2013 Nonprofit Seminar - Conducted by Chambliss, Bahner & Stophel, along with the Center for Nonprofits and Community Foundation of Greater Chattanooga

1. November 14, 2013
What Every Nonprofit
Should Know: Key Legal
Developments Issues
Presented by
James L. Catanzaro, Jr. • Christopher J. Hennen • J. Nelson Irvine • Kirby W. Yost
© 2013 Chambliss, Bahner &
Stophel, P.C. All Rights Reserved.
Chambliss, Bahner & Stophel, P.C.
Liberty Tower • 605 Chestnut Street, Suite 1700 • Chattanooga, TN 37450
chamblisslaw.com

2. Hot Topics in the
Nonprofit World
Christopher J. Hennen

3. Increased Revocations
• In 2010, IRS began revoking tax
exempt status of organizations that
had not filed their Form 990s for the
previous 3 years
• As of August 2012, 443,441
organizations had their tax exempt
status revoked for this reason
• Many have applied for reinstatement, while others
are in the process
3

4. Internal Revenue Service Backlog
• IRS, when fully staffed, processes approximately
60,000 applications per year
• Generally, applications separated into 4 categories
• Depending on the category and additional
information required, process normally takes either
3 months, 4-5 months, or 9 months
4

5. Internal Revenue Service Backlog
• Currently, many applicants experiencing
significant delays. One factor is high number
of revocations and applications for
reinstatement
• For applications requiring additional
information, IRS is currently assigning
applications received in May 2012
5

6. Documenting Contributions
• Charitable deductions a huge incentive to donors
• Many nonprofits rely on this incentive for funding
6

7. Documenting Contributions
• IRS requirements for documenting charitable
contributions have become increasingly complex
• Recent tax court cases indicate higher level of
disallowed deductions for failure to submit proper
documentation
7

8. Social Entrepreneurship
• New trend towards hybrid of the for-profit and nonprofit structures
• Two recent entity developments
– Low-Profit Limited Liability Company (L3C)
– Benefit Corporation (B Corp)
• Significant issues remain with these hybrid entities
8

9. Executive Compensation
• IRS rules state that nonprofit CEOs should receive
'reasonable compensation'
• In recent years, the IRS has even redesigned the
Form 990, in part to force greater transparency
around nonprofit compensation
9

10. Executive Compensation
• IRS continues to prioritize CEO compensation as one
of its main areas of focus in uncovering fraudulent
nonprofit practices
• A helpful resource for evaluating executive
compensation is Charity Navigator's recently issued
2013 Charity CEO Compensation Study, available
online
10

11. Unrelated Business Income (UBI)
• Sometimes called UBTI (Unrelated Business Taxable
Income)
• UBI is income from a trade or business that is
regularly carried on and is not substantially related
to furthering the exempt purpose of the
organization
• Increasing priority for IRS, as reports continue to
indicate significant underreporting
11

12. Charitable Solicitations
• In Tennessee, charitable solicitations governed by
The Charitable Solicitations Act
• Requires that charitable organizations which solicit
contributions directly or indirectly from, or within,
the State of Tennessee register unless exempt
12

13. Charitable Solicitations
• Registering in TN
– File an Application for Registration of a Charitable
Organization, along with its organizing documents
(e.g. a charter) and, if it has obtained one, a letter
of determination of tax exempt status from the
IRS
• Cost of registration varies state to state – in
Tennessee, initial fee is $50.
– Annual fees vary on sliding scale
• Penalties for violation: civil fine, potential criminal
13

14. Charitable Solicitations
• Charleston Principles govern internet solicitations
• Generally, an out-of-state entity must register if
– its non-internet activities would require
registration or
– the entity targets a person in the state,
repeatedly receives contributions from that state,
or
– follows up online activity by inviting further
offline activity
14

15. Questions?
15

16. Fiduciary Obligations and Duties
of Nonprofit Directors/Officers
(Your Silence Can Be Held Against You)
James L. Catanzaro

17. What is a fiduciary?
• An individual in whom another has placed trust and
confidence to manage and protect property or
money
17

18. • A director or officer of a nonprofit organization has
been given assets to use for a specific benefit of the
public
18

19. • Directors and officers, therefore, are treated nearly
the same as parents of children
19

20. • As stated by law, an officer or director must satisfy
duties of care and loyalty
– Duty of care: use reasonable care and judgment
– Duty of Loyalty: place interests of organization
first
20

21. The fundamental requirement for the performance of
these duties is an adequate level of knowledge about
the business of the organization and applicable
limitations.
21

22. Following are questions you should ask and have
answered if you don't know.
22

23. 1. What are the sources of receipts for the
organization and what conditions apply?
23

24. 2. What grant conditions apply and are the
conditions being satisfied?
RISK: Improper use of funds may result in loss of key
resource or worse!
24

25. B. For contributions received, what conditions (if
any) apply for their use?
25

26. 2. Are the organization's assets properly
safeguarded?
26

27. A. Is there an independent audit done of the
organization's financial statements and does the
board control that process?
•
What if management practices cited in audit
findings?
27

28. B. Are there adequate financial controls in place
concerning the expenditure of monies?
•
Board and signature requirements
•
Credit card use
•
Handling of contributions
28

29. C. How is compensation set for officers?
•
Excessive benefit transactions
•
Waste of assets
•
Use of survey data/experts
•
Board involvement!
29

30. D. Is there an effective conflict of interest policy and
process in place?
•
Annual disclosures?
•
Findings by uninterested members
•
Taking other bids
30

31. 3. Is the organization in compliance with applicable
laws and reporting obligations?
31

32. A. Who prepares the organization's Form 990 and
what is the process for approval and filing of
same?
32

33. B. Are there processes for periodically reviewing the
purpose, mission and operations?
33

34. C. Does the board have access to and hire legal
counsel?
34

35. A Key Point of Clarification
What level of inquiry if necessary?
•Is the Board to function as a super CEO?
•What level can be expected of the volunteers?
35

36. The obligation depends upon the facts, but reliance
upon experts and management may suffice provided
that a reasonable logic underpins such reliance
•What about really complex proposals that are of
potentially significant impact?
36

37. Ultimate Downside
• If officers and directors do not have a handle on
these basic questions, their silence may be
construed as acceptance of or agreement to
inappropriate and/or wrongful acts
– Personal liability
– Organizational loss of exempt status
– Loss of support
37

38. Questions?
38

39. Governance Issues for Directors
and Officers
DELEGATION, RELIANCE AND ACCOUNTABILITY
J. Nelson Irvine

40. What Board Members Should
Know and Do
• Acting Responsibly and Avoiding Liability
• Acting Corporately as a Board
• Acting Personally as an Individual by each Director
and Officer
• Acting or Not Acting
• Guidelines for how to act or not act as a director
and/or officer
CORPORATE GOVERNANCE
40

41. Duties of Directors and Officers
• Prescribed by:
– Corporate law and common law, cases, attorney
general opinions, organizational documents,
bylaws, codes of ethics, articles of associations,
articles of organization or trust documents and
agreements
• Delegated by:
– Board of directors
– Committees of the Board
– Officers authorized to delegate duties by
designated persons in charter
41

42. Duties of Directors
Compared to Officers
Both have Duty of Loyalty and Duty of Care
42

43. General Standard for Directors –
Duty of Care
a) A director shall discharge all duties as a director,
including duties as a member of a committee:
1) In good faith;
2) With the care an ordinarily prudent person in a
like position would exercise under similar
circumstances; and
3) In a manner the director reasonably believes to
be in the best interests of the corporation.
43

44. General Standards for Directors Reliance
(b) In discharging such duties, a director is entitled to
rely on information, opinions, reports, or
statements, including financial statements and
other financial data, if prepared or presented by:
1) One (1) or more officers or employees of the
corporation whom the director reasonably
believes to be reliable and competent in the
matters presented;
44

45. General Standard for Directors Reliance
2) Legal counsel, public accountants or other
persons as to matters the director
reasonably believes are within the person's
professional or expert competence; or
3) A committee of the board of directors of
which the director is not a member, as to
matters within its jurisdiction, if the director
reasonably believes the committee merits
confidence.
45

46. Duties and Responsibilities
of Directors
– Directors:
• Oversight and general responsibility:
"all corporate powers shall be exercised by or under the
authority of, and the affairs of the corporation managed
under, the direction of the corporation."
–May rely: on others: officers, employees, professional
advisors, committees, and "others" e.g. volunteers
[proposed law]
–May delegate: to others [officers, employees,
professional advisors, and volunteers]
46

47. Duties and Responsibilities
of Officers
• Officers: Have Delegated Duties and
Responsibilities:
– By the Bylaws, the Board, Others Officers
"Each officer has the authority and shall perform the
duties set forth in the bylaws or, to the extent
consistent with the bylaws, the duties prescribed by
the board of directors or by direction of an officer
authorized by the board of directors to prescribe the
duties and authority of other officers."
•May rely
•May delegate
• Officers: May or May Not be Directors
47

48. Reliance on Others
A director or an officer is not acting in good faith if he
or she has knowledge concerning the matter that
makes reliance otherwise permitted unwarranted
48

49. Delegation of Duty
to Review Form 990
• Can an executive director delegate the duty to the
board or a director?
• Can a director delegate the duty to the executive
directors?
• Can the board delegate the duty to a committee of
the board?
49

50. Who is Looking at Your 990?
• Forms 990 are public records
– Donors and creditors as well as regulatory
agencies such as the State Attorney General pick
up information from Forms 990
– Reporting agencies like Guidestar use and rely on
information in the Form 990
– State and local tax assessors may use and rely on
statements of mission, purpose and related
activities
50

51. 990 Review Process
• Part VI, Governance, Management and Disclosure
– Section B. Policies
• 11a. Has the organization provided a complete
copy of this Form 990 to all members of its
governing body before filing the Form?
• 11b. Describe in Schedule O the process, if any,
used by the organization to review this Form 990
– ARE THE DIRECTORS INFORMED ABOUT THE
PROCESS?
– DO THE DIRECTORS PARTICIPATE IN THE
PROCESS?
51

52. Schedule O
990 Process Statement
Example 1
• "Form 990 is prepared by an independent CPA firm
and submitted to the executive director for review"
• [Form 990, Part VI, Section B, Line 11]
– DIRECTORS HAVE A DUTY AND A RIGHT TO BE
INFORMED
– DIRECTORS HAVE A RIGHT TO INSPECT RECORDS
52

53. Schedule O
990 Process Statement
Example 2
"Form 990 is prepared by the independent accounting
firm, then reviewed and verified by the chief financial
officer and reviewed by the chairman of the finance
committee. Copies of the form are then sent to all
members of the executive committee for review and
comment. Copies are made available to all members
of the board of directors. The final version is filed with
the Internal Revenue Service."
[Form 990, Part VI, Section B, Line 11]
53

54. Protection from Liability under
Tennessee Law
Neither a director nor an officer is personally liable for
any action taken or not taken as a director or officer
or any failure to take any action, if he or she
performed the duties of office in compliance with the
corporate standard
54

55. Immunity under Tennessee Law
• All directors, trustees or members of governing
bodies of nonprofit corporations and organizations
"shall be immune from suit arising from the conduct
of the affairs of" such corporations and
organizations
• BUT such immunity is removed when such conduct
"amounts to willful, wanton or gross negligence"
55

56. Additional Liability
Protection in Charter
The charter may contain a provision eliminating or
limiting the personal liability of a director to the
corporation or its members for monetary damages
for breach of fiduciary duty as a directors:
•Except for:
– breach of the duty of loyalty
– for acts or omissions not in good faith or
intentional misconduct or a knowing violation of
law
– unlawful distributions
56

57. Right of Contribution for
Unlawful Distributions
A director held liable for an unlawful distribution is
entitled to contribution from every other director who
voted for or assented to the distribution without
complying with the applicable standards of conduct as
well as from each person who received the unlawful
distribution
57

58. Are Directors Sometimes
Trustees?
• Nonprofit corporation directors are not trustees
• Nonprofit corporation officers are not trustees
• What if the bylaws refer to directors as "trustees"?
• What if directors or officers are also "trustees" of a
trust?
A trustee has a higher standard of conduct.
58

59. When is a Director a Trustee?
• When he or she is acting in a capacity other than as
a director or officer
• When he or she has fiduciary duties under
employee benefit plans and ERISA
– e.g. officers who are administrators of plans
• When he or she participates in a decision to change
an exempt purpose or function of the corporation,
i.e. amend the charter or bylaws
– e.g. use of donated property – cy pres – notice to
attorney general
59

60. When is a Director not a Trustee?
• TNCA provides:
"a director shall not be deemed to be a trustee with
respect to the corporation or with respect to any
property held by the corporation, including, without
limitation, property that may be subject to
restrictions imposed by the donor or transferor of
such property"
60

61. Duty of Loyalty Issues
The Three "C's"
Conflicts of interest
Corporate opportunity
Confidentiality
Corporate law
61

62. Conflicts of Interest
"A conflict of interest transaction is a transaction with the
corporation in which a director or officer of corporation has a
direct or indirect interest."
A conflict of interest transaction is not voidable or the basis for
imposing liability on the director or officer:
• if the transaction was fair at
• if approval is obtained from
the time it was entered into or
the attorney general and
reporter; or
• if the transaction is approved,
after disclosure, by
• If approval is obtained from a
independent directors, who
court having equity
have no direct or indirect
jurisdiction in an action in
interest, either acting as a
which the attorney general
board or as a committee of
and reporter is a party
the board; or
By comparison, a conflict of interest transaction by a trustee is
voidable
62

63. Corporate Opportunity
• A corporate director, of both a nonprofit and a for
profit corporation, must offer first to the
corporation any business opportunity that involves
an activity in which the corporation has an interest
before the director takes the business opportunity
for himself or herself
• The requirement in standards of conduct that a
director act in good faith requires the director to
make a full and timely disclosure of the business
opportunity
– e. g., an opportunity to purchase a piece of real
estate that the nonprofit corporation could use
for its business
63

64. Confidentiality
• The requirement that a director keep confidential
the business of the nonprofit corporation arises
under the duty of loyalty in:
– Conflict of interest situations
– Corporate opportunity situations
– Contract negotiations
– Employee and HR reviews and decisions
– Regulatory compliance matters; and
– Executive Sessions of the Board
64

65. Rights of Directors
• To be informed
• To have access to management: CEO or Executive
Director or Officers of the Board
• To have access to books and records, minutes,
financial statements, Form 990, Form 1023, charter,
bylaws, codes of ethics
• To participate in decisions to vote including the
right to dissent and have dissent recorded
• To be indemnified
65

66. Director's Right to Inspect Records
• Members of nonprofit corporations have had a right
to inspect records under the Tennessee Nonprofit
Corporation Act [T.C.A. §§ 48-66-101 to 105]
• Tennessee Business Corporation Act was amended
effective January 1, 2013 to give directors a right to
inspect "books, records and documents of the
corporation at any reasonable time to the extent
reasonably related to the performance of the
director's duties as a member of a committee"
• Tennessee Nonprofit Corporation Act is being
amended in a similar manner
66

67. Tennessee Nonprofit Corporation Act
Proposed Amendments
Proposed Director's Statutory Right of Inspection:
(a) A director of a nonprofit corporation is
entitled to inspect and copy the books,
records and documents of the corporation
at any reasonable time to the extent
reasonably related to the performance of
the director's duties as a director, including
duties as a member of a committee, but not
for any purpose or in any matter that would
violate any duty to the corporation or law
other than this [act]. [T.C.A. § 48-66-105(a)]
Common Law provides for is right now.
67

68. Tennessee Nonprofit Corporation Act
Proposed Amendments
"Document" means:
A. Any tangible medium on which information is
inscribed, and includes any writing or written
instrument.
B.
An electronic record.
"Electronic" means relating to technology having electrical,
digital, magnetic, wireless, optical, electromagnetic or similar
capabilities.
"Electronic Record" means information that is stored in an
electronic or other medium and is retrievable in paper form
through an automated process used in conventional
commercial practice . . . [T.C.A. §48-51-201(14), (17) and (18)]
68

69. Tennessee Nonprofit Corporation Act
Proposed Amendments
• Proposed Duty to Inform
– A statutory duty of an officer to inform either a superior
officer, the board of directors, or a board committee
about affairs of the corporation within the scope of the
officer's functions or of any action or probable material
violation of law involving the corporation or breach of
duty by an officer, employee or agent of the corporation
69

70. Tennessee Nonprofit Corporation Act
Proposed Amendments
• Proposed Contract Rights – Removal of Officer
– a provision that, except as otherwise provided in the
charter or bylaws, an officer may be removed at any time
with or without cause by the officer who appointed the
officer being removed unless the board provides
otherwise. This provision is based on and modeled after
the Model Act 3rd Ed
– DELEGATION, RELIANCE AND ACCOUNTABILITY
70

71. Tennessee Nonprofit Corporation Act
Proposed Amendments
• Proposed Electronic Notices
– For example, "notice or other communications
may be delivered by electronic transmission "if
consented to by the recipient" or "if the electronic
transmission is otherwise retrievable in
perceivable form; and the sender and the
recipient have consented in writing to the use of
such form of electronic transmission".
71

72. Questions?
72

73. Unrelated
Business Taxable Income
Kirby W. Yost

74. Tax Exemption
• A Tax Exempt Entity generally does not pay income
tax because that income funds a purpose that the IRS
has recognized as tax-exempt
• BUT- If the income received is unrelated to the taxexempt purpose of the entity, it is unrelated business
income (UBI or UBTI), and therefore subject to
taxation
• The entity must report and pay income taxes for UBTI
at the corporate rate
74

75. What is Unrelated Business
Income?
"… any trade or business the conduct of
which is not substantially related (aside from the
need of such organization for income or funds or the
use it makes of the profits derived) to the exercise or
performance by such organization of its charitable,
educational, or other purpose or function
constituting the basis for its exemption under section
501 ..."
75

76. 3-Part Test
• So, considering whether an income-producing activity
creates UBI, look at the 3-part test:
1. Is it a trade or business?
2. Is it regularly carried on?
3. Is it substantially related to furthering the exempt
purpose of the organization?
76

77. So, What is a
"Trade or Business"?
• Something that has a "Profit
motive" – whether it actually
brings a profit or not
– It may have a "profit
motive" if it resembles an
activity done by taxable
commercial entities
– Does the entity's taxexemption provide the
entity an unfair advantage
in carrying out the activity?
• An activity can still be a
trade or business if it is
included within a larger
group of activities related to
the entity's exempt purpose
– For example, if an exempt
organization that
publishes a magazine
related to its exempt
purpose, sells advertising
in that magazine, selling
the ads is a trade or
business (even though it is
a part of a magazine
related to the exempt
purpose)
77

78. Regularly Carried On
• Activities must show a frequency and continuity
– How does the frequency compare to similar
commercial activity carried on by taxable entities?
• Are the activities pursued in a manner similar to how
for-profit organizations pursue comparable
commercial activities?
– Hospital operating a sandwich stand for 2 weeks
during a state fair – NOT "regularly carried on"
– Hospital operating a commercial parking lot every
Saturday to raise money – IS "regularly carried on"
78

79. Not Substantially
Related to Exempt Purpose
• Activity does not contribute importantly to
accomplishing that entity's exempt purpose (other
than by supplying funds)
– Rev. Rul. 81-138 – Chamber of Commerce's lease of
building below market rent to an industrial tenant
for the purpose of spurring economic development
was substantially related to the Chamber's exempt
purpose
79

80. Not Substantially
Related to Exempt Purpose
• Consider the size and extent of the activities vs. the
nature and extent of the exempt function the activity
intends to serve
– To the extent an activity is conducted on a scale
larger than reasonably necessary to perform an
exempt purpose, it does not contribute importantly
to the function the activity intends to serve (that
excess portion would be UBI)"
• Selling products created from performance of exempt
purpose CAN be "Substantially Related"
• Dual use of assets or facilities – consider each use or
activity independently
80

81. Trade/Business Activities
Excluded
These activities (along with a few others) are specifically excluded
from the definition of "unrelated trade or business":
• Any trade/business where
substantially all work is
performed by volunteers
• Any trade/business performed
primarily for the convenience
of members, employees,
students, patients, etc. of the
entity
• Qualified sponsorship income
(where sponsor gets only
acknowledgement)
• Selling donated merchandise
(i.e. thrift shop operated by
tax exempt entity)
• Certain bingo games
• Distribution of nominal cost
items, which are incidental to
soliciting donations
• Renting mailing list to another
charitable organization
• Convention and trade show
activity – if entity's purpose is
to promote/educate on
respective industry
81

82. UBI Exclusions
• Interest and other investment income
• Royalty income
• Rents
• Certain research income
• Gains/losses from sale of property
• Income from services provided under Federal License
(very narrow exclusion)
• Member income of co-op electric company (very
narrow exclusion)
* FOR EACH EXCLUSION, YOU MUST THEN CONSIDER
WHETHER AN EXCEPTION APPLIES
82

83. Exceptions to Exclusions
• Investment income EXCEPTIONS
– investment is debt-financed
– Annuities received from a controlled corporation
– income is from a security loan
• Royalty income EXCEPTIONS
– Royalty is debt-financed
– Royalties received from a controlled corporation
83

84. Exceptions to Exclusions
• Rental Income Exceptions
– Rent from real property or personal, only under "mixed
lease" situations, so long as personalty rents = 10% or less
• Rent attributable to
• Rent is income from
personal property = more
unrelated debt-financed
than 50%
property
• Rent amount is based on
net profit of tenant
• Rents received from a
controlled corporation
• Rent is in exchange for
personal services (i.e.
hotel room rent)
• Rents received from
certain organizations
(Social clubs, VEBAs,
SUBS, GLSOs (narrow
exception)
84

85. Exceptions to Exclusions
• Gains/losses from sale of property
– Except from unrelated income from debt-financed
property
• Income from services provided under Federal License
– Except if income is from unrelated debt-financed
property
85

86. Special Rules
• If an organization is one of the following, it must
consider UBI under special rules:
– a Social Club (under 501(c)(7))
– a Voluntary Employee's Beneficiary Association
(under 501(c)(9)) ("VEBA")
– a Supplemental Unemployment Compensation
Benefit Trust (under 501(c)(17)) ("SUB")
– a Group Legal Services Organization (under 501(c)
(20)) ("GLO")
– a Veterans' Organization (under 501(c)(19))
86

87. Deductions for UBI
• If income is UBI, the organization can take a
deduction for its expenses directly connected to that
unrelated trade or business
• Where the organization makes dual use of property
or activities, those expenses must be allocated
appropriately to only deduct expenses used for UBI
• This includes a deduction for expenses directly
connected with debt-financed property or the
income derived from it
• Special circumstances for advertising expenses where
advertising sales are an "exploitation of an exempt
activity"
87

88. Questions?
88

89. Disclaimer
This presentation is provided with the understanding that the
presenters are not rendering legal advice or services. Laws are
constantly changing, and each federal law, state law, and
regulation should be checked by legal counsel for the most current
version. We make no claims, promises, or guarantees about the
accuracy, completeness, or adequacy of the information contained
in this presentation. Do not act upon this information without
seeking the advice of an attorney.
This outline is intended to be informational. It does not provide
legal advice. Neither your attendance nor the presenters
answering a specific audience member question creates an
attorney-client relationship.
89