The CPA’s Role in Governance, Accountability,
Claudia L. Kelley and Susan Anderson
2006 - The nonprofit sector plays a major role in the U.S.
economy, encompassing, according to an April 2005 statement
by IRS Commissioner Mark Everson before the Senate Finance
Committee, more than 1.8 million organizations, with assets
totaling $2.5 trillion and revenues of $1.25 trillion. The
importance of nonprofits has become especially evident in
the relief efforts for victims of Hurricane Katrina in 2005
and the Asian tsunami of 2004. Federal, state, and local
governments increasingly rely upon nonprofits’ services
after natural and manmade disasters. Nonprofit organizations
(NPO) must maintain the public’s confidence in order
to raise the funds necessary to fulfill their missions.
many NPOs have been found to engage in financial improprieties.
Highly regarded organizations—including the United
Way of America, the Nature Conservancy, and Adelphi University—improperly
diverted funds to insiders. The Red Cross was criticized
for diverting donations specified for victims and victims’
families of the September 11, 2001, terrorist attacks to
other uses. When NPOs are perceived as acting irresponsibly,
the public can quickly feel that its trust has been violated.
Reports of unsavory behavior in one NPO can cause a decline
in giving to other charities. In response to these problems,
stakeholders of charitable organizations are demanding more
accountability and transparency.
Senate Finance Committee is considering tax-exempt reform
containing provisions similar to those found in the Sarbanes-Oxley
Act (SOX). The Panel on the Nonprofit Sector, an independent
group of NPO leaders convened by the Independent Sector
a nonpartisan leadership forum for charities, foundations,
and corporate-giving programs, recommended more than 120
separate actions to strengthen accountability and governance.
State attorneys general are pursuing allegations of abuse
in the nonprofit sector more vigorously. California enacted
the Nonprofit Integrity Act of 2004, which applies provisions
similar to SOX to nonprofits. New Hampshire passed a law
requiring charities with annual revenues greater than $1
million to have audited financial statements. Massachusetts
and New York are considering similar requirements.
demand for greater NPO accountability provides opportunities
for CPAs. As reported in Association Management
(April 2004), 77% of the participants at the AICPA’s
first National Consensus Conference on Nonprofit Governance
strongly agreed that the nonprofit community must act to
affirm its integrity to members, donors, the government,
and the public. CPAs, in their roles as NPO employees, volunteers,
directors, auditors, and advisors, can provide help to improve
NPO governance and transparency. This article describes
weaknesses in a nonprofit’s operations and policies.
By identifying these potential problems, CPAs can help NPOs
improve organizational effectiveness.
well-publicized scandals and increasing government scrutiny
demonstrate the need for due care on the part of NPO board
members and senior managers. Nonprofit directors and officers
have three fiduciary duties under current law: the duty
of care, the duty of loyalty, and the duty of obedience.
If directors do not exercise these duties, they may be personally
liable for their actions.
duty of care requires that directors be informed and act
in good faith. This duty addresses the manner in which the
directors exercise their responsibilities, rather than the
correctness of a decision. The duty of care requires that
directors be informed, attend board meetings, and have access
to organizational data.
duty of loyalty requires directors to exercise their powers
in the best interest of the organization rather than in
their own or anyone else’s interest. Avoiding conflicts
of interest, in appearance or in fact, is a prime element
of this duty. Directors are prohibited from self-dealing
unless there is full disclosure to the board and the transaction
is clearly in the organization’s best interests. To
prevent the appearance of a conflict of interest, directors
and officers should avoid all self-dealing activities.
duty of obedience requires that directors adhere to the
organization’s mission. The directors’ decisions
and oversight must be in accordance with, and in furtherance
of, the organization’s mission.
CPAs can assist NPOs by reviewing board members’ activities.
1 contains a checklist of issues involving directors.
These questions assist CPAs in identifying areas to improve
board effectiveness and reduce liability exposure.
CPAs advising nonprofits must understand the
requirements for obtaining tax-exempt status. NPOs must
be organized and operated for an exempt purpose described
in IRC section 501(c), and this purpose must be stated in
the organization’s articles of incorporation. If an
NPO is to receive tax-deductible contributions, it must
be organized and operated for religious, charitable, scientific,
safety, literacy, or educational purposes, or to prevent
cruelty to children or animals. To qualify as a charitable
organization, entities other than churches must file Form
1023 with the IRS. Other NPOs must submit Form 1024.
2 contains questions pertaining to an NPO’s formation,
several of which address state law. While the IRC governs
the tax status of nonprofit entities, their formation and
operations are regulated by the states and generally enforced
by the state attorney general.
Exempt organizations must adhere to several restrictions
to maintain their exempt status. In 2004, the IRS revoked
the status of 379 organizations as public charities (Announcement
2004-103), demonstrating the importance of continually monitoring
an exempt organization’s activities. Compensation,
political activities, and fundraising are particularly complex
Most NPOs are subject to the prohibition against
private inurement, meaning that no part of the net earnings
unduly benefits a private shareholder or individual [Treasury
Regulations section 1.501(c)(3)-1(c)(2)]. The IRS can revoke
an organization’s tax-exempt status if its assets
are used in a manner that benefits insiders [Treasury Regulations
section 1.501(a)-1(c)]. Inurement can include unreasonable
compensation, non–arm’s-length financial transactions,
below–market-interest-rate loans, and certain joint
ventures with for-profit entities.
must exercise care in transactions with a director, officer,
substantial donor, or anyone in a position to exercise significant
influence over its affairs. The IRC assesses excise taxes
on excess-benefit transactions in which the economic benefit
an organization provides is greater than the value of the
consideration (including services) it receives. A 25% tax
is levied on the recipient of the excess benefit, as well
as on the organization’s managers who knowingly participate
in the excess-benefit transaction (IRC section 4958). Unreasonable
compensation is one type of excess benefit; however, if
rebuttable presumption rules in the regulations are met,
then the compensation is presumed to be reasonable. The
regulations also describe a rebuttable presumption for property
3 contains questions that CPAs should consider to ensure
that an organization is not in danger of engaging in inurement
or an excess-benefit transaction.
and political activities. Section 501(c)(3)
charities may not engage in any political campaign on behalf
of (or in opposition to) any candidate for public office.
This is an absolute prohibition. The IRS may revoke the
organization’s exempt status if any amount of political
activity is conducted. Charities must also take care in
trying to influence public opinion or legislation, because
no substantial part of an NPO’s activities may be
lobbying [IRC section 501(c)(3)]. Because the law does not
define this “no substantial part test,” charities
may choose to make a lobbying election under IRC section
501(h), which provides an objective test for determining
permissible amounts of lobbying expenditures.
of charitable organizations cannot make partisan comments
in the organization’s publications or at its functions.
Political candidates can speak at charitable events, but
the organization must meet the requirements of IRS News
Release 2004-79. An organization that is exempt under section
501(c)(4), (5), or (6) can advocate a position on a policy,
but it is subject to a tax on expenditures related to the
election or appointment of a public official. Revenue Ruling
2004-6 provides additional details regarding these activities.
to the Bipartisan Campaign Reform Act of 2002, section 501(c)
organizations are not permitted to solicit “soft money”
on behalf of, or to contribute soft money directly to, NPOs
that make expenditures in connection with a federal election.
NPOs engaged in issue advocacy and political campaign activity
may be subject to both IRS and Federal Election Commission
(FEC) rules. Organizations such as the Alliance for Justice
and OMB Watch are available to help NPOs navigate through
the rules of both statutes. Exhibit
4 lists questions that CPAs should ask regarding an
exempt organization’s political and lobbying activities.
and solicitation. Most states require registration
of charitable soliciting organizations and paid fundraisers.
CPAs can check the website for their state’s secretary
of state to obtain the exact requirements. The National
Association of State Charities (www.nasconet.org)
and the National Association of Attorneys General (www.naag.org)
have developed a unified registration statement in an effort
to consolidate the information and data requirements of
all states that require registration of nonprofit organizations
soliciting charitable contributions. Many states now accept
the unified registration statement rather than their own
state form. (Exhibit
5 presents relevant questions about fundraising and
income tax (UBIT). NPOs often attempt to raise
money through means other than contributions. Tax-exempt
organizations earning income from a trade or business that
is regularly carried on, but is not substantially related
to the organization’s exempt purpose, are subject
to UBIT (IRC section 511). For example, a church that sells
clothing bearing its name has unrelated business income,
as do NPOs that receive advertising revenue from their websites.
IRC section 513 provides for exemptions from UBIT of several
types of income, including rent and royalties.
of financial information. All section 501(c)
organizations, except private foundations, churches, and
government-related organizations, must provide copies of
their annual information returns (Form 990) and exemption
applications upon request [IRC section 6104(d); Treasury
Decision 8818, 4/9/99]. The organization is excused from
providing copies for documents that are posted online. Contributors’
names and addresses are not required to be disclosed. Penalties
for failure to follow the disclosure rules apply to the
person responsible rather than the organization. (Exhibit
6 is a checklist of questions on disclosure, internal
controls, and tax requirements.)
resources are available to help CPAs learn more about issues
facing NPOs. The AICPA has developed an Audit Committee
Nonprofit Organization Toolkit (available for free download
see The CPA Journal Book Review, February 2006)
containing detailed guidance on 20 topics pertinent to NPOs.
Subjects addressed include an audit committee charter matrix
and self-evaluation, defining and obtaining financial expertise
for audit committee members, fraud, internal control, hiring
external experts, hiring independent auditors, evaluating
the internal audit team, and independence.
New York State Attorney General’s office has extensive
information for charities on its website (www.oag.state.ny.us),
including a publication providing guidance for board members
titled “Right from the Start:
of Directors and Officers of Not-for-Profit Organizations.”
7 lists other websites that provide useful information
are in a position to help restore the public’s trust
in NPOs and thereby enable the continued vitality of these
socially desirable entities. They can assist NPOs in establishing
strong oversight, governance policies and procedures, fiscal
responsibility, and accountability. Whether as a director,
employee, independent accountant, or volunteer, the CPA’s
expertise is in demand.
L. Kelley, PhD, CPA, is a professor of accounting
at Appalachian State University, Boone, N.C.
Susan Anderson, PhD, CPA, is an associate
professor in the department of accounting at North Carolina
A&T State University, Greensboro, N.C.
The checklists in this article are intended as
useful starting points for discussions on NPO governance.
Because nonprofits differ widely, not all items in each
checklist apply to every organization.
more of this month's Special Focus on Nonprofit Management,
Expense Reporting for Nonprofits"