Erin and I attended the 18th Annual Western Conference on Tax-Exempt Organizations (WCTEO) co-sponsored by Loyola Law School and the UCLA School of Law, Lowell Milken Institute for Business Law and Policy on November 20 and 21. Here are highlights of some of the great sessions:

Washington Update. Ruth Madrigal, U.S. Treasury, walked us through the past year’a accomplishments and the current year’s priority guidance plan, which was updated earlier this month. Regarding the current year’s plan, of particular note: proposed regulations under §501(c) relating to political campaign intervention, additional guidance on §509(a)(3) supporting organizations, final regulations under §§4942 and 4945 on reliance standards for making good faith determinations (see proposed regs), and final regulations under §4944 on program-related investments and other related guidance (see proposed regs). Tammy Ripperda, Internal Revenue Services – Exempt Organizations, emphasized what she said were excellent improvements in internal processes and customer service since May 2013 controversy. She noted in particular the new Form 1023-EZ, which has an estimated 90 days response time (and anecdotally, we are hearing has closer to a 2-3 week response time to date). While noting some controversy about the Form 1023-EZ, she defended its development and use, stating that, statistically, small nonprofits are historically compliant. She also mentioned that a sample of 1023-EZ applications would be subject to additional questions in a pre-determination process. And there would also be a post-determination process checking up on some of the 1023-EZ applicants). Finally, Ripperda identified the 5 key focus areas of the Exempt Organizations Unit regarding compliance: (1) exemption issues; (2) protection of assets (including diversions); (3). tax (UBIT and employment); (4) international activities (terrorist, FBAR filings); and (5) emerging issues.

Mergers, Acquisitions, Dissolution and Alliances of Exempt Organizations. Attorneys Arthur Rieman and Lisa A. Runquist walked us through a hypothetical involving a nonprofit considering various options for its future:

• Creating a new revenue-generating program will first require that the board make sure that the program is consistent with its exempt purposes. While it may be possible to expand the organization’s exempt purposes by amending the articles of incorporation, the organization must make sure that the “investment” of charitable assets to build the program doesn’t violate charitable trust principles (i.e., you can’t use funds raised in support of the old mission to pursue an unrelated new part of the mission).
• Creating a nonprofit joint venture with a for-profit requires analysis of whether the joint venture is furthering the exempt purposes of the nonprofit, whether the joint venture is going to be a nonprofit or for-profit, and what type of control mechanism is required to protect the nonprofit’s interest. If the nonprofit joint venture is unrelated to the nonprofit’s exempt purpose, the nonprofit must also consider whether its investment in the joint venture is consistent with prudent investment requirements. Additionally, the nonprofit must consider any disqualified person and interested person conflict of interest, self-dealing, and excess benefit transaction issues and how to manage them in compliance with applicable laws.
• Converting a nonprofit to a for-profit where board members of the nonprofit are going to become the owners of the for-profit will require care to ensure that self-dealing, excess benefit transaction, and private inurement rules are not violated. Fair market value must be paid by the owners (get an independent appraisal) and such monies should be distributed to another nonprofit with a consistent exempt purpose.
• Selling the assets to the nonprofit’s chair of the board may be a possibility if done correctly (including getting approval of the majority of the board without counting the vote of any interested directors) and ensuring fair market value is paid to the nonprofit. Valuations are tricky and the nonprofit will want to make sure they are truly independent and that the valuation reflects the actual transaction. If, for example, post-valuation, the buyer states they are unwilling to take on any of the liabilities that were included in the valuation, the nonprofit may need a new valuation.
• Dissolving the nonprofit will require certain steps be taken, including obtaining a dissolution waiver of objections from the Attorney General. See General Guide for Dissolving A California Nonprofit Corporation. The nonprofit will need to determine what other nonprofit would be a desirable and acceptable recipient of its remaining assets among many other things.
• Merging the nonprofit will require certain steps to be taken, and there may be additional steps necessary where the nonprofit is merging with a nonprofit in another state or the nonprofit is merging into a for-profit.

Advising Versus Earmarking. Attorneys Jennifer L. Franklin and Ingrid Mittermaier discussed the differences between “advising” and “earmarking” in various tax law contexts, including donor-advised funds (DAFs), fiscal sponsorships (Model C or pre-approved grant relationship), and “friends of” organizations affiliated with foreign charities. The emphasis was on the sponsoring organization, fiscal sponsor, and friends of organization maintaining discretion and control of any charitable contributions including the legal authority to grant such contributions to a grantee other than the one identified as the contemplated ultimate charitable recipient. Jennifer and Ingrid also discussed the issues related to common board members when differentiating between advising and earmarking and the issues related to a ultimate grantee that was not a U.S. public charity.

Hosted Lunch. Former Chief of Staff of the Joint Committee on Taxation, George K. Yin, provided a scathing criticism of the Form 1023-EZ, calling it essentially a self-certifying method of getting 501(c)(3) status.

Charitable Diversions (and Not the Good Kind): Dealing with Embezzlement. Attorneys Ofer Lion and Suzanne Ross McDowell discussed the too-common problem of charitable diversions (embezzlement) and introduced a 12-step response framework: internal nondisclosure agreements for board members, internal investigations (with thoughtful determination of who conducts the investigation), public relations plans, insurance, indemnification requirements, board liability issues, employee release / settlement agreements, governmental notice requirements (local, AG, IRS), tax-exempt status issues, succession plans.

Current Developments. Attorney Bruce Hopkins walked us through his comprehensive list of annual developments in laws affecting nonprofits. Among the trends and rulings Hopkins noted: (1) an exempt activity focused on “consulting” is very likely to raise commerciality concerns; (2) an organization was denied tax exemption as public charity because a substantial portion of its activities, in pursuit of social justice, could only be accomplished by legislative action (PLR 201408030); (3) an organization was denied exemption in part because its activities were unduly integrated with its affiliated social welfare organization (PLR 201408030); and (4) the IRS, in course of processing an exemption application, took into consideration remarks made by the applicant’s founder in social media, resulting in denial of the application (PLR 201417017).

Attorney General Update. Sonja Berndt, California Deputy Attorney General, provided a very helpful update of the AG’s regulation of charities. See an older version of the slide deck here. Charities operating in California should be very familiar with the AG’s regulations as there are transactions that may require giving notice to the AG or obtaining the AG’s approval and the AG is the state enforcement agency to ensure charities and their leaders are operating and taking actions appropriately. Berndt emphasized (1) the dangers of false reporting, which can result in individual liability for breach of fiduciary duty, aiding and abetting a fiduciary’s breach of fiduciary duty, and unfair business practice; and (2) common problems with executive compensation. She also listed the top 9 Ways to Get Investigated (which we’ll cover in a separate blog post). Sean Delany of the Lawyers Alliance for New York led us through the Nonprofit Revitalization Act and comparisons between New York and California laws in several key areas.

Social Enterprise Entities. Attorney David A. Levitt discussed the “hybrid” entities, including the benefit corporation, the flexible/social purpose corporation, the Delaware public benefit corporation, and the low-profit limited liability company. What the hybrid entities have in common: (1) they blend business purpose with social or charitable purpose; (2) their directors can and/or must take non-economic issues into considerations when making business decisions; and (3) they are taxed like other for-profit entities. He also cited part of the opinion in EBay vs. Newmark that served as in impetus for the hybrid social enterprise movement: “Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.” See Using New Hybrid Legal Forms.