A Controversial Provision Requires Charities to Tell IRS About Misdeeds of Top Officials

The Internal Revenue Service is seeking help from some unusual quarters as it enforces a law designed to punish

charity executives and trustees who commit financial misdeeds. Following a directive from Congress, the IRS asks charities to report anyone who has received what it calls an “excess benefit” — such as overly generous salaries, retirement benefits, or contracts for services — on the informational tax returns, or Form 990, they submit annually. Charities must also provide copies of those forms to anyone who asks to see them.

Many charities and nonprofit lawyers take issue with the requirement that they blow the whistle on wrongdoing at their own organization.

“Many charities are understandably concerned about their donor community’s reaction to such a disclosure,” says Carolyn Klamp, a lawyer for the Asher Student Foundation, in Los Angeles, which reported its board chairman to the IRS, and sought its help in dealing with financial irregularities.

Varied Interpretations

Beyond the public-relations problem, another difficulty with the self-reporting requirement is that different charities are interpreting it very differently, says Marc Owens, who oversaw charity compliance with tax rules at the Internal Revenue Service until 2000. As a result, the law isn’t being applied consistently.

“One group is calling something excessive, while on the other side of town another group isn’t doing any reporting at all” for the same sort of transaction, Mr. Owens says. Even if the IRS catches the second group doing something wrong, it would not be fined for failing to report a problem, he says. If such reporting is required, he suggests that charities that flout the law should be fined.

Another challenge, notes Mr. Owens, is that the people the law covers are those most influential at a charity, including the chief executive and the board of directors. “If the individual who’s receiving the benefit dominates the organization, it has little incentive to change what it does,” he says.

Evelyn Brody, a professor at Chicago-Kent College of Law who specializes in nonprofit tax law, says the public-disclosure requirement could open charities to defamation lawsuits if they accuse someone of committing a crime.

“Are you supposed to disclose facts that might lead somebody to think there was an excess benefit?” she says. “What if the IRS doesn’t agree? What if they agree but no amount is assessed? Then the employee can say, ‘You maligned me, I can’t get a job, I have a civil suit against you.’”

Getting Attention

Catherine Livingston, a lawyer who served at the Treasury Department while the law was being drafted and worked closely with Congress to shape it, says that when she was in private practice, her clients didn’t reach that stage, because fear of the consequences drove them to make sure there wouldn’t be any problems to report.

The public-reporting requirement, says Ms. Livingston, who has recently rejoined the Treasury Department, serves as a good way to make sure charities are paying attention to whether they have any problems with overly high compensation or other such issues. “You remind your clients they have to sign the 990,” she says. “It puts pressure on the client to not turn a blind eye to troubling information.”