

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IRS Denies Tax Exemption to Non-Traditional Church Friday, Aug 21 2009 

The term “church” is not actually defined in the Internal Revenue Code but when the IRS determines what a church is for tax exemption purposes, in more recent rulings it has exhibited a disturbing lack of predictability.

The ECFA recently reported on a non-traditional church that was denied church status by the IRS earlier this year.  The organization applied for exemption as a church and religious organization (accounting for 60% of its activities) and as an educational organization by way of its seminary (40%).  Every service, from sermons to seminary classes was offered online.  There was no established physical meeting or teaching space.

In this case the IRS based its finding on several grounds in denying the organization tax exemption status; the primary basis in its adverse determination letter (found at http://www.irs.gov/pub/irs-wd/0912039.pdf) related to the characteristics needed to meet the definition of a church.

Since 1978, the IRS has typically relied upon its own fourteen-point criteria to define a church:

  1. Distinct legal existence
  2. Recognized creed and form of worship
  3. Definite and distinct ecclesiastical government
  4. Formal code of doctrine and discipline
  5. Distinct religious history
  6. Membership not associated with any other church or denomination
  7. Organization of ordained ministers
  8. Ordained ministers selected after completing prescribed courses of study
  9. Literature of its own
  10. Established places of worship
  11. Regular congregations
  12. Regular religious services
  13. Sunday schools for the religious instruction of the young
  14. Schools for the preparation of its members

This list was recognized in American Guidance Foundation v. U.S., 490 F. Supp. 304 (D.D.C. 1980).  The court however chose to emphasize certain aspects from the list above, namely factors No.6 (Membership not associated with any other church or denomination), No.10 (Established places of worship), and No.12 (Regular religious services).  Additionally, the court declared to be of central importance “the existence of an established congregation served by an ordained ministry, the provision of regular religious services and religious education of the young, and the dissemination of a doctrinal code.”

The 14 factors stated above were not accepted as a definitive test in Foundation for Human Understanding v. Commissioner, 88 T.C. 1341 (1987).  Rather the court said that the IRS must consider all facts and circumstances.

But in analyzing the facts and circumstances of this case, the IRS appears to have actually narrowed the definition of a church.  Some of its reasoning on what is considered the most important criteria is as follows:

  • Sunday School.  “Your Sunday school classes exist entirely on the Internet . . . Because there are no tests or final examinations required of these students, there is no way to establish that the students are learning their religious lessons.  Thus, as a practical matter, you have no Sunday schools for the religious instruction of the young.”

The IRS appears to expect characteristics that are present in only some American churches.  Catholic churches, for example may have “tests and final examinations” for the children to assure that they have learned their “religious lessons,” but that is not typical of most Protestant churches – traditional or otherwise.  Furthermore, not every gathering of believers has the necessary resources or teachers available to conduct Sunday school.

  • Exclusive Membership.  “You state that you do not require prospective members to renounce other religious beliefs or their membership in other churches or religious orders to become members of your church. . . .This membership is insufficient to be treated as a regular congregation.”

Certainly many churches today do not inquire into all memberships of past churches and require renunciation when the congregant is willing to accept the creed of the present church.  This again may mark a line between highly organized Catholic churches and more informal Protestant ones.

  • Size of Pastorate & Congregation.  “You have one minister, [name], ministering to your ‘congregation,’ which is composed of only [number] people.  Thus you do not have a complete organization of ordained ministers ministering to their congregations.”

Size is not listed as a factor on the 14-point list; however, this factor seems to play an important role in the IRS’s consideration.  Many churches in our country have only one pastor.  We are not privy to the size of the congregation rejected here, but in our country small churches, including spin-offs, startups, and rural churches are perhaps more the rule than the exception.

  • Internet.  “Your services are held only on the Internet.  This is not a building or a physical place.  Thus you have no established places of worship.”

The internet has generated a plethora of never anticipated legal questions.  Some examples include acceptable methods to serve process, unauthorized practice of law across state lines, and intellectual property issues.  Simply because location is difficult to pin down does not mean it does not exist, as argued here.  As the world becomes smaller through tools such as video conferencing, this issue will increase in relevance.

Regardless of whether the organization considered should have received church status recognition, if this is the analysis to be used in making future determinations, how many of our existing churches would survive this test?

Alternatives to Forming a Charitable Nonprofit Friday, Aug 7 2009 

In the July/August 2009 edition of the American Bar Association’s Business Law Today, nonprofit attorney Gene Takagi and assistant Emily Chan write about the alternatives to setting up a tax exempt charitable organization. They point out that in an environment that is increasingly competitive, the majority of new charities do not succeed.

Charity founders and their attorneys should consider many things before proceeding to file for exemption – beyond the simple questions of how, when, and what are the costs.  First, the authors stress the importance of good planning and research.  The charity should develop a business plan.  “The plan should define the nonprofit’s mission and identify its core activities, potential supporters, and targeted beneficiaries. It also should contain an assessment of the nonprofit’s environment, including its potential allies and competitors, and a projected multiyear budget.”  If there is not a “plan for viability,” good intentions alone will not provide for the needs of the intended recipients.

Secondly, charity founders need to be aware of the implications of tax exemption.  The prohibition of private inurement is a pillar of a nonprofit organization.  An ignorance of these rules could result in heavy penalties for the leadership or even a loss of tax exemption.  In addition, charities must comply with many ongoing reporting and governance obligations.

Takagi and Chan recommend considering the following alternatives:  (1) an alliance with an existing nonprofit, (2) fiscal sponsorship, or (3) a donor-advised fund.

There is no need to reinvent the wheel.  The authors point out that many charity founders do a poor job scanning other charities (over 1.8 million nonprofits last year) to find out if there are other that are already doing the same kind of work.  Collaboration may reduce a beginner’s risks while also giving the benefit of the older charity’s experience and established access to the contribution market.

A “fiscal sponsorship” is when the founders of a new charitable project form a relationship with an existing charity.  This can be set up many different ways, but it usually involves the sponsoring charity allowing the new project to benefit from its tax exempt status and other administrative support in exchange for a small portion of the funds generated for the new project.  The authors commend this arrangement but stress the importance of a well-drafted fiscal sponsorship agreement.

Takagi and Chan would direct those planning to form a grant-making private foundation to consider the benefits of using a donor advised fund instead.  These funds allow the donors to advise the sponsoring organization how they would like their contributions to be used, and these wishes will be consistently honored, though the donor technically loses control over the direction of money.  The authors list some advantages of using this method: 1) No formation costs, 2) Possibility of making immediate deductible contributions, 3) More generous deduction limits (because the sponsoring organization is a public charity), 4) No administrative, investment, or governance responsibilities (and associated risks), and 5) No need to provide oversight over grants.

The authors encourage both charitably-minded individuals and the attorneys they approach to consider some of the alternatives to forming a new tax exempt organization before assuming there is but one way to accomplish their charitable goals.

The complete article can be found at http://www.abanet.org/buslaw/blt/2009-07-08/takagi.shtml.

Minimum Wage Requirements as they Apply to Churches Saturday, Aug 1 2009 

On July 24, 2009, the federal minimum wage increased from $6.55 to $7.25 for those covered by the Fair Labor Standards Act (FLSA).  Where the state and federal minimum wage both apply but differ, the federal rate will apply when higher.  Some states have a higher minimum wage, some lower, and some mirror the federal rate.  Another major provision for employees under the FLSA is time and a half pay for work done in excess of 40 hours a week.

When does the FLSA apply?

Application of the Fair Labor Standards Act

There are two general cases under which an employee is covered by the FLSA rules:

  • Enterprise Basis – All employees working for organizations that engage in interstate commerce and that do at least $500,000 of business each year are covered.  Also included are all employees of hospitals, businesses providing medical or nursing care for residents, schools and preschools, and government agencies.
  • Individual Basis – All employees whose work regularly involves them in “interstate commerce” are covered.  This includes employees that regularly phone, mail, or travel out of state.  Also most “domestic service workers,” such as day workers, housekeepers, chauffeurs, cooks, or full‑time babysitters are included.

It has not always been clear to what extent the FLSA affects churches and other nonprofits.  The “Enterprise Basis” can apply to a church that brings in over $500,000 a year in activities that compete with for-profit business, such as the rental income provided from leasing their facilities to others.  Many churches run schools, which also puts them under the “Enterprise Basis.”[i] Under the “Individual Basis” church employees are regularly doing activities that can be construed as interstate commerce, such as telephoning, mailing, or traveling out of state.  In addition, most churches have domestic service workers that would be covered by the Act.

If these organizations are involved in interstate commerce, they are not exempt from the FLSA rules on the basis of their tax-free status.  The Supreme Court in Alamo Foundation v. Secretary of Labor[ii] was referring to the FLSA when it stated, “[T]he statute contains no express or implied exception for commercial activities conducted by religious or other nonprofit organizations, and the agency charged with its enforcement has consistently interpreted the statute to reach such businesses.”[iii]

But how do churches know whether they are engaging in “interstate commerce?”

One view comes from Kathleen Turpin, an expert in employment law and author of Working Together, A Guide to Employment Practices for Ministries.  She recommends asking the following questions to help churches determine if the FLSA applies to them:

  • Do we order teaching materials or other supplies from out of state?
  • Do we send newsletters or other information to people out of state?
  • Does anyone on staff travel out of state as part of their job?
  • Does our ministry have a Website where people out of state order items?

According to Turpin if the answer to any one of these questions is in the affirmative, the organization is probably engaging in interstate commerce and needs to comply with the FLSA.

Possible Exemptions for Clergy & Other Religious Workers

Even if an organization’s employees are determined to be engaging in interstate commerce, some of its employees may yet be exempt from FLSA coverage.  One exception is found in the language of the FLSA which excludes “administrative, executive, and professional employees.”  The Dept. of Labor explains that this generally includes those that would otherwise be covered by the FLSA but earn at least $455 a week on a salaried basis.  Because this category is already above the minimum wage, the only noticeable difference from being covered under the Act is the lack of required overtime pay.

The 4th Circuit Court has also recognized a “ministerial exemption” to the FLSA, first argued in Shenandoah Baptist Church[iv] and discussed more fully in the 2004 case of Shaliehsabou v. Hebrew Home of Greater Wash., Inc.[v] The exemption can exclude a member of the clergy from being an “employee” within the FLSA meaning.  The notion of this exemption derived from a debate on the floor of Congress that was later delineated in some guidelines issued by the Dept. of Labor’s Wage and House Administrator.[vi] The relevant portion of those guidelines provides:

“Persons such as nuns, monks, priests, lay brothers, ministers, deacons, and other members of religious orders who serve pursuant to their religious obligations in schools, hospitals, and other institutions operated by their church or religious order shall not be considered to be ‘employees.’”[vii]

The 4th Circuit went on to use Title VII descriptions of “ministerial duties” to come up with the “primary duties” test to determine whether the exception applies.  They focused on “the function of the position,” rather than whether the person was formally ordained.  “[A]s a general rule, if the employee’s primary duties consist of teaching, spreading the faith, church governance, supervision of a religious order, or supervision or participation in religious ritual and worship, he or she should be considered ‘clergy.’”[viii]

Therefore, even though the clergy of a church are not covered by the FLSA due to the “ministerial exemption,” exemptions to the general rule are construed narrowly, and other employees may be covered by the FLSA.  Thus regarding these employees, the church is obliged to comply with minimum wage and overtime regulations.

Volunteers Not Covered by FLSA

Although the definition of “employee” under FLSA (found in Title 29 § 203 of the U.S. Code[ix]) is more sweeping than its use in other government regulations (such as ERISA), it does not include those who volunteer their time to a charitable organization.

There is not a specific exemption mentioned in the FLSA for church or charity volunteers in the private sector but the enforcers of the FLSA have interpreted it as if there was such an exemption.[x] But it is important to note that even if workers consider themselves “volunteers,” their intent alone will not exclude them from FLSA rules if they are accepting some other form of compensation.  In the Alamo case, former drug addicts who were working for free for the organization, considered themselves volunteers, but they were also residing there for free.[xi] This benefit transformed the workers from the “volunteer” category to “employee status.”[xii]

Churches thus need to be aware of the ramifications associated with rewarding volunteers for their labors.  Volunteers may be compensated for reasonable expenses directly associated with their work (gas money, etc) and accept small conveniences on the job (such as meals) as long as benefits in lieu of compensation do not exceed $500 a year.   If an organization is overly compensating its volunteers, it becomes seen as an employer in the eyes of the government, and the organization could face actions by the worker or the Dept. of Labor for not complying with FLSA wage laws.



[i] Dole v. Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990).

[ii] Alamo Foundation v. Secretary of Labor, 471 U.S. 290.

[iii] Id. at 296-7.

[iv] Shenandoah Baptist Church, 899 F.2d 1389 (4th Cir. 1990)

[v] Shaliehsabou v. Hebrew Home of Greater Wash., Inc., 363 F.3d 299

[vi] Shaliehsabou, at 305.

[vii] Id.

[viii] Id., quoting Bruce N. Bagni, Discrimination in the Name of the Lord: A Critical Evaluation of Discrimination by Religious Organizations, 79 Colum. L. Rev. 1514, 1545 (1979).

[ix] Fair Labor Standards Act – Title 29 § 203(e)(1) Except as provided in paragraphs (2), (3), and (4), the term “employee” means any individual employed by an employer;  (g) “Employ” includes to suffer or permit to work.

[x] Walling v. Portland Terminal Co., 330 U.S. 148 at 152, stating “Section 3(g) of the Act defines ’employ’ as including ‘to suffer or permit to work’ and § 3(e) defines ’employee’ as ‘any individual employed by an employer.’ The definition ‘suffer or permit to work’ was obviously not intended to stamp all persons as employees who, without any express or implied compensation agreement, might work for their own advantage on the premises of another. Otherwise, all students would be employees of the school or college they attended, and as such entitled to receive minimum wages. So also, such a construction would sweep under the Act each person who, without promise or expectation of compensation, but solely for his personal purpose or pleasure, worked in activities carried on by other persons either for their pleasure or profit. But there is no indication from the legislation now before us that Congress intended to outlaw such relationships as these. The Act’s purpose as to wages was to insure that every person whose employment contemplated compensation should not be compelled to sell his services for less than the prescribed minimum wage. The definitions of ’employ’ and ’employee’ are broad enough to accomplish this. But, broad as they are, they cannot be interpreted so as to make a person whose work serves only his own interest an employee of another person who gives him aid and instruction.”

See also Alamo, at 295 stating, “An individual who, without promise or expectation of compensation, but solely for his personal purpose or pleasure, works in activities carried on by other persons either for their pleasure or profit, is outside the sweep of the Fair Labor Standards Act.”

[xi] Alamo, at 293, stating “[T]he associates who worked in these businesses were ‘employees’ of the Alamos and of the Foundation within the meaning of the Act. The associates who had testified at trial had vigorously protested the payment of wages, asserting that they considered themselves volunteers who were working only for religious and evangelical reasons. Nevertheless, the District Court found that the associates were ‘entirely dependent upon the Foundation for long periods.’  Although they did not expect compensation in the form of ordinary wages, the District Court found, they did expect the Foundation to provide them ‘food, shelter, clothing, transportation and medical benefits.’”

[xii] Alamo, at 290, stating “The Foundation’s associates are ‘employees’ within the meaning of the Act, because they work in contemplation of compensation. Walling v. Portland Terminal Co., 330 U.S. 148, distinguished.  The fact that the associates themselves protest coverage under the Act is not dispositive, since the test of employment under the Act is one of ‘economic reality.’  And the fact that the compensation is primarily in the form of benefits rather than cash is immaterial in this context, such benefits simply being wages in another form.”

Pulpit Freedom: Right or Privilege? Saturday, Jul 25 2009 

Last week Tax Analysts reported that Alliance Defense Fund (ADF) intends to continue pushing “Pulpit Freedom Sunday” each year until the IRS is provoked to action.  Its debut last September involved 32 pastors speaking out boldly expressing their views on candidates and issues related to the election the following November.

Since the Johnson Amendment of 1954 (brought by Senator Lyndon B. Johnson), tax exempt organizations, including churches, have been prohibited from endorsing or opposing political candidates for public office.  Although this prohibition includes sermons, since its implementation, ADF reports that no pastors have been punished for violating it, nor have any churches lost tax exemption.

But the ADF maintains that the law encroaches upon the 1st Amendment right to freedom of speech, and even though no action has been taken under the restriction, it has silenced many churches that would otherwise be vocal.  Furthermore, ADF attorney Erik Stanley says that the current law is unclear, making it difficult for pastors – even lawyers – to know how to interpret its restrictions.  The “Pulpit Initiative” is intended to push the constitutional issue and bring clarity.  This year the ADF is calling for two courses of action.  To challenge the constitutionality of the Johnson Amendment, pastors are challenged to speak for and against candidates running for public office.  But to also educate more pastors of their rights, ADF is encouraging them to boldly speak their views of incumbent politicians, something permitted under current law.

A foundational question at issue is whether a church’s tax exemption is a privilege or a right.

Most people consider a “right” to be something inherent – and consequently very difficult to take away.  But what aspect of a church would make its right to tax exemption inherent?  Some point to the long history of such exemptions, but others would attribute the right to the role that churches fulfill.  Historically, much of the work done by churches has been viewed as the kind that which would naturally fall upon the government in the absense of the churches, such as performing acts of benevolence for the needy or attending to the “mental health” of their congregations.  Consequently, under this theory, the government exempts churches from taxes to encourage this necessary work.  In that sense the churches might loosely be considered to be distant arms of the government, using government funds to accomplish government work.  If the church becomes involved in partisan activities – work that is not nor should be performed by the government, those activities would not be exempted from taxation because they do not fulfill any charitable role of the government.

In any case, the Supreme Court has declared that tax exemption is not an inherent right.  In the 1970 case of Walz v. Tax Commission of the City of New York, the Court in a 5-4 decision preserving property tax exemption for a church said that the exemption was “permissible, but not constitutionally required.”  Going a step further in 1972, the Court of Christian Echoes National Ministry, Inc. v. U.S. said, “tax exemption is a privilege, a matter of grace rather than a right.”  But a bigger shift came in the 1983 case of Regan v. Taxation with Representation when the Court compared the exemption to a “tax subsidy.”

If exemption is indeed seen as a privilege or a subsidy, the church is getting some benefit beyond what is due them inherently and should not be surprised to see guidelines prescribing behavior.  Already existing examples include the prohibition against private inurement and unreasonable compensation, as well as the administrative burdens of tracking unrelated business income or monitoring international grants closely.  For various rationales, all these conditions come along as a result of the tax benefit provided.

But in a public debate on the Johnson Amendment this past May, Professor Douglas Laycock from the University of Michigan Law School argued the existence of “unconstitutional conditions” – that there are certain rights that cannot be withheld in exchange for government benefits.  Without this protection great abuse would result.  As an example that this doctrine is weakening, ADF’s chief counsel Ben Bull pointed out that ADF is currently defending a church that refused to perform a civil union for a lesbian couple, and its exemption is now threatened because the IRS claims they are no longer operating in the “public interest.”

So perhaps the greater fear is not the loss of the right to endorse a candidate, but that the pendulum is not done swinging and the conditions for tax exemption grow more invasive.  ADF is currently defending in several cases where, in their own words, “publicly preaching words straight from the Gospel has led to censorship…and even jail.”  Regardless of the uncertain outcome of those cases, the enacted Johnson Amendment already bans pastors around election times from speaking on moral issues that are fair game during non-election season – even though they mention no candidates by name.  If a pastor’s sermon could be construed as an endorsement, it’s off limits. The vagueness of the standard alone leaves a lot of room for the pendulum to continue swinging.

Pulpit Freedom: Right or Privilege? Saturday, Jul 25 2009 

Last week Tax Analysts reported that Alliance Defense Fund (ADF) intends to continue pushing “Pulpit Freedom Sunday” each year until the IRS is provoked to action.  Its debut last September involved 32 pastors speaking out boldly expressing their views on candidates and issues related to the election the following November.

Since the Johnson Amendment of 1954 (brought by Senator Lyndon B. Johnson), tax exempt organizations, including churches, have been prohibited from endorsing or opposing political candidates for public office.  Although this prohibition includes sermons, since its implementation, ADF reports that no pastors have been punished for violating it, nor have any churches lost tax exemption.

But the ADF maintains that the law encroaches upon the 1st Amendment right to freedom of speech, and even though no action has been taken under the restriction, it has silenced many churches that would otherwise be vocal.  Furthermore, ADF attorney Erik Stanley says that the current law is unclear, making it difficult for pastors – even lawyers – to know how to interpret its restrictions.  The “Pulpit Initiative” is intended to push the constitutional issue and bring clarity. This year the ADF is calling for two courses of action.  To challenge the constitutionality of the Johnson Amendment, pastors are challenged to speak for and against candidates running for public office.  But to also educate more pastors of their rights, ADF is encouraging them to boldly speak their views of incumbent politicians, something permitted under current law.

A foundational question at issue is whether a church’s tax exemption is a privilege or a right.

Most people consider a “right” to be something inherent – and consequently very difficult to take away.  But what aspect of a church would make its right to tax exemption inherent?  Some point to the long history of such exemptions, but others would attribute the right to the role that churches fulfill.  Historically, much of the work done by churches has been viewed as the kind that which would naturally fall upon the government in the absense of the churches, such as performing acts of benevolence for the needy or attending to the “mental health” of their congregations. Consequently, under this theory, the government exempts churches from taxes to encourage this necessary work.  In that sense the churches might loosely be considered to be distant arms of the government, using government funds to accomplish government work. If the church becomes involved in partisan activities – work that is not nor should be performed by the government, those activities would not be exempted from taxation because they do not fulfill any charitable role of the government.

In any case, the Supreme Court has declared that tax exemption is not an inherent right.  In the 1970 case of Walz v. Tax Commission of the City of New York, the Court in a 5-4 decision preserving property tax exemption for a church said that the exemption was “permissible, but not constitutionally required.”  Going a step further in 1972, the Court of Christian Echoes National Ministry, Inc. v. U.S. said, “tax exemption is a privilege, a matter of grace rather than a right.”  But a bigger shift came in the 1983 case of Regan v. Taxation with Representation when the Court compared the exemption to a “tax subsidy.”

If exemption is indeed seen as a privilege or a subsidy, the church is getting some benefit beyond what is due them inherently and should not be surprised to see guidelines prescribing behavior.  Already existing examples include the prohibition against private inurement and unreasonable compensation, as well as the administrative burdens of tracking unrelated business income or monitoring international grants closely. For various rationales, all these conditions come along as a result of the tax benefit provided.

But in a public debate on the Johnson Amendment this past May, Professor Douglas Laycock from the University of Michigan Law School argued the existence of “unconstitutional conditions” – that there are certain rights that cannot be withheld in exchange for government benefits. Without this protection great abuse would result. As an example that this doctrine is weakening, ADF’s chief counsel Ben Bull pointed out that ADF is currently defending a church that refused to perform a civil union for a lesbian couple, and its exemption is now threatened because the IRS claims they are no longer operating in the “public interest.”

So perhaps the greater fear is not the loss of the right to endorse a candidate, but that the pendulum is not done swinging and the conditions for tax exemption grow more invasive.  ADF is currently defending in several cases where, in their own words, “publicly preaching words straight from the Gospel has led to censorship…and even jail.” Regardless of the uncertain outcome of those cases, the enacted Johnson Amendment already bans pastors around election times from speaking on moral issues that are fair game during non-election season – even though they mention no candidates by name.  If a pastor’s sermon could be construed as an endorsement, it’s off limits. The vagueness of the standard alone leaves a lot of room for the pendulum to continue swinging.

Defining “Excessive UBI” Monday, Jul 20 2009 

Unrelated business income (UBI) occurs when a nonprofit organization engages in a trade or business that is regularly carried out that is not substantially related to that organization’s exempt purposes.  Charities must pay taxes on this UBI in a manner similar to their for-profit counterparts.  In addition to taxes, however, the charities are not permitted to carry on too much unrelated business without endangering their tax-exemption.  The rules for determining firstly what constitutes unrelated business and secondly whether there is excessive UBI are generally acknowledged to be murky areas of the law.

Issue 1:  What is Unrelated Business?

Commerciality doctrine.  The first issue of determining whether the activity of a tax-exempt organization is considered unrelated business is controlled by what has come to be known as the “commerciality doctrine.”  Because this judge-made doctrine has taken on varying definitions and interpretations, it currently lacks uniform application and consequently requires a separate article from this one to depict its evolution in the courts.  But in short, it is described by nonprofit expert Bruce R. Hopkins this way:  “A tax-exempt organization is considered to be engaged in a nonexempt activity when that activity is engaged in a manner that is classified as commercial in nature.  An activity is a commercial one if it has a direct counterpart in, or is conducted in the same manner as is the case in, the realm of for-profit organizations.”  Once the charity’s activity is determined to be unrelated business, the second issue must be considered.

Issue 2:  How much UBI will be considered “excessive UBI” and consequently jeopardize the charity’s tax exempt status?

As mentioned above, the unrelated business income tax (UBIT) on a charity’s UBI might not be the only consequence.  Too much unrelated business can jeopardize the tax exempt status of a charity.

Case Law.  Public charities establish and keep their tax exempt status by being organized and operated exclusively for exempt purposes as specified in IRC § 501(c)(3).  Although courts sometimes substitute the word “primarily” in place of “exclusively” the latter is still the correct term of art.  According to Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633, its definition is no longer open for debate. The Court of Manning Association v. Commissioner, 93 T.C. 596 explains:

“The word ‘exclusively’ has not been literally construed to mean ‘solely’ or ‘absolutely without exception,’ Church in Boston v. Commissioner, 71 T.C. 102, 107 (1978), and we have recognized that ‘a nonexempt purpose even perhaps somewhat beyond a de minimis level has been permitted without loss of exemption,’ Copyright Clearance Center v. Commissioner, 79 T.C. 793, 805 (1982).  Nevertheless, there is a limit beyond which the statute may not be stretched. That limit was set forth by the Supreme Court in Better Business Bureau v. United States, 326 U.S. 279, 283 (1945), as follows:

‘[T]he presence of a single [nonexempt] * * * purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly [exempt] * * * purposes.’”

The case of Goldsboro Art League v. Commissioner 75 T.C. 337 puts it like this:

“A substantial nonexempt purpose will disqualify an organization from tax exemption despite the number or the importance of its exempt purposes. * * * Whether an organization satisfies the operational test is a question of fact.”

Therefore, a nonexempt purpose cannot be “substantial” or it will jeopardize the tax exempt status.  This determination is based on the specific facts of each situation.

In reality, neither case law nor the IRS has given any kind of formula for determining the parameters of “insubstantial” UBI.  Rarely are the actual numbers in these cases recorded for our analysis.  In the case of New Faith, Inc. v. Commissioner, T.C. Memo 1992-601, the charity’s commercial activity accounted for approximately 80% of its gross expenditures and nearly 100% of its gross revenues; the charity’s tax exemption was lost in this case.   The case of Church in Boston v. Commissioner, 71 T.C. 102, involved a situation where 20% UBI was found to be too substantial, also resulting in the lost of tax exemption.  That Court stated:

“These facts demonstrate that petitioner’s * * * nonexempt activities * * * are more than incidental or a ‘slight and comparatively unimportant deviation from the narrow furrow of tax approved activity.’ St. Louis Union Trust Co., 374 F.2d 427 at 432-433.”

The court of Manning actually refutes the notion of any safe harbor and stresses again that each case is decided on its individual facts.  In Manning, the charitable organization was erroneously interpreting previous case law to mean that it could safely devote up to 10% of its activities to UBI:

“Petitioner calls attention to World Family Corp. v. Commissioner, 81 T.C. 958 (1983), as suggesting, in petitioner’s words, that ‘where a nonexempt function represents less than ten percent of total efforts, the doctrine of ‘exclusively’ will not be contravened.’ It then treats that suggestion as a ‘rule of law’ establishing a ‘10-percent safe harbor’ limitation, and undertakes to show that only about 10 percent of the time was expended by its officers and others on its behalf on matters relating to genealogy while some 90 percent of efforts were devoted to other matters such as negotiating the lease, etc.  * * * [C]ontrary to petitioner’s position, World Family Corp. v. Commissioner establishes no such 10-percent safe harbor rule.” [Emphasis added]

In fact, the Court in World Family Corp. v. Commissioner (81 T.C. at 967 n. 10) stated:

“We establish no general rule for future cases in finding 10 percent to be insubstantial. We noted a similar caveat in Church in Boston in which we found approximately 20 percent of expenditures to constitute more than an insubstantial activity: ‘We hasten to point out that while the facts in the instant case merit a denial of exempt status to petitioner, we do not set forth a percentage test which can be relied upon for future reference with respect to nonexempt activities of an organization. Each case must be decided upon its own unique facts and circumstances.’ Church in Boston v. Commissioner, 71 T.C. 102, 108 (1978). [Emphasis added]

Before harkening back to the test iterated in the Better Business Bureau case, supra, the Manning Court went on to say, simply:

“This case must also be decided upon its own unique facts and circumstances. It is unnecessary for us to ‘make a determination based upon some economical and moral calculus * * *. It is sufficient only to find, as we do, that ‘more than an insubstantial part of its activities is not in furtherance of an exempt purpose.’’  Christian Stewardship Assistance, Inc. v. Commissioner, 70 T.C. 1037, 1042 (1978).”

Therefore case law gives no clear guidelines and even explicitly rejects “safe harbors” for this area, though the cases show that at least 20% can be too much.  But the courts refuse to be pinned down on to a particular ratio and reserve the right to examine the facts and circumstances of each case before making a determination of excessive UBI.

Expert Opinion: 15% to 30% borders excessive UBI.  Below are the general impressions from different attorneys and nonprofit experts regarding what constitutes excessive UBI.  Most feel that 15% to 30% is as far as an exempt organization should push the limit.

Mosher & Associates is a firm out of Chicago that specializes in nonprofit legal issues.  In an article entitled “Learning to Recognize and Manage Unrelated Business Income Tax” found in their first quarterly report of their Nonprofit Update in 2007, they write:

“[T]oo much unrelated business activity can jeopardize an organization’s tax-exempt status. While no set limit exists, as a general rule, organizations generating more than 20% of their gross revenues should consider setting up a subsidiary to conduct such business activities.”

In an article on UBI from the Ann Arbor law firm Magill & Rumsey, P.C.,

“Organization leaders must also be attentive to excessive unrelated business income. A large proportion of unrelated business income could indicate that the organization is not organized and operated primarily for its tax-exempt purposes. While there appears to be no hard and fast rule, many authorities believe that a safe level of gross unrelated business income is 20 to 30% of the organization’s total income depending upon the specific organization and the nature of activities involved.”

On the other hand, Wendell Bird, a nonprofit expert out of Atlanta, wrote the following in his 1999 article “Publishing Activities of Exempt Organizations” appearing in Tax Exempt Organizations.  Although it is geared to address publishing activities, the case seems to suggest that there are circumstances where UBI that exceeds 50% is permissible.

“In more recent technical advice, the Service ruled that a religious college and school that operated a publishing division that ‘amounted to more than one-half of the organization’s total receipts,’ and was well beyond the textbook needs of the college and school, generated UBI but did not revoke the exemption.  This was so even though the pricing was ‘probably comparable to ordinary commercial prices,’ and the sales methods were ‘indistinguishable from ordinary commercial sales practices.’”

Commensurate-in-scope doctrine. Lastly this doctrine, built from a 1964 Revenue Ruling and a 1971 General Counsel Memorandum, seems to allow some organizations to maintain very high levels of UBI in relation to their total revenue if the UBI goes directly to further the charitable purposes.  This is sometimes called “destination of income” test.  This test looks to see if there is “real, bona fide, or genuine charitable purposes, as manifested by the charitable accomplishments of the organization, and not a mathematical measuring of business purpose as opposed to charitable purpose.”  Gen. Couns. Mem. 32869 (Oct. 9, 1963).   The case involved in the 1964 Rev. Rul. involved a charity that had was earning substantial amounts of rental income from its property and giving it to charitable purposes.

But this doctrine cannot be safely relied upon by charities as there are many cases that clearly state that just because an organization uses its profits for charitable purposes does not mean that the excessive UBI is excused.  According to Fishman & Schwarz’s Nonprofit Organizations, a distinction may be drawn between these seemingly contradictory cases.  The founding cases for the commensurate-in-scope doctrine all involved situations of passive income sources such as rental income.  Passive sources of income such as dividends, interest, and royalties often do not even qualify for UBIT, based upon the rational that they are not as disruptive to the for-profit market.  Ultimately, Fishman & Schwarz do not recommend placing heavy reliance upon this doctrine, as it is in great need of more clarification.

For Profit Entities to avoid Excessive UBI.  In light of the difficulty involved in drawing clear lines around excessive UBI, many charitable organizations choose to spin their commercial activities off into a for-profit organization.  Although it comes with downsides, this format can prevent the charity from jeopardizing its vital tax exempt status.

International Grant-Making: Policies for Public Charities Thursday, Jun 4 2009 

Tax-exempt 501(c)(3) public charities must take special precautions when making grants to foreign organizations.  Though currently less encumbered than private foundations, public charities have become increasingly more regulated in foreign grantmaking since September 11, 2001.

When a public charity disburses funds to an individual or organization, foreign or domestic, it must be for exempt purposes.  If the recipient is a foreign organization that has a US Determination Letter, a presumption will be raised that the funds will be used for exempt purposes – the same as if the recipient were an exempt domestic organization.  The result is a reduced burden on the granting charity to monitor the use of funds by the grantee.

If, however, the foreign grantee does not have a US Determination Letter, the public charity may still support that grantee (Rev. Rul. 68-489), but the burden shifts to the US charity to show that the foreign organization’s activities are consistent with the US charity’s exempt purpose and that the US charity was not merely a conduit from individual donors to the foreign organization (which would not be deductible).  This independence is established when the US charity maintains discretion and control over its grant funds.  The IRS determination of proper “discretion and control” has proven to be a fact-intensive one, decided on a case by case basis.

Therefore a public charity involved in foreign grantmaking is advised to establish and adhere to clear grantmaking procedures in its bylaws, documenting its efforts to maintain discretion and control.  With these in place, the charity is afforded greater protection from an adverse IRS ruling in the event of an audit.  Some “best practice” principles to guide the formation of these grantmaking policies are:

  • Board requires written grant proposals from foreign grantee
  • Board pre-approves all foreign grants and only after detailed review of the grant proposal and further investigation if necessary
  • Board reserves the right to refuse grants that are requested from foreign organizations, withdraw approval of a grant, or even request to receive a refund of any unused grant funds
  • Charity and foreign grantee have a written agreement as to the use of the funds
  • Grants are given only for projects that are actually in furtherance of the US charity’s exempt purposes, avoiding support for mere administrative expenses of grantee
  • Board distributes grant funds on an “as needed” basis
  • Foreign grantees do not receive any funds earmarked for them by donors; disbursement should come from the charity’s general fund
  • Board requires periodic accountings of grant funds by the foreign grantee
  • Board members, committee members, or volunteers conduct regular on-site visits to project locations to ensure the funds are being used in accordance with the terms of the grant agreement

In addition, the US Treasury released a 2006 updated version of “Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities” in an effort to ensure that funding is used for the proper exempt purposes of the US charities, helping them avoid abuse by fraudulent or terrorist organizations.  The paper addresses principles of accountability and transparency in governance, financing, and programming.   It can be located at: http://www.ustreas.gov/press/releases/reports/0929%20finalrevised.pdf.

Changes to the Form 990: Be in the Bigger Stack Monday, Jun 1 2009 

After nearly thirty years of no changes, the IRS has revamped Form 990, the annual return that charities and other tax-exempt organizations are required to file.  In an effort to gain greater transparency, the form now requires more detailed reporting from filers.  On the one hand, the extra information sought allows the charities to explain their activities more fully to the IRS (and to the donor pool, as the form is made publically available), but it also gives the IRS more indicators in determining whether each charity deserves to retain its tax exempt status.

As the IRS sorts through the stack of over a million 990’s and divides them into two piles, every charity wants to be placed in the bigger of the two – the pile containing no red flags.   The other stack consists of those forms that raise concerns which may result in an audit, or could ultimately result in the loss of the precious tax-exempt status.

The new 990 which is effective for the 2008 tax year,  takes the shape of an eleven-page “core form” which includes a summary, along with sixteen (previously only two) schedules to be completed where applicable.  Beyond simple reorganization, more impactful changes in the new form include 1) graduated transition for smaller organizations whereby they are permitted to file the 990-EZ rather than the full 990, 2) substantial revisions to the reporting of the organization’s compensation of officers, directors, trustees, key employees, and highest compensated employees, 3) new disclosures regarding donor advised funds and other similar funds or accounts, museums and other organizations maintaining collections, conservation organizations,  trust and escrow arrangements, endowment funds, and other investments, 4) new reporting requirements for joint ventures less than 50% owned by the organization to be reported, 5) new information required regarding arrangements with professional fundraisers, special events, and gaming activities, 6) entirely new schedules for reporting on foreign activities, hospitals, tax-exempt bonds, transactions with interested persons, and non-cash contributions,  and finally 7) a revised Instructions section with a glossary containing new definitions.

Section VI on Core Form 990

An aspect of the new form that charities may mistakenly consider to be insignificant is Section VI which asks about the organization’s governance, management, and disclosure policies.  The reason this may be overlooked is because the form itself specifies that the policies addressed in the “yes/no” questions of that section are not legally required to be in place.  The questions pertain to such things as the independence of board members, what process is used to review Form 990 and whether the organization lets its board see it before it is filed, whether it has a conflict of interest policy in place, a whistle blower policy, a document retention and destruction policy, whether it takes minutes during meetings, delegates anything to a management company, and whether it makes its Form 1023 and governing documents publically available for inspection.

But it is clear that the IRS considered these policies more than “suggestions” by this official statement: “Even though governance, management, and disclosure policies and procedures generally are not required under the Internal Revenue Code, the IRS considers such policies and procedures to generally improve tax compliance.”  The takeaway message from this statement should be clear.  Although it is not required by law for a tax-exempt organization to have certain policies in place, an organization places itself at much greater risk of suspicion if it does not.   Without proper accountability policies in place, the IRS is less confident that the organization is not engaging in nonexempt activity or private inurement.

For a Christian organization, many of the IRS-suggested policies are required anyway if it wants to become a certified member of the reputable group ECFA (Evangelical Council for Financial Accountability).  The ECFA certification indicates to donors that the charity complies with ECFA criteria in the following seven areas: 1) Doctrinal Statement, 2) Board of Directors and Financial Oversight, 3) Financial Statements, 4) Use of Resources, 5) Financial Disclosure, 6) Conflicts of Interest, and 7) Fund-Raising.

More than before, it is becoming important to shape organizational policies around the Form 990.  It would be useful to perform a “practice run” with the Form 990 earlier in the year before it is time to file.  The board would be able to see in black and white what the public (much less the IRS) would see and how the organization’s practices and policies might affect its reputation, which is invaluable to an organization dependent on donors.  A practice run allows the organization to focus on topics spotlighted on the form while there is still time to make changes.  (Only changes made during the tax year are reflected on the 990, even if made before filing the following year.)

The donors want to know precautionary policies are in place, and the IRS certainly does as well.  It is always desirable to be in the IRS’s bigger stack.

Welcome Monday, Jun 1 2009 

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