Ruling Could Mean More Scrutiny by IRS

A recent ruling by the U.S. Tax Court that a charity’s outside fund-raising consultant could be considered an “insider” has given the Internal Revenue Service a new tool to go after charities in search of improprieties, a lawyer who represented the non-profit organization in the case told a meeting of Washington lawyers.

The court concluded that the I.R.S. was right to revoke the tax-exempt status of the United Cancer Council, an Indianapolis health charity that had a contract with the Watson and Hughey Company, a fund-raising consultant, even though company officials were not charity board members or officials (The Chronicle, December 11).

“There’s a lot of room for the I.R.S. to challenge a contract under this decision,” Leonard J. Henzke, Jr., one of the lawyers for the council, told a program on the case sponsored by the District of Columbia Bar.

In his opinion, Tax Court Judge Herbert L. Chabot said that part of the net earnings of the cancer council had improperly “inured to the benefit” of an insider — Watson and Hughey, a Virginia company that later changed its name to Direct Response Consulting Services.

Mr. Chabot said that Watson and Hughey was an insider at the charity because the company’s contract gave it so much control over the charity’s finances and fund raising.

The judge said that the compensation that Watson and Hughey received from United Cancer Council, through the company’s use of mailing-list names and from direct payments for its services, exceeded what could legally be considered reasonable compensation.

Mr. Henzke said the ruling appeared to mark the first time a court applied the prohibition on inurement beyond the “insiders” commonly thought of — officers, directors, and employees — to an outside group.

The court’s action, he said, gives the revenue service a green light to examine other charities that have fund-raising, management, or other kinds of contracts with companies and to look for improper “control” by the firms over some aspect of the charities’ operations.

The Tax Court ruling also will make charity board members nervous, said Mr. Henzke, in light of a law passed in 1996 that allows the revenue service to fine top executives and board members of charities who approve or receive overly generous financial benefits.

If the I.R.S. gets more aggressive at looking at charity contracts with companies, it could hold charity board members responsible for approving any deals it thinks are inappropriate, he said.

Mr. Henzke noted that one provision of the new law makes clear that charity board members and other officials could avoid trouble with the I.R.S. if they make compensation decisions by relying on data and studies that show how much money other charities are paying in similar situations.

“That’s rather easy to do when you are dealing with the salary of the chief executive,” said Mr. Henzke. “But if a university wanted to enter into a 20-year contract with an outside contractor to manage its golf course, you are just not going to find any data or statistics as to what would be reasonable in that kind of situation.”