OPERATIONS – RUNNING THE BUSINESS
Clients must understand that running a nonprofit is the same as running a business, and often is more complex. Although it is not the lawyer’s role to give accounting and payroll advice, the lawyer does need to advise the client that it is imperative to set up effective accounting, recordkeeping and payroll tax systems, and to seek appropriate professional financial advice. In addition, charitable organizations are subject to the same wage and hour, employment, and health and safety laws as for-profit entities, and can be exposed to the same liability as private corporations for violating state and federal law. Many organizations also will be required to apply for business licenses and comply with local and state regulations. For example, a daycare operation will have to comply with local and state laws governing day care; a homeless shelter offering food with food service regulations, etc. When discussing the structure of business operations, the following points should be discussed with the client:
Employees: Policies for Paid Staff and Volunteers
Organizations operate most effectively when the people running them have a clear understanding of their role, and what is expected of them. Personnel policies should be drafted before any staff are hired, and should apply to both paid and volunteer staff. In addition, best practices suggest that the duties and responsibilities of the Executive Director (if the Executive Director is to be a board member or officer) should be spelled out as well. Depending on the organizational structure, you may want to consider separate management-level personnel policies in a separate handbook. Most small nonprofits do not have labor unions, but if the clinic does represent a nonprofit with a union, it is imperative to enlist the help of a lawyer who is a specialist in labor law. Labor law is different from employment law, and there are very specific state and federal regulations relating to unions and an employer’s responsibility with regard to workers organizing activity.
Any workplace policies always should be set forth in an employee handbook. It goes without saying that the handbook should be drafted or reviewed by an employment lawyer, who can advise the organization with regard to myriad (and often confusingly overlapping) local, state, and federal employment issues. In addition, be aware that in some states, personnel policies or handbooks will be deemed to be a contract between employer and employee, and discrimination laws vary even by locality (e.g., municipal ordinances regarding disparate treatment related to sexual orientation). Each year, these policies should be reviewed by the board and updated as necessary. A checklist for workplace policies is an important tool to getting started. Some basics that the employer should consider inserting in its personnel policies include:
- Employee evaluation and disciplinary action up to termination;
- Job classifications and job descriptions (including paid and volunteer staff, as well as that of the Executive Director);
- Recruitment, hiring and non discrimination policies;
- Employment conditions, including workers compensation and safety procedures;
- Employee benefits, including leave policies (military, family, jury duty, etc.);
- Intellectual property development (if applicable) and nondisclosure requirements;
- Internet and email use policies, use of other workplace equipment;
- Complaint, grievance and whistleblower processes;
- Additional regulations relating to hours of work and overtime; outside or contract employment.
Clients should be advised to develop specific policies regarding volunteers that closely track the employee policies with regard to recruitment, hiring, screening, placement, supervision, and training. These policies are critical in protecting the organization and its volunteers from liability. You may also want to advise clients to consider using releases with volunteers, as well as obtaining liability insurance.
Wage and Hour Issues
Wage and hour issues (as well as payroll accounting and withholding problems) plague many small non-profits, who frequently run afoul of the law because they have a poor understanding of wage and hour law. Law school legal clinics should have a regularly updated database with the name and contact information for the state wage and hour regulatory agency, and all state and local statutes and regulations regulating wages and hours of work. In addition, most of these state agencies have a wealth of educational material, and provide on-site seminars and technical assistance personnel to help employers. It is important that the clinic have access to the agency’s materials and assistance for its clients. All wage and hour policies should be reviewed carefully to ensure compliance with state and federal wage and hour law, and compliance with statutory “tests” that apply for determining the status of employees. Clients should be discouraged from using “independent contractors,” unless a lawyer has reviewed the contract, as often the law will consider contractors to be employees, regardless of the understanding between the contractor and the nonprofit. Smaller nonprofit corporations may not be subject to federal wage and hour regulations under the Fair Labor Standards Act but they usually always are required to comply with state or local wage and hour and health and safety regulations. The U.S. Department of Labor has a wealth of information related to federal , as well as links to state wage and hour offices.
Creating a Solid Financial Structure: Accounting, Recordkeeping, Audits, Budgets, Income, and Tax Returns
Not only are nonprofit corporations subject to specific and complex regulations regarding payroll and the use of funds, but unfortunately and increasingly, they are vulnerable to financial fraud committed by employees. Thus, it is critical that the nonprofit have a solid financial management structure in place that is reviewed regularly by the budget/finance/audit committee of the board, and is reviewed at least annually by the full board. It is not the lawyer’s role to give specific financial advice, so clients should be encouraged to contact financial experts who can, at a minimum, assist them with preparing: 1) an annual budget with a selected fiscal year that reflects a complete view of all income sources and expenses; 2) a financial policy containing explicit procedures that will protect against fraud and accounting errors; 3) select an appropriate accounting method; 4) establish a payroll system. Payroll issues are extremely complex, and unless the organization is large, or has an experienced payroll specialist on staff, an outside payroll company should be used.
Generating Income: Often exempt organizations do not understand that they are permitted to engage in revenue-generating activities that generate a profit, as long as such activities are substantially related to the purpose of the nonprofit. If, however, these activities have a tenuous relationship to that purpose, the nonprofit can incur substantial liability, and even jeopardize its exempt status. The IRS regulations related to tax liability for “unrelated business income” are extremely complex. Thus, if the clients insist on pursuing such an activity, it is imperative they consult with a CPA experienced in this area. Nonexempt organizations which do operate unrelated businesses must file a Form 990-T (Exempt Organization Business Income Tax Return). Form 990-T and related instructions are on the IRS Web site.
Investment Income: Any nonprofit that wishes to generate income through investments must not only obtain experienced financial advice before doing so, but must make sure it is authorized to do so in its bylaws. The board should have a committee charged with overseeing these investments, developing a strategy, and which performs regular review. The board may want to consider hiring an outside, independent investment advisor that also advises the board, or go through an independent funds manager. To allay fears of any potential liability arising out of such activities, the board also may want to consider exploring purchasing D&O insurance.
Audits: Audits are essential to maintaining fiscal accountability and transparency, and it is important for the board to retain a reputable CPA firm to perform independent audits on a regularly scheduled basis. Frequently, organizations will have to provide the latest audits when submitting applications for funding. The board also of course should be advised to immediately consult a CPA if the organization receives an audit notice from the IRS or a state agency (such as a payroll audit by the Employment Division).
Several legal issues may arise in connection with fundraising that lawyers should be aware of. Some (but by no means all) important considerations are: 1) whether or not the activities will require a permit from the state agency that oversees charitable activities; 2) compliance with government regulations related to sending money overseas (especially the sending of money overseas since 9/11); 3) Ensuring that contracts with fundraising firms or independent paid fundraisers contain provisions requiring that their activities comport with all applicable laws and; 4) compliance with state and federal consumer and advertising regulations. Compliance with state and federal consumer or advertising laws is becoming an increasingly significant issue with the proliferation of Internet advertising. The National Association of State Charities Officials and the National Association of Attorneys General organized a “Uniform Registration Statement” (URS), which consolidates the requirements of all states’ solicitation laws. More information can be found on the MultiState Filer Project Web site. In addition, clients should be advised that Internet advertising might be subject to the provisions of the federal CAN SPAM Act of 2003. The Federal Trade Commission’s Web site contains more information on this Act.
Political Activities and Advocacy
Organizations can lose their federal tax-exempt status if they engage in political activity, which is defined by the IRS as “directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office.” Such exempt organizations may engage in lobbying activities, however, subject to specific limitations. For any organization that intends to engage in any type of elections-related activity or legislative advocacy, it is very important to review the federal IRS regulations pertaining to such activities. There are specific tests related to lobbying activities, as well as rules regarding the types of political activities that are permissible, such as voter education, candidate forums, and the like. See the IRS Web site for additional information.
Working with the Board of Directors – Establishing Standards for Good Governance
Although the Federal Sarbanes-Oxley Act does not apply directly to nonprofit corporations, they are subject to increasing scrutiny, most recently for excessive executive pay and lack of transparent fiscal management. Governance policies are critical to avoiding liability, and should be reviewed and updated by the board and legal counsel annually. Obviously, all such policies should be checked for consistency with the organization’s bylaws and articles of incorporation. The Panel on the Nonprofit Sector, which was an independent group of exempt organization leaders, drafted “Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations.” This is a new set of principles of ethical conduct for organizations operating in the nonprofit sector, and is a result of the work of a broad cross-section of charities and foundations. Nonprofits can go to IndependentSector.org to sign on to the principles, and download a copy.
As noted above, it also is prudent to carefully review the Form 990 and its instructions when formulating board governance policy. This Form was changed substantially in 2007, and it now contains a section with numerous questions related to corporate governance. The IRS may pay particular attention to the answers to these questions, so it pays to take extra care in formulating corporate policies. The IRS Web site on governance can provide some basic information including the new 990 requirements. Idealist.org has excellent tips on board governance as well. Some items to consider including in governance policies include:
- Board member duties regarding financial management, and conflicts of interest;
- Employee policies, including evaluation of management, grievance procedures, employee whistleblower procedures, and record retention;
- Annual training for new and ongoing directors that includes elements of good corporate governance;
- Procedures for regular evaluation of board effectiveness;
- Process for regular review of all policies: governance policies, all procedures related to compliance with state and federal laws related to tax-exempt status, duties of board members, and fiscal operations.
Filling Out Tax Returns
In general, tax-exempt organizations must file tax returns they also are required to pay taxes such as Social Security, Medicare (FICA), and state unemployment and payroll taxes. The Federal forms are Form 990 or 990 EZ and Form 990 Schedule A. There also may be some state tax returns and some county or local government property tax returns; check with your state taxing authority. Clients should be advised to download new forms each year from the IRS, as the forms are changed annually. The IRS keeps an updated Web site with information on the appropriateforms and instructions with regard to the 990, as well as general for nonprofits.
As is noted above, pay special attention to the Form 990 questions related to corporate governance. Since these questions are not only found in the Corporate Governance Section, but elsewhere in the Form 990, the Form should be reviewed as a whole, rather than just a section at a time. In addition, it is prudent to begin this review early each year so they any changes can be brought before the board before the return is filed. Penalties are assessed for each day the forms are filed late, so it is critical to make sure these are filled out, reviewed, and filed on time.
The IRS does not mandate a particular accounting method for charities, but the method selected must be the same each year. If the organization wishes to change accounting methods, it must obtain written permission from the IRS. Any organization wishing to change its accounting methods should consult first with an accountant, as there are a variety of tax rules that apply depending upon the method selected.