Charities at their best provide for important human and societal needs and so deserve the significant tax and other benefits they enjoy.
Charities are not always at their best, however, and board members and officers on occasion fail—sometimes in serious ways—to fulfill their duties to ensure that charities pursue their missions and use their resources for the public good. Those failures can harm all charities by undermining public confidence.
Unfortunately, state-level oversight of charity governance falls far short of what is needed to identify and reign in organizations that abuse the system and to educate charity leaders about their responsibilities.
Due to the lack of effective state-level oversight, government officials and charity experts have begun to emphasize the need for a national solution to charity governance problems.
The Internal Revenue Service has stepped up attention to governance issues, most notably through the revised Form 990, and many experts in tax-exempt law—including Marcus S. Owens, a former director of the IRS Exempt Organizations Division—are urging Congress to create a new national regulatory organization, one that would operate more like a private organization than a government agency, to oversee nonprofit organizations much the way the Financial Industry Regulatory Authority regulates the securities industry, as The Chronicle of Philanthropy reported in its October 29 issue.While we support the goal of improving charity governance, we think there is a simpler and more effective way to ensure that charity leaders fulfill their fiduciary obligations. We propose that Congress step in, not to usurp the traditional authority of the states over charities—either through the IRS or a new federal regulatory body—but to finance expanded state charity oversight offices that could then both effectively investigate governance failures at charities and provide guidance to nonprofit leaders on their legal duties.
We recognize that existing government oversight of charities fails in many ways. State officials have the legal authority to investigate and sanction charities and their leaders, but budget pressures and other priorities have for the most part thwarted efforts to increase their use of that authority.
Only a few states—notably California, Illinois, Ohio, New York, and Pennsylvania—have more than a half-dozen full-time lawyers assigned to oversee charities, according to a recent survey by Garry W. Jenkins, an Ohio State University professor, and those states have some of the largest numbers of charities.
The IRS has tried to make up for the shortcomings of state officials by focusing more on governance matters, but the agency has neither the expertise nor the resources to monitor and enforce the fiduciary standards that arise under state law.
The IRS’s Exempt Organizations Division audits less than 1 percent of tax-exempt organizations annually, struggles to issue desperately needed guidance, and is the “Cinderella in the kitchen,” as Joel L. Fleishman, a Duke University professor and author of The Foundation has put it, when it comes to competing for money and other resources within the IRS.
Instead of creating a new national regulatory body or asking the IRS to police charity governance, we propose that Congress build on the existing and broad authority of state attorneys general to oversee and, if needed, sanction charities by offering states a dedicated source of financial support to expand or create charity-supervision offices.
For states that already have such offices, federal money would permit the hiring of additional lawyers, accountants, and other staff members who could investigate possible governance failures at charities and educate charity leaders about their governance duties. For states that do not have such offices, the offer of federal money will be a powerful incentive to create them.
And for the few states in which oversight of charities is the responsibility of a state official other than the attorney general, the money could go to that official’s agency instead.
As a condition of federal financial support, an assistant attorney general, or an equivalent state official, should head the charity-supervision office in each state to ensure that the office will have sufficient authority and prominence.
At the same time, the charity-supervision office should develop a staff with knowledge of nonprofit law by building on the existing expertise of state charity officials and by taking advantage of existing networks of state charitable officials, such as the National Association of State Charity Officials, as well as the training available through Columbia Law School’s Charities Law Project. This staff of dedicated nonprofit experts, as well as the financial support from the federal government, will help limit political influence over investigation choices and provide a measure of accountability for such offices.
The obvious, although not only, potential source of financing for those offices is the private-foundation investment income tax, which has averaged more than $450-million annually in recent years. Both the staff of the Senate Finance Committee and the Panel on the Nonprofit Sector, a group organized by the national nonprofit coalition Independent Sector, recommended that Congress use a portion of those tax revenues to support state charity-oversight efforts. If more money is needed to cover the costs, Congress could adjust the current proposals to increase the tax rate as needed to provide sufficient revenue.
The Internal Revenue Service would allocate dollars based on the number of charities or the amount of charitable assets under supervision in each state and require reporting from the states on their activities and investigations. This role would give the IRS greater access to information uncovered by state officials about possible federal tax-law violations without asking the already overburdened Exempt Organizations Division to assume responsibility for learning, interpreting, and enforcing charity governance standards provided by the laws of the 50 states.
To ensure public accountability, Congress should also require states to publish information about their investigations as a condition of federal financing.
Such state charity-supervision offices would continue the long history of state supervision of charities while federal money would overcome the budget limitations that have hindered the effectiveness of such supervision. Keeping charity supervision in state offices, instead of moving such supervision to a national body, also permits greater experimentation with both governance requirements and enforcement techniques.
State offices are also more accessible to the vast majority of charities, including many hospitals and universities, that operate primarily or exclusively in a single state. Building on the existing, if insufficient, network of state charity-supervision offices also avoids much of the uncertainty, cost, and complexity inherent in the bolder proposals put forward by Marcus Owens and other commentators to create a new national entity to oversee charities.
Using federal money to finance state-administered programs is a model that has already proven to be effective. Some well-known examples of federal-state programs include the Federal-State Unemployment Insurance Program, administered by the Department of Labor, and the Community Development Block Grant program administered by the Department of Housing and Urban Affairs.
Following the example of those and other federal-state programs, our proposal would allow the IRS to oversee the financing and procedural aspects of the charity oversight program, while allowing state charity offices to enforce fiduciary standards that arise under state law. This approach would benefit charities by improving the enforcement of governance standards broadly, without creating new layers of bureaucracy or more federal reporting obligations for charities.
Well-financed state regulation is also preferable to other overhaul proposals, such as relying on increased self-regulation or expanding the types of people and entities that can sue a charity and its leaders for governance failures.
Self-regulatory bodies, which currently include organizations as diverse as the Council on Foundations and the Evangelical Council for Financial Accountability, always face the risk that they will be less than aggressive in pursuing governance failures at the organizations they depend upon for support and, more important, reach only those charities that chose to follow their rules.
Expanding the number of players that can sue a charity would both increase the potential for harassment suits and almost certainly lead to uneven enforcement, with prominent or controversial charities receiving the lion’s share of such legal attention. Our plan maintains the existing authority of the state attorneys general to pursue lawsuits against charities but gives the attorneys general sufficient financing to use that authority effectively.
James Madison, in “The Federalist No. 51,” wrote: “If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: You must first enable the government to control the governed; and in the next place oblige it to control itself.”
Mortals run charities and so government must hold charity leaders accountable; mortals run governments and so government overseers must be accountable for their actions. The combination of federal money and state oversight can ensure accountability on both counts.
Lloyd Hitoshi Mayer is an associate professor at the University of Notre Dame Law School and of counsel at Caplin & Drysdale, a Washington law firm. Brendan M. Wilson is a lawyer at Akin Gump Strauss Hauer & Feld. This article is based on a longer article available at http://www.ssrn.com, to be published in the Chicago-Kent Law Review.
