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Regulators nationwide have launched a crackdown on nonprofit organizations and charities, tracking everything from what a priest says about politics during church to how much money top executives make. And the scrutiny is coming from several watchdogs, including Congress, state legislatures and the Internal Revenue Service, which recently sent 2,000 letters to nonprofits nationwide alerting them of stricter enforcement and possible auditing. The crackdown has sent many nonprofits running to their attorneys, asking questions about how the tighter enforcement might affect them, and what they should do to avoid legal problems. “Nobody wants to play around and nobody wants to take chances,” said Neal Buethe of Briggs and Morgan in Minneapolis, which has several clients who have received the IRS letter. “Some have gotten these letters from the IRS as sort of a warning to the IRS’ focus on executive compensation. That seems to be the hot topic for the IRS right now . . . .I was in a meeting with a group of lawyers saying their clients have the same letters . . . .I don’t sense there’s a feeling that [nonprofits] are being picked on, but I think there’s a heightened awareness that they make sure they don’t have problems with excessive benefits.” 17 states weigh in The salaries and perks of nonprofit CEOs has caught the ire of the IRS, which, in August, announced an investigation to identify what groups may pay excessive salaries or benefits to top executives. California recently became the first state to pass legislation that will, among other things, require tighter auditing procedures by nearly 90,000 charities. Sixteen other states also have introduced similar bills. And the Senate Finance Committee has held several hearings on potential abuses by nonprofit groups, with proposed federal nonprofit legislation in the works. Regulators and lawyers representing clients in the nonprofit sector say several factors are behind the crackdown, including a drop in public confidence in charitable giving, reports of lavish perks and salaries for top officials and scandals over financial abuse by charities. “Public confidence in charitable giving is disturbingly low, and so we decided to take action and sponsor a measure that we believe protects charities, protects the donors and protects their programs,” said Tom Dresslar, spokesman for the California Attorney General’s Office, which co-sponsored the California bill. “There have been a series of scandals involving fund-raising foundations and financial mismanagement. And California saw it’s share . . . .The whole purpose [of the bill] is to protect, not punish. We’re trying to prevent financial problems and prevent misconduct before they happen.” Erica Greeley, director of strategic policy planning for the National Council of Nonprofit Associations in Washington, said the reputation of the nonprofit sector took some hard hits after the 9/11 attacks. She partly blamed this on the actions of a few organizations that tarnished the image of many, and a public misunderstanding of how charities operate. “The events following 9/11 perpetuated the misunderstanding that nonprofits are ‘pass through’ organizations, that they pass dollars through their organizations to those in need,” she said. “This is not the case of many organizations that need to adequately fund their own overhead costs in order to provide services to the public.” Moreover, she argued, tighter regulations on the nonprofit sector have made it tough for charities to get their jobs done. “When nonprofits are forced to increase the time we spend on documenting operations and adhering to new regulations, we have less time and resources for the services we provide to the public,” she said. To avoid legal hassles or the appearance of any wrongdoing, lawyers and the IRS are advising nonprofits to make sure they are in compliance with three key IRS guidelines regarding executives salaries: Compensation should be approved in advance, not retroactively, by a board or a committee that poses no conflict of interest. The board or committee should make its decision using appropriate, comparable data showing what other executives in the same area earn. Documentation of the committee’s or board’s deliberation, detailing who agreed, disagreed and how disagreements were handled. Barbara Dunn, a partner at St. Louis firm Howe & Hutton, also encourages nonprofits to have tax experts on boards. “The bottom line is, the people who are being selected to be on boards should certainly serve as not just the rubber stamps, but they should be prepared to review and scrutinize the organization,” said Dunn, who represents tax-exempt groups. On Sept. 29, California Governor Arnold Schwarzenegger signed a bill calling for tighter scrutiny of nearly 90,000 nonprofits, making California the first state successfully to pass such legislation. The new law has three key provisions: Charities with revenues of $2 million or more must form audit committees and hire outside auditors to conduct independent financial audits and make them public. Compensation for top officials in all charities must be approved by the group’s board of directors. For-profit companies that solicit donations for charity must hand over contributions within five days of receiving money. James Seely, a lawyer with the San Francisco-based Association Legal Services, which counsels nonprofit trade groups and professional associations, said the five-day requirement provision is “unnecessary,” and called the overall bill “too restrictive.” He added that “[a]n overriding concern is whether a law of this sort will be mimicked in other states and even extended to nonprofit corporations other than charities.” The California Association of Nonprofits also opposed the bill, arguing that it would financially hurt charities by forcing them to spend already scarce funds on items like an auditor. But the bill’s proponent’s denounced that argument, saying that the new auditing requirement affects less than 5% of all charities, and that the cost for an auditor runs between $7,000 and $10,000, which represents less than one-half of 1% of a charity’s total budget. The California law, coupled with the congressional pressure and IRS scrutiny, have lawyers wondering if the government is asking too much of groups simply trying to do some good. “On the audit side, it likely may be asking too much,” Dunn said. “You’ve got the large organizations and smaller ones. In many instances, it could be burdensome.” According to a recent study by the Chronicle of Philanthropy, the 2003 median salary of 215 chief executives surveyed was $291,356, up 3.66% from the year before, and double last year’s 1.9% inflation rate. The study also found that the five highest-paid chief executives for nonprofits work in the health care profession-four of them earning more than $1 million a year. Topping the list was Harold Varmus, president of the Memorial Sloan-Kettering Cancer Center in New York, who earned $1.69 million in 2003. John Gunn, executive vice president of Sloan-Kettering, said an executive of Varmus’ caliber merits a $1.6 million salary. “First, he’s a Nobel Prize winner,” Gunn said. “Two, he ran an enormous organization, namely the National Institutes of Health. And three, he has great standing in the scientific and clinical community and he’s able to attract some of the best and brightest people to come and work here.” “Executive compensation caught the IRS’ attention,” said IRS spokeswoman Nancy Mathis. “The nature of compensation has changed. And we do take notice of stories that appear in the newspapers, too. It’s not like we’re not aware of the issues out there.” Mathis said that the IRS sent letters to nonprofits whose tax information contained questionable facts. For example, salaries appeared too high, or no salary was printed at all. A closer eye On a grander scale, Mathis said the IRS is keeping a closer eye on charities after several years of “not keeping our eye on the ball on the enforcement side.” She said the IRS for too long primarily focused on being a service organization for nonprofits, rather than a law enforcer. That’s changing now. Mathis said the IRS has launched a four-step initiative to monitor nonprofits better. Among the priorities are: Anti-terrorism. The IRS is looking at charities suspected of funneling money to overseas terrorist organizations. Tax avoidance schemes. The IRS is tracking down groups that use tax-exempt status as a scheme to avoid paying taxes. Credit counseling agencies, which are being investigated for charging high fees but providing few services. “We just want them to be assured that everyone is going to play by the rules,” Mathis said. Layton Olson, an attorney with Howe & Hutton who represents tax-exempt trade organizations and charities, said tighter regulations could financially hurt many nonprofits, particularly those with overseas connections. “A big legal issue facing foundations is all of the security kinds of things. If you make grants overseas, what is your responsibility to know where your money goes? The government wants reports and that really drives up costs,” Olson said.

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