Rethinking Charity Rules

Senate panel offers 200 ideas for revising nonprofit regulation

In one of the most sweeping Congressional discussions of nonprofit groups in the past two decades, key senators

and nonprofit officials are debating the role government should play in monitoring and regulating philanthropic activity.

This week, nonprofit officials will have a formal opportunity to respond to more than 200 ideas concerning how government regulates the activities of charities, foundations, and donors, floated last month by aides to a Senate committee a day before it held a hearing in which it opened a comprehensive review of nonprofit organizations.

At the hearing, Sen. Max S. Baucus, of Montana, the top-ranking Democrat on the Senate Finance Committee, which oversees nonprofit organizations, described a field marred by inflated salaries, insider deals, and evasive tax shelters — and trumpeted the need for extensive legislative reform.

“This proliferation of sloppy, unethical, and criminal behavior is unacceptable,” Senator Baucus said. “It has led to a crisis in confidence. It has hurt fund raising by legitimate charities. And it overshadows the good work done by the majority of civic-minded groups.”

Many officials in the nonprofit world, including Diana Aviv, president of Independent Sector, a coalition of about 600 nonprofit groups and grant makers, say they welcome the attempt by lawmakers to curb charitable abuses. But Ms. Aviv cautioned that legislative and regulatory efforts need to proceed slowly so that they don’t harm the many small charities that operate properly.

“The Finance Committee has raised the red flag that business as usual is no longer acceptable,” Ms. Aviv says. “They have issued a challenge to the nonprofit field to come up with concrete solutions to some of the problems we’ve seen, and the opportunity is here for us to rise to that challenge.”

Key Issues

With the election campaign season in full swing, nobody expects significant legislation on charities to be passed this year. But seasoned nonprofit lobbyists, Senate aides, Internal Revenue Service officials, and nonprofit officials say that many of the ideas advanced by the Senate committee will command serious attention.

While it may not be clear what or when any changes will be made, the dimensions of the debate are clear. Among the key ideas and questions raised in the Senate hearings, discussion draft, and interviews with nonprofit officials:

• Charity performance. Should the federal government make charities spell out their goals and measure their progress in fulfilling their mission, assuming they think that such progress can be measured? In a discussion memo prepared by aides to the Senate Finance Committee, the staff members suggested that the Internal Revenue Service require that groups with budgets of $250,000 or more supply such information to the IRS. They also proposed letting the IRS oversee an accreditation program for charities and suggested that the federal government might want to give preferences in awarding grants and contracts to groups that can prove they are following “best practices” in their management and operations.
• Board governance. What role should the federal government play in detailing the composition and operation of boards of directors of charities and foundations? In the discussion memo, the Senate aides suggested that boards include no more than 15 people, and that at least one-fifth be independent enough of the charity that they can make unbiased decisions. They also said that board chairmen and treasurers of charities should not be paid, and suggested that foundation trustees should either not be paid for their services or that the government should limit how much they can receive.
• Nonprofit spending. How much should government get involved in setting compensation limits for nonprofit officials and in detailing how much they are allowed to spend on meals, travel, and other expenses? The Senate memo suggested that the government might want to force foundations that pay their executives $200,000 or more to submit information to the IRS justifying that decision. It also said that the IRS might want to set a rate for how much nonprofit groups should spend on a typical meal, travel, or lodging, just as the government does for its employees.
• Sweetheart deals. Does the government need to stiffen rules designed to prohibit charity officials from gaining undue financial benefits for themselves, their friends, and their relatives through their nonprofit work — and impose penalties for those who abuse the system? The discussion memo suggested that a law designed to prevent “self dealing” by foundations needs to be extended to cover charities.
• Enforcement. While lawmakers discuss appropriating more money to the IRS and state attorneys general to step up efforts to find charities, foundations, and donors engaged in wrongdoing, is more money really needed — or is Congress attempting to enact laws that no agency has time to enforce, and which ultimately divert charities from carrying out their missions?

The scope and tone of the inquiry into the nonprofit field has left some charity officials worried that far-reaching legislative action lies ahead.

“My concern is the punitive focus of the conversation,” says Melissa S. Flournoy, chief executive officer of the Louisiana Association of Nonprofit Organizations, in Baton Rouge, which represents 680 groups, including small grass-roots human-service organizations, midsize museums, and large local United Ways. “By only focusing on the bad behavior of a few actors, this could lead to a dramatic overcorrection and overregulation.”

What is even worse than the tone of the conversation, say some nonprofit observers, is that the government is even having the conversation at all.

The Finance Committee’s discussion document suggests a “spectacular overreach,” says Adam Meyerson, president of the Philanthropy Roundtable, in Washington, a group of donors, foundations, and corporations that promotes efforts to support private enterprise.

“In the name of correcting some abuses, this draft proposes a sweeping and revolutionary transformation of the way public policy approaches the charitable sector,” Mr. Meyerson says. “It is quite a remarkable intrusion into the internal affairs of private organizations — one not remotely justified by a desire to protect against some of the very real abuses we have seen.”

If some of the key proposals from the hearing and discussion document make it into law, they could put many charities out of business, says Michael W. Bartnik, a lawyer in Troy, Mich., who represents nonprofit groups.

Mr. Bartnik says that interpreting new regulations and providing additional data and analysis on informational tax forms — another suggestion made by the aides to the Finance Committee — would take time and would require organizations to retain lawyers to help them stay in compliance. The increased costs, he says, could cause many groups to run short of cash and be forced to stop operating.

To prevent unnecessary and costly changes, some nonprofit officials say they are advising the Finance Committee to slow down and to consider that only 250,000 of the 950,000 charities and foundations in the United States have $25,000 or more in assets.

Says Florence L. Green, executive director of the California Association of Nonprofits, in Los Angeles: “We need to make changes that don’t cost time and money — the two resources nonprofit groups lack.”

Seeking Tax Revenue

Money is one thing the Finance Committee understands, which helps explain why two of its top legislative priorities for nonprofit organizations involve areas that can help the government raise more money to whittle away the increasing federal budget deficit.

The two ideas most likely to move fastest into legislation involve credit-counseling groups that improperly receive tax exemptions — and thus don’t pay taxes — to prey on people who have problems with debt, and donor-advised funds that are used to pay for expenses that have nothing to do with charity, according to Sen. Charles R. Grassley, Republican of Iowa and chairman of the Finance Committee.

Senator Grassley said after the hearing last month that credit-counseling groups would be his top priority as he drafts legislation.

He also said he wants to place limits on donor-advised funds to ensure they are not misused by the donors who set them up to pay for personal expenses, including the cost of children’s tuition and family reunions — two abuses that were cited in the hearing and that have reduced government tax revenue.

Donor-advised funds allow people to donate cash, stock, or other assets to special accounts, claim a charitable deduction on their federal income taxes, and then recommend how, when, and to which charities the money in the account should be distributed.

Finance Committee aides also have suggested that lawmakers might impose a payout requirement on donor-advised funds, requiring donors to distribute at least 5 percent of the net assets in their funds to charity every year in much the same way that private foundations must give away their assets. While that would not add to tax revenue for the government, it could increase the flow of private dollars into charities, relieving government of some of its obligation to serve the public good.

IRS Crackdown

If the Finance Committee finds ways to increase federal tax revenue, that could bolster its case for providing a greater appropriation to the IRS to help it crack down more than before on tax shelters, self-dealing, excessive compensation, and other abuses at foundations and charities. Senator Grassley has said that he wants to increase the IRS’s annual budget for overseeing tax-exempt organizations to about $200-million from the $80-million it currently receives. An estimated $60-million of the $200-million would go toward state enforcement and other efforts.

Mark W. Everson, the IRS commissioner, agrees that the agency would need a substantially increased appropriation if it is asked to perform these services. He was the first witness to testify at the hearing, telling senators that the federal government has lost billions of dollars through illegal tax shelters. Several other witnesses at the hearing added to his case, describing a series of scams in which charity officials, donors, and financial planners have used nonprofit groups for their own financial benefit.

Mr. Everson told senators that of the 31 types of tax transactions the IRS has recently identified as potentially abusive, almost half involve tax-exempt organizations. The growing number of questionable activities at nonprofit groups has led the IRS to consider tax-exempt organizations one of its four highest enforcement priorities, Mr. Everson said.

The IRS plans to perform a broad review of foundations to include audits of 400 grant makers, Mr. Everson said, in the hopes of identifying excessive compensation paid to top officials and other problems. IRS officials said last month that they also planned to examine charities that the IRS believes pay their top officials too much. To help handle this increased workload, Mr. Everson plans to hire 73 additional auditors.

Mr. Everson also urged senators to approve President Bush’s budget, which would provide the IRS with a 17-percent increase over last year in its budget for audits of tax-exempt groups.

Under the current budget, Mr. Everson said, the service has the resources to audit just one-half of 1 percent of the roughly one million charities in the country every year.

Major Overhaul Decried

No one in the nonprofit world seems to object to the IRS getting more money to help it root out fraudulent activity that taints the reputation of groups that operate properly. At the hearing, Ms. Aviv, of Independent Sector, lauded the Finance Committee for suggesting that it increase funds for the IRS and for state regulators.

But, she and other nonprofit officials say, a major overhaul of federal government oversight, adding a wide range of regulations with which charities would have to comply, would create too many problems for charities.

One area that particularly troubles some charities: having government intrude in the performance issues of nonprofit groups.

In its discussion document, aides to the Finance Committee propose allocating $10-million to help the IRS oversee a nationwide charity accreditation program. Some critics of that program, including Marion Fremont-Smith, a senior research fellow at the Hauser Center for Nonprofit Organizations, at Harvard University, and of counsel to Choate, Hall & Stewart, in Boston, describe it as short-sighted.

“Attempting to use the IRS to administer a voluntary accreditation process would be absolutely inappropriate,” she says. “The service is not equipped to do it.”

An accreditation program might sound good on paper, but $10-million would not cover the cost of a program, says Michael Weekes, chief executive officer of the Massachusetts Council of Human Service Providers, in Boston. Says Mr. Weekes: “The program is simply not well thought-out.”

As nonprofit organizations begin to mobilize to lobby legislators against certain proposals, some say they plan to address issues of performance and accreditation, board oversight and management, and guarding against one-size-fits-all reform.

Lobbyists and other nonprofit observers say they like their chances of helping to chart the course of a possible legislative package. They say that unlike previous major Congressional inquiries — such as those surrounding the 1969 Tax Act, which produced contentious debate and required foundations to start paying out 5 percent of their net assets every year — the actions the Finance Committee has taken so far suggest that it plans to hold open discussions before rushing to make legislative changes.

“This is not 1969 all over again,” says Eugene R. Tempel, executive director of the Center on Philanthropy at Indiana University, in Indianapolis. “There are certainly areas where the nonprofit sector can push back.”

A copy of the memo prepared by aides to the Senate Finance Committee is available for download at: http://finance.senate.gov/hearings/testimony/
2004test/062204stfdis.pdf.

The hearing transcript is available at: http://www.kaisernetwork.org/health_cast/uploaded_files062204
_senate_charity_transcript.pdf.

A video of the hearing is available at: http://www.senate.gov/~finance/hearings/other/hearing062204.ram.