I think it’s Hamilton’s influence; not the Founder, but the musical Hamilton. In fact, I’m listening to the original Broadway cast hip-hop recording at the moment.

But what brought that to mind was a further escalation in the ES (elephant seal) combat I discussed yesterday. In today’s EO Tax Journal Bruce Hopkins, of the Bruce R. Hopkins Law Firm in St. Louis, Missouri, responds to Marv Friedlander’s objection to the thesis of his new book challenging the IRS’s authority to require governance questions on the annual Form 990 report most tax-exempt organizations must file.

Hopkins writes that he was “stunned” to read Friedlander’s comments. He first points to California Independent System Operation Corp. v. FERC, 372 F.3d 395 (D.C. Cir. 2004). At ¶ 26, the D.C. Circuit wrote:

Every state has statutes affecting corporate governance. Presumably the members of the federal and state commissions charged with securities and corporate regulation are chosen with an eye to their expertise in matters corporate. Certainly the legislative bodies have given them powers with a view to that subject matter. The same cannot be said of the legislative empowerment of FERC, nor presumably are its members chosen principally for their expertise in corporate structure.

Hopkins obviously believes the same is true of the IRS, even its Exempt Organizations Division.

But even more, Hopkins begins to sing: “Marv seems to advocate turning the book into a musical!  How did he know?  (This leaking in Washington has got to stop.)  This revelation has forced me to send you the text of the opening number in the screenplay being drafted.”

Um, Hamilton it is not.  Nor is it even apparently a “screenplay.” It is, however, Hopkins succinctly stating his case:

The IRS says that a poorly governed entity will violate the tax law and otherwise become unruly. For many decades, nonprofit governance was the singular province and concern of the states. Their corporation, trust registration, and charitable solicitation acts ruled nonprofits’ fates. Then, without warning, the IRS struck, announcing it was regulating governance in 2007.

The nonprofit community was aghast; only its lawyers were secretly in regulatory heaven. The IRS pushed its regulation agenda, with tax exemption for public charities on the line. It began dictating policies, dealing with conflicts of interest, whistle-blowing, avoidance of crime. Also document retention, expense reimbursement, joint venturing, gift acceptance, investing. It got to the point that nearly everything a charity did had to be in a policy, rigidly vesting.

The agency revamped the annual information return, asking over 30 governance questions. It drafted good governance policies, many so ridiculous they were abandoned and shunned. The worst part was the IRS ruling policy, wrongly predicated on the private benefit doctrine.

The view of the IRS became this: small boards and related boards are universally forbidden. No matter that state law permits one-individual boards; the IRS summarily preempted that. If the entity has a small board, maybe as “small” as five or seven, it can stick exemption in its hat. The IRS hates boards consisting of related parties, such as brother, sister, son, daughter, father, or mother. It despises nonprofit boards comprised of individuals who are married, particularly to each other.

 

 

The first thing I thought of when I read today’s EO Tax Journal (by the irrepressible Paul Streckfus) was two bull elephant seals fighting over turf. Growls, howls and the musky scent of combat hormones in the air. In one corner, the top Exempt Organizations guru, Bruce Hopkins, touting his new book, Ultra Vires: Why the IRS Lacks Jurisdiction and Authority to Regulate Nonprofit Governance. In the other, Marv Friedlander, outspoken former IRS Chief, EO Technical, shouting at Streckfus’ readers that Hopkins was wrong.

The topic? Questions on Form 990, the annual “tax” information return filed by most tax-exempt organizations. Now the 990 is like the weather; everyone complains about it, but nobody can do anything about it. It changes glacially, once in a blue moon, and then everyone complains about the changes in it.

So having two bull seals going at it, over questions on the 990 is … weirdly normal in our world.

But this one is deeper. Not the wording or the meaning of the 990 questions, but whether the IRS can ask them at all. Was the IRS “ultra vires,” or beyond its legal authority?

The questions (on P. 6, Part VI, Section B of the 990) are simple enough: does the organization have a conflict of interest policy? A whistleblower policy? Written document retention policy? A compensation reasonableness review process (presumably consistent with the IRS’s procedures to avoid taxable “excess benefit transactions” under IRC § 4958)? All good sound management policies. And therein lies the rub.

Marv Friedlander, in an all-too-rare display of candor for an IRS EO official, ‘fesses up that he was the “initial instigator behind the governance” questions. He says: “In bowling, if the form is right, the pins should drop. In exempt organizations, if procedures for safeguarding an organization are in place … the likelihood of compliance with tax law is increased.” In other words, the ends justify the means.

Hopkins (disclosure: I was co-counsel with Hopkins in some fairly-significant legal matters in the distant past) respectfully disagrees, in long form. His book demonstrates that the IRS “has a lengthy record of getting the underlying law wrong and imposing detrimental policies and practices on” tax-exempt organizations.

Friedlander actually agrees with some of this history; in today’s letter to EO Tax Journal, he relates an instance where he had to correct one of his IRS agents. The agent had repeatedly blasted an applicant for exemption with questions and demands for changes in the organization’s organizing documents — and then denied the application.

The grounds for denial? That the organization’s willingness to comply with the agent’s demands demonstrated that the organization was likely to violate IRS rules in the future!

Yikes! Shades of the Lois Lerner days.

To his credit, “I personally apologized to the organization,” Friedlander writes, noting that he eventually granted the exemption application. Bet that made the applicant feel all warm and fuzzy after spending time and money trying to comply with the agent’s repeated questions and demands.

Hopkins, however, goes on, in matters not addressed by Friedlander, that this is “federal mission creep” (my term, not Hopkins’) by the IRS. State law addresses nonprofit organizations; states have long been dominant in areas of corporate (or entity) regulation. Federal law addresses federal tax exemption. The new 990 questions are all in the area previously exclusively state-law governed. Exploring the nature of agency law, Supreme Court decisions such as the hotly-debated Chevron doctrine, and the development of the IRS’s imposition of governance and operational standards, Hopkins shows that the IRS has no authority to impose such rules on EOs.

The IRS admits, in the Form 990 heading for Part VI, Section B itself, that “This Section B requests information not required by the Internal Revenue Code.” The 990 instructions (on page 18) do say: “Whether a particular policy, procedure or practice should be adopted by an organization depends on the organization’s size, type and culture.” But the real effect — costs and time — will fall on those trying to do the right thing. Those who want to break the rules will likely do so anyway.

Friedlander says that this language demonstrates that the IRS governance questions are not prohibited commands, but only “good governance advice because states, outside watchdog groups, Senate and House committees, news media, and interested individuals also have roles in ensuring that governing boards properly assume their fiduciary responsibilities.” He cites to complaints about the United Way, televangelists, Synanon, and other organizations whose managements went seriously awry.

But the 990 instructions also say “Although federal law does not mandate particular  management structures, operational policies, or administrative practices, every organization is required to answer each question in Part VI. For example, all organizations must answer lines 11a and 11b, which ask about the organization’s process, if any, it uses to review Form 990, even though the governing body isn’t required by federal tax law to review Form 990.”

Pretty mandatory. We are going to make you say PUBLICLY whether you are using the IRS-mandated whistleblower policies, even though we can’t compell you to do so. We’ll leave that to other people. Just because we think it’s a good idea to have others criticize you, to keep you in line. In other words, regulating by fear?

And that’s not all. There is the new threat that the IRS will clamp down on organizations that are not using procedures and policies which aren’t “required by federal tax law.” Not subtle. And in operation today, since the IRS has started using “data-driven” selection for examinations from the 990 filings, which they openly admit includes the answers to these “not required by federal tax law” questions on the 990.

There is nothing wrong with the IRS reviewing organizations’ tax returns to see if they are violating the law. And nothing wrong with using data mining or other techniques to ferret out miscreants.

But all this “advice” costs a lot of money and time, especially for small organizations. It costs thousands of dollars a year for an organization to hire compensation specialists and lawyers to satisfy the ‘whistleblower’ and other requirements. That’s a policy choice, not a tax compliance issue. It is Congress and the states which should impose these requirements, as Hopkins clearly demonstrates in his new book.

And as another top practitioner just pointed out to me, “It’s not as if the IRS needs to go out and look for more things to do.”

Nor should it, since the mentality behind the “we can do this, so we will” push for the IRS to step beyond its jurisdiction and authority can justify ANYTHING in the name of avoiding violations of the law. The IRS is famous for nebulous “advice” and even more ambiguous “facts and circumstances” rules of law. Certainty is lacking in the vast majority of exempt organization law, where “facts and circumstances” justify traps for the unwary. Or even the wary.

So if the IRS wants to advise organizations on good management practices, let it do more of what it has been doing: explain things on its website, hold outreach sessions, and do all the things that other regulatory agencies do to help compliance.

But, of course, those normal and common steps would require the IRS to recognize that it imposes burdens, and it must justify those burdens by the benefits derived from them. And THAT is the real danger here: the IRS thinks all organizations are bad and must be restrained because a few, and only a few, have run amok. But THAT decision is the province of Congress and the states, not the IRS.