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On-Going Governance and Compliance Requirements for Tax-Exempt Organizations

Client Advisory

August 3, 2010

I.          Introduction.

Once a tax-exempt organization (“TEO”) has been organized and obtained its tax-exempt ruling, directors and officers should turn their attention to the TEO’s on-going Federal and (if applicable) New York governance and compliance obligations, many of which are summarized below. These summaries can be quickly reviewed to identify governance or compliance areas which may require attention. A section highlighting governance, information and compliance obligations specific to New York museums and historical societies is also included. The summaries in this advisory are not intended to be exhaustive or exclusive. As TEOs come in a variety of types and sizes, many will have special or additional obligations not identified here.

II.        IRS Requirements.

The Internal Revenue Code requires that most TEOs file at least one annual return. The required form will be Form 990-N (for certain small organizations), 990-PF (for private foundations) or 990 (for public charities). The IRS recently revised Form 990 to require public charities to provide significantly more information about their governance and operations than was previously required. Provided below is a discussion of the most important new queries on Form 990 concerning a TEO’s policies and procedures. While Form 990-PF has not yet been updated, private foundation officers and directors may find it advisable to adopt the below discussed policies and procedures to demonstrate that their standards of behavior are similar to those recommended for public charities.

The Form 990 annual return for public charities includes a section requiring disclosures about the governance and management of the reporting TEO, including information about specific polices and procedures. While the IRS recognizes in the form’s instructions that the tax law does not require TEOs to have any specific policies and procedures, it suggests that their adoption will decrease the likelihood that transactions or activities inconsistent with tax-exempt status will occur. As such, while there is no penalty for not having these polices and procedures in place, reporting TEOs should seriously consider adopting and implementing them in order to deter illegal or unethical conduct through the promotion of good governance practices. It is possible that the failure to do so will increase the likelihood of an IRS audit.

The polices and procedures on which the Form 990 seeks information include the following:

1.         Compensation Authorization. The Form 990 asks whether the procedures for authorizing the compensation of the TEO’s top management officials and its other officers and key employees include (i) the review and approval of the compensation by the disinterested members of the TEO’s governing body or compensation committee, (ii) the use of independent compensation data (covering persons in comparable positions at similar organizations) and (iii) the contemporaneous substantiation of the deliberation and decision (typically through keeping minutes of the meeting). As discussed below, the New York Not-for-Profit Corporation Law also has specific rules governing the authorization of officer compensation.

2.         Conflicts of Interest Policy. If the TEO has a written conflicts of interest policy, the Form 990 asks (i) whether the policy requires officers, directors (or trustees) and key employees to disclose interests that could give rise to conflicts and (ii) whether the TEO regularly and consistently monitors and enforces compliance with the policy. The conflicts of interests policy should define what constitutes a conflict of interest, facilitate disclosure about actual or potential conflicts and provide procedures for managing any conflict of interest. The IRS provides a model policy that includes these various safeguards. Annual disclosure of actual or potential conflicts is often done through the use of questionnaires, with respondents directed to disclose any additional conflicts that may arise during the course of the year. Any conflicts of interest policy for a New York TEO should also comply with the New York Not-for-Profit Corporation Law’s procedural requirements for reviewing and approving conflicts involving officers and directors, as discussed below.

3.         Whistleblower Policy. A written whistleblower policy should encourage the TEO’s staff and volunteers to come forward with credible information on illegal practices or violations of the TEO’s policies. The whistleblower policy should identify the persons to whom the illegal practices or violations can be reported, indicate who will investigate the reports and state that the TEO will protect the reporting individual from retaliation or other adverse actions.

4.         Document Retention and Destruction Policy. A written document retention policy should identify those persons who have responsibility and oversight for the retention and storage of the TEO’s documents and records and, where applicable, the routine destruction of any such documents and records. The policy should explicitly prohibit any destruction of records intended to hinder governmental investigations.

5.         Review of Form 990. The Form 990 asks whether a copy of the final Form 990 was provided to the TEO’s governing body. Additionally, the process by which the Form 990 was reviewed by the TEO, if any, must be described. The TEO’s governing documents should clearly identify who has the responsibility for reviewing and approving the Form 990; for larger TEO’s, this is often done by the audit committee of the board.

III.       New York Requirements.

A.        Attorney General’s Charities Bureau. Charitable and certain other TEOs operating in New York State must register and file annual reports with the Charities Bureau of the Office of the Attorney General (the “Charities Bureau”). This is required by two separate but overlapping laws: Article 7-A of the New York Executive Law (“Article 7-A”) and Section 8-1.4 of the Estates, Powers and Trusts Law (“EPTL 8-1.4”).

Generally, Article 7-A requires the registration of charitable and other non-profit organizations that intend to solicit contributions in New York State, while EPTL 8-1.4 requires the registration of New York and foreign corporations formed for charitable purposes, as well as trusts, estates and other persons or entities holding and administering property in New York State for charitable purposes. Depending on its type and activities, an organization may be subject to one or both of these registration and reporting laws. There are several exemptions to registration, including exemptions for museums and historical societies, which are subject to similar reporting requirements administered by the New York State Museum, the State’s official research museum.

Once registered under one or both of these laws, a TEO must file an annual report with the Charities Bureau, accompanied by a copy of its Federal informational return. Article 7-A registrants must also provide information about any fundraising professionals used by the TEO for fundraising activities in New York and any government contributions or grants received. If an Article 7-A registrant’s total support and revenue is between $100,000 and $250,000, it must include with its annual report an independent accountant’s review report and, if total support and revenue exceeds $250,000, it must instead include an audit report.

Certain annual filing exemptions allow registered TEOs to disregard the information and documentation requirements of the annual report, although the exemption must be claimed by filing the annual report and indicating on the report what exemptions are being claimed. For example, Article 7-A registrants are not required to report where fundraising professionals were not used and funds raised in New York State were less than $25,000 for the fiscal year. EPTL 8-1.4 registrants are not required to report where both gross receipts and assets did not exceed $25,000 during the fiscal year.

Non-compliance with the annual reporting requirement may result in the imposition of monetary penalties and, for Article 7-A registrants, automatic revocation of their registration. Additionally, one practical effect of non-compliance is that, if the TEO wishes to take a major corporate action that requires the Attorney General’s approval, such as amending its certificate of incorporation, selling all or substantially all of its assets, merging or consolidating with another corporation or dissolving, the TEO may be required to file its overdue annual reports and pay its overdue filing fees before the Attorney General will consider granting any such approval.

B.         New York Not-for-Profit Corporation Law. TEOs organized in New York are usually formed under the Not-for-Profit Corporation Law (“NPCL”). Those formed under another New York law, such as the Education Law for education corporations, are generally subject to many provisions of the NPCL. Important topics covered by the governance and compliance provisions of the NPCL include:

1.         Annual Meetings and Elections. All directors (or trustees, as applicable) should hold an annual and regular meetings, and corporations that have voting members should hold an annual meeting of members. Elections of directors should be held when called for under the corporation’s certificate of incorporation or by-laws. Directors serving one year terms should stand for annual re-election, while directors with longer terms, whether or not serving on a staggered board, should stand for re-election when their terms are up. Unless a director is appointed to the board by virtue of their office (ex officio) or former office (emeritus) in the corporation or another organization, directors may serve up to a maximum term of five years before they must stand for re-election.

2.         Annual Reports. At the annual meeting of members, the board of directors is required to present an annual financial report to the members covering the fiscal year ending not more than six months before the meeting. If the corporation has no members, the president and the treasurer present the annual report to the board. The financial report must be verified by the president and the treasurer or certified by a public accountant selected by the board. Additionally, unless otherwise specified in the particular gift instrument, the treasurer annually reports to the members, if any, or the board about the use made of and the income derived from any assets received by the corporation for a particular purpose.

3.         Books and Records. A corporation is required to keep, at its office, complete and correct books and records of account and minutes of the proceedings of its members (if any), board of directors and executive committee (if any), with the records concerning its membership to be kept in the same office or with its in-state transfer agent or registrar (if any). The corporation’s books and records may be kept at an out-of-state office of the corporation if so specified in its certificate of incorporation.

4.         Investment Authority. Under the NPCL, the board of directors is granted specific authority to make investment decisions concerning the corporation’s funds. This authority can be delegated to committees, officers or employees of the corporation or independent advisors or managers, who may be paid for their services. Under the NPCL, in delegating investment authority over the corporation’s assets directors must, in addition to generally discharging their duties in good faith and with the degree of diligence, care and skill of an ordinarily prudent person in like circumstance, consider the long and short term needs of the corporation in carrying out its purposes, the corporation’s present and anticipated financial requirements, expected total return on its investment, price level trends and general economic conditions. Note that any contract with an independent advisor or manager that grants them investment authority over the corporation’s assets must be terminable by the corporation, without penalty, upon not more than 60 days notice.

5.         Committees.  Boards of directors usually delegate some of their responsibilities to standing committees. Common committees include executive, audit, investment, nominating and compensation committees, with any board committee required to have at least three directors. As there are specific procedures for constituting and delegating authority to standing and other committees under the NPCL, the board should confirm that these authorization procedures have been complied with in order to avoid questions as to whether a committee was properly constituted and authorized to act.

6.         Director, Officer and Other Compensation. While directors of TEOs customarily serve without compensation, the board has the power to fix the compensation of directors for services in any capacity, unless otherwise provided in the corporation’s certificate of incorporation or by-laws. Where a corporation has paid officers, their salaries, if not fixed in or pursuant to the corporation’s by-laws (such as by an authorized compensation committee), must be approved by a majority of the entire board (and not just a majority of the members of the board present at the meeting). Generally, any compensation paid to officers, employees, agents or directors must be reasonable and commensurate with the services provided.

7.         Conflicts. As discussed above, all corporations should have a conflicts of interest policy to assist the corporation in identifying, evaluating and, if warranted, approving interested transactions. The NPCL provides specific procedures that, if followed, protect a desirable interested transaction between the corporation and one or more of its directors or officers from being void or voidable on account of its interested nature. An interested transaction may be approved by the vote of the board of directors or an authorized board committee as long as no interested director’s or officer’s votes are counted or by the vote of the members (if any), if, in each case, the material facts of the interested transaction have been disclosed in good faith to, or are otherwise know by, the board, committee or members. Additionally, if there was no such disclosure or knowledge or if the vote of an interested director or officer was necessary to authorize the transaction, the transaction may still be approved if the interested parties can affirmatively establish that the transaction was fair and reasonable to the corporation at the time it was authorized by the board, committee or members. Boards should confirm that their conflicts of interest policies are in accord with these statutory procedures.

8.         Indemnification. An important protection for directors and officers is the right to be indemnified from civil or criminal suits brought against them by third parties or on behalf of the corporation itself. An important related right is the corporation’s advancement of expenses to the affected directors or officers for the costs of defending civil or criminal suits. The NPCL provides parameters within which corporations are entitled to provide such indemnification or advancement of expenses. All corporations should periodically review their governing documents to determine if their existing indemnification and advancement of expenses rights are as broad as are desirable for the organization.

Boards should also be aware of several NPCL procedural requirements that apply to indemnification and the advancement of expenses. First, unless ordered by a court, any indemnification of a person who has not been successful in defending a civil or criminal action requires specific authorization by the board of directors. The board must find that the required statutory standard of conduct has been met or, if a quorum of uninvolved directors is not available to make this determination or if a quorum of disinterested directors instead directs, specific authorization may instead be made either by the members (if any) or by the board upon the written opinion of legal counsel that indemnification is proper in the circumstances because the applicable standard of conduct has been met. Second, expenses incurred in defending a civil or criminal action or proceeding may be paid by the corporation in advance of the final disposition of such action or proceeding only if the director or officer provides the corporation with a written promise to repay the advanced amount to the extent such director or officer is ultimately found not to be entitled to be indemnified.

Corporations also have certain disclosure obligations with respect to indemnification.  If the corporation indemnifies a director or officer other than by reason of a court order or upon approval of the members, or if any other action with respect to indemnification of directors and officers is taken by amendment of the by-laws, resolutions of the directors or by agreement, a statement detailing the indemnification made or the action taken must be (i) sent to the corporation’s members entitled to vote for directors (if any) within three to fifteen months, depending on the date of the next annual meeting, or (ii), if there are no members, included in the corporation’s records that are open for public inspection.

9.         Insurance. An important part of liability protection for a corporation and its directors and officers is insurance. Corporations are authorized to purchase and maintain insurance to fully indemnify directors and officers (i) in instances where their indemnification by the corporation is permitted under the NPCL and (ii) in instances where their indemnification by the corporation is not so permitted as long as the insurance provides retention amounts (deductibles) and co-insurance provisions approved by the New York superintendent of insurance. Corporations may also purchase insurance to indemnify themselves from any indemnification obligations they may be required to make under the NPCL. Corporations that purchase or renew any such insurance are required to send a statement to their members entitled to vote for directors (if any) describing such insurance within three to fifteen months of the purchase or renewal of the insurance, depending on the date of the next annual meeting.

10.        Foreign Corporations. In addition to the Charities Bureau’s filing requirements discussed above, certain provisions of the NPCL are applicable to foreign (i.e., non-New York) not-for-profit corporations that are authorized to conduct business in New York. For example, directors who approve distributions or loans of the corporation’s cash or property to members, directors or officers (other than as compensation) will be subject to liability in most cases, as such distributions and loans are largely prohibited under the NPCL. Also, the NPCL’s standards for indemnification, advancement of expenses and insurance apply to foreign corporations as well, unless the principal activities of the corporation are conducted outside the State, the greater part of the corporation’s property is located outside the State and (i), for Type A corporations (which include social organizations and trade associations), less than one third of its members are New York residents or (ii), for Type B corporations (which includes charities and educational or religious organizations), less than 10% of its annual revenues are derived from the solicitation of funds in the State.

C.         New York Museums/Historical Societies. New York State considers its museums and historical societies to be educational organizations and, as such, they are subject to regulation by the Board of Regents of the University of the State of New York (“Board of Regents”) under the New York Education Law (“Education Law”). In addition, museums and historical societies are generally subject to the provisions of the NPCL to the extent they do not conflict with the Education Law. The rules of the Board of Regents (“Regents Rules”) principally govern the operations of museums and historical societies. Some of the common governance and compliance requirements applicable to museums and historical societies are:

1.         Mission Statement. Institutions must have a written mission statement that is derived from the institution’s purposes set forth in its charter and identifies the benefits derived from the institution’s activities. The mission statement should be reviewed and revised, as necessary, at least every five years.

2.         Code of Ethics. Institutions must have a written code of ethics that is applicable to trustees, administrators, staff and volunteers, addresses issues of public trust, contains a conflicts of interest policy and is reviewed each year.

3.         Composition of the Board of Trustees and Committees. Generally, the board of trustees must number between five and twenty-five members. No more than one-third of the members may be related to one another by birth, marriage or domicile. If there is a relationship between the institution and another corporation, society, organizational or institution in which the institution and the other entity are related by common membership, governing bodies, trustees, officers or shared finances, collections or facilities, no more than one-third of the institution’s board may be officers or directors of the other entity at the same time. Also, unlike under the NPCL, trustees may not be compensated for their services as trustees.

Special rules also apply to the composition of certain board committees. Any executive committee must have at least five members, and there must be a board-constituted audit committee, composed of a minimum of three board members other than the treasurer and president, that reviews financial transactions and reports.

4.         Annual Report. Institutions must file an annual report with the New York State Museum, which oversees New York’s museums, historical societies and other similar cultural agencies. The report records the educational, cultural and financial activities of the institution, and requires the submission of, among other things, copies of the institution’s Federal informational return and any independently audited financial statements.

5.         Financial Oversight and Review.  The Regents Rules expressly require institutions to carry out typical financial governance actions, such as preparing an annual budget and financial statements that are regularly reviewed by the board, adopting formal financial policies and maintaining written records of financial transactions pursuant to generally accepted accounting practices.

Similar to organizations required to register with the Charities Bureau, if the institution’s annual operating budget exceeds $100,000, it must have an annual independent review (if the budget is between $100,000 and $250,000) or annual independent audit (if the budget is over $250,000) by a certified public accountant in accordance with generally acceptable accounting principles applicable to not-for-profit corporations.

6.         Collections Management Policy. Museums and historical societies with collections must have a written collections management policy that (i) provides clear standards to guide institutional decisions regarding their collections, (ii) is in regular use, available to the public upon request and filed with the commissioner of the New York State Education Department for inspection by anyone wishing to examine it and (iii), at a minimum, satisfactorily addresses the subject areas of acquisitions, loans, preservation, access and deaccession. Note that the New York State legislature is considering adopting new restrictions on the deaccession of collection items, which is currently governed by emergency rules adopted by the Board of Regents.

Any collection management policy should also incorporate the relevant sections from the recently enacted Section 233-aa of the Education Law which provides rules governing, among other things, acquiring title to unclaimed property, providing donors and prospective donors with copies of the institution’s mission statement and collections policy and the application of conservation measures to loaned property.

7.         Records Retention.  Museums and historical societies with collections are required to maintain records of the acquisition, deaccession or loan of collection items. These records should contain (i) the names and contact information of donors and lenders, (ii) a description and the location of collection items and (iii) up-to-date terms and restrictions of the acquisition, deaccession or loan of collection items, including copies of all documents conveying title to or loaning collection items. Specific records related to any unclaimed property acquired by the museum or historical society must also be kept.


Questions regarding this advisory should be addressed to Austin D. Keyes (212-238-8641, keyes@clm.com), Howard J. Barnet, Jr. (212-238-8606, barnet@clm.com) or Dan Pittman (212-238-8854, pittman@clm.com).

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
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