The PPP loan application requires applicants to make the following certification: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The Small Business Administration (SBA) has stated that this certification must be made in good faith and take into account the applicant’s “current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.”

The SBA has indicated that loans made over $2 million are likely to be audited.  In that event, there is the possibility that organizations with large endowments which obtained PPP loans of over $2 million end up being subject to civil and criminal penalties.

The SBA has created a safe harbor regarding the certification if the loan was under $2 million.  This means the SBA will assume the certification was made in good faith.  However, organizations with endowments, especially those with seven to ten figure endowments, may run the risk of serious harm to their reputation from constituents and the press.

The post Charities with Large Endowments May Face Government and Public Scrutiny for Taking PPP Loans first appeared on Perlman Sandbox.

In response to the dilemma faced by many charities during the 2008 recession, which had limited operating income, but large sums in endowments, 47 states adopted some form of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) which, amongst other things, allows charities to draw on the principal of endowment funds under certain circumstances.

Under New York’s version of the uniform law, the New York Prudent Management of Institutional Funds Act (NYPMIFA), institutions can, under certain circumstances, spend endowment funds below their original gift amount (“historic dollar value”) without court approval or Attorney General review, if the institution’s board of directors concludes that such spending is prudent. More specifically, NYPMIFA requires that boards, when deciding whether to appropriate from an endowment fund, must act “in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances,” and must consider, if relevant, the following factors:

1. the duration and preservation of the endowment fund;
2. the purposes of the institution and the endowment fund;
3. general economic conditions;
4. the possible effect of inflation or deflation;
5. the expected total return from income and the appreciation of investments;
6. other resources of the institution;
7. where appropriate and circumstances would otherwise warrant, alternatives to expenditure of the endowment fund, giving due consideration to the effect that such alternatives may have on the institution; and
8. the investment policy of the institution.

There are situations where an institution cannot spend below historic value without court approval, including when donors specifically explicitly prohibit this type of spending in the gift instrument.

Lastly, an institution may lift or modify a donor-imposed restriction on the management, investment, or purpose of an institutional fund if the fund is less than $100,000 in value and has been in existence for more than 20 years. If an institution determines that such a restriction is unlawful, impracticable, impossible to achieve, or wasteful, the institution may release or modify the restriction, in whole or part, without court approval, after giving written notice to the Attorney General, who then has 90 days to object. If the Attorney General does not notify the institution within 90 days, the institution may proceed with the release or modification.

The post Charities’ Response to COVID-19: A Guide to Using Endowment Funds for Emergency Purposes first appeared on Perlman Sandbox.

Some donor advisors request the DAF to purchase a ticket to a charitable event, such as a gala, in order to support a charity of their choice. Typically, such tickets cost more than the fair market value of what the purchaser receives in return, such that when purchased directly (not through a DAF), the purchaser enjoys a tax deduction on the price of the ticket exceeding the fair market value.

The charitable community sought guidance on a DAF’s purchase of tickets, specifically regarding whether DAFs could pay the charitable portion of the ticket cost (i.e., the part above fair market value). According to the proposed regulation, however, the prohibition would be absolute. The DAF cannot pay for any portion of the ticket, regardless of the fact that if a person bought the ticket directly, he or she would receive a charitable deduction for the portion of the ticket over and above fair market value.

The proposed IRS regulations place the primary burden of compliance on the donor advisor, who would be fined if the funds in the DAF were used for ticket purchases. Potential excise taxes may also be imposed on any fund manager of the sponsoring organization who authorizes such a payment knowing it would confer a prohibited benefit. Charities and DAFs should take note and bar these types of payments, as donors may unwittingly advise DAFs to pay for tickets and in so doing, putting the donor advisor and the sponsoring organization at risk of being fined. This might sour relations between the donor and the sponsoring organization. Charities and DAFs are therefore advised to take affirmative steps to ensure that any donations made by DAFs are prohibited from being used to purchase event tickets.

The post Stop! Purchase of an Event Ticket with DAF Dollars Could Land You in Hot Water with the IRS first appeared on Perlman Sandbox.

In launching such an organization beyond its native borders, NGOs often find themselves in cloudy legal waters.   The primary issue when establishing a US presence centers on the amount of control the foreign parent can exercise over the newly formed US entity.  What can prevent the American fledgling from running rogue, ignoring the mandate of the parent charity, and possibly even harming the foreign NGO’s reputation?  What can prevent the US organization from spending the funds it raises in a way that defies the parent NGOs wishes?    The following is a brief illustration of some of the ways to solve or at least mitigate these concerns.

Foreign NGO’s control over affiliated US entities

Foreign NGOs often find that the United States is fertile ground for fundraising, research and other activities related to its purposes.  When they seek to raise funds here, they want American taxpayers to receive a tax deduction for their donations.  To do so, NGOs often establish what is commonly referred to as a “Friends of” organization, taken from the common use of the wording “friends of” in the organization’s name, such as American Friends of the Louvre or American Friends of Bucerius.  Typically, the parent organization tries to retain as much control over the US counterpart as possible  to ensure compliance with the foreign entity’s charitable goals.

Of utmost significance to this “control issue” is the IRS mandate that in order for donations from Americans to be tax-deductible, the US entity receiving the donations cannot be organized and operated solely as a “conduit” to solicit earmarked funds on behalf of a pre-existing foreign entity. If the IRS determines that the US charity is such a conduit, it will disregard the US charity in determining the deductibility of donations and rely on the tax status of the end recipient of the funds.  If the recipient is not tax- exempt as is the case with the majority of foreign NGOs, then there is no tax deduction to the donor.  Furthermore, the IRS can rescind the tax-exempt status of a US Friends of Organization if it finds that its sole purpose is to raise and transmit funds to a non-exempt entity.

To avoid being deemed a conduit, the US “friends of” organization must maintain discretion and control over the funds solicited within the United States.  It may be that the US organization primarily directs its funds to support the foreign institution, and may even disperse all grants to it. But to avoid conduit status, all funding decisions must be made on a per-grant or per-project basis by the US charity, and cannot be explicitly promised or committed to the foreign institution as part of the organization’s legal structure. In other words, the US organization must have the right to say no to the foreign parent.

With this in mind, there are a variety of ways in which to structure the legal relationship between a foreign institution and its American offshoot in order to retain some form of control such that it preserves the tax deduction for US donors.

Governance and Bylaws

In my experience, the optimum way to achieve this goal is through the US charity’s bylaws.   The bylaws name the foreign NGO as the sole member of the US charity with the right to appoint and remove all directors at will.  These appointed directors may or may not be persons on the foreign entity’s own board.  This structure allows the NGO to replace directors if they are not fulfilling their charitable purpose[1] or if they are harming the reputation of the foreign NGO. Hopefully, if they do have to be replaced, the new directors uphold and protect the parent’s vision[2].

Use of Trademarks

If the NGO has used the name of the US charity in interstate commerce, it can register the name as a trademark in the US.  Usually, this is possible when a NGO has been fundraising or conducting other activities in the US prior to forming the American entity.  If the NGO qualifies for trademark protection, it can then license the name to the US organization. The terms of the license can include requirements to support the charitable programs and maintain the NGO’s reputation.

In the event of a breach of the agreement, the NGO can subsequently disallow the US charity from using the name.   While the US charity will remain a tax-exempt entity, it will be required to change its name which could have serious adverse effects.  This action frees the NGO to start another charity and license the trademarked name to it. [3]

Affiliation Agreements

Many US charities and foreign entities draft “affiliation” agreements to limit the activities of the US charity.  While these agreements can be enforceable, they must give the US charity enough discretion over its operations and funds to avoid being deemed a conduit by the IRS, thus resulting in the loss of tax exemption and/or the disallowance of tax deduction to donors. The agreements must be carefully tailored as it is possible that the cumulative control the NGO retains can tip the scales into making the US charity a “conduit” when the separate provisions of the agreement will not.

There are hundreds of foreign NGOs which have established US charities to support the their goals and further their missions. To do so successfully, it’s wise to establish a solid foundation that will help the organization to continue to raise tax deductible donations in the United States.

[1]NGO should not replace directors if the organization fails to give money to the foreign entity. This could be considered an abuse of control and could lead to a loss of the US entitiy’s tax exemption.

[2] It should be noted that if the US charity is required to produce audited financial statements (e.g., when registering to solicit in certain states) this type of control will require the NGO and the US charity to issue consolidated financial statements. If required, it would create additional work for the foreign NGO’s auditors.

[3] THE NGO and the new charity must be transparent with any donors, vendors and other interested parties. Notice should be given that the new US entity is not affiliated with the old US entity that is barred from using the name.

The post US Affiliates of Foreign NGOs – A Primer first appeared on Perlman Sandbox.

Many of my clients receive much of their funding in the form of restricted gifts designated for specific purposes or programs.  I find that many of them unnecessarily pay for the administration of their restricted funds with general operating revenue – sometimes creating a cash-starved charity.  These charities are often unaware that many of these expenses can be paid by the restricted fund itself.

To clarify, a restricted charitable gift is a contribution of money or property to a charity with respect to which the donor specifies certain terms and conditions that govern the administration and application of the gifted assets. Many charities assume that restricted funds must only be used for the stated restricted use, such as research, scholarships, or program services and that administrative expenses relating to managing those funds, such as bookkeeping, oversight and the associated overhead are off limits.

Clients are often unaware that under the laws of several states and the Uniform Prudent Management of Institutional Funds Act (UPMIFA), administrative expenses associated with administering restricted funds can be paid out of the same restricted funds.  Such expenses are not only limited to investment fund manager fees but may also include any reasonable expense of administering the fund, including an allocation of salary and overhead if such salary or overhead was reasonably used to administer the restricted fund.  Also often overlooked are accountant fees, legal fees, payroll fees, subscriptions and memberships, postage, shipping, computer supplies, meals, travel, training courses and insurance.

As a case in point, New York’s Not-For- Profit Corporation Law (N-PCL) Section 513 “Administration of Assets Received for Specific Purposes” states:

“… the governing board shall apply all assets thus received to the purposes specified in the gift instrument and to the payment of the reasonable and proper expenses of administration of such assets… 

UPMIFA, which has been adopted in one form or another by most states, allows for “costs that are appropriate and reasonable in relation to the assets…”   [1]

The underlying question then is what exactly qualifies as “reasonable and proper expenses of administration”?   Any payments made to investment institutions for providing investment advice and management are legitimate expenses of administration because they require direct management of those restricted funds. But some allowable costs may not seem to be direct costs of administration.  For instance, some universities expense an allocation of fundraising costs to their endowment to reflect the cost of raising funds for the endowment.

There are various ways to approach establishing the legitimate use of restricted funds for the funds’ administrative expenses.  My own method is to review the organization’s financial statements and backup documentation line by line to determine which expenses can be distributed from the restricted funds.  Although this analysis may be arduous, the end result to the charity is that a reimbursement to the general fund can often be the best use of all of its resources.

The post Restricted Funds – Administrative Expenses are Sometimes Permissible first appeared on Perlman Sandbox.

While there are few precedents for establishing the limits of a board’s liability when organizational funds have been embezzled, it is generally clear that if board members have acted within their fiduciary capacity and have not been grossly negligent in their oversight of the nonprofit’s funds, they cannot be held liable for the stolen funds. That does not prevent a state’s Attorney General from laying the blame on a board, however.  I recall an Assistant Attorney General contending that the organization’s treasurer (an unpaid officer) had been negligent in his responsibilities because he should have discovered the fraud much sooner than he had.

So what should a board do once it suspects or has discovered evidence of embezzlement?

Determine the Extent of the Embezzlement 

The Board’s first responsibility is to investigate the alleged crime.  The organization’s treasurer, legal counsel, and forensic accountant and/or auditor should make a good faith attempt to determine the extent of the theft, examining all records available to marshal whatever evidence there might be.  Although the initial instinct may be to call the police when a criminal activity is suspected, such early reporting raises the risk that the report may turn out to be an unsubstantiated accusation against an innocent employee. It is therefore a good idea to undertake a diligent audit of the firm’s records (even if it will require incurring some expenses to do so) prior to getting law enforcement involved.

Confront the Perpetrator(s)

Once the organization has sufficient evidence that there has been a misappropriation of funds, the alleged perpetrator must be confronted and given an opportunity to give his or her side of the story. If the individual cannot fully explain the missing funds, the suspected employee(s) should immediately be removed by placing him or her on an unpaid leave (if the organization is still unsure if a crime has been committed, a decision to place the employee on paid leave may be preferential) or by termination of employment. If there is serious concern that the employee will attempt to cover up the misappropriation, the board may want to delay the confrontation with the employee while more evidence is established. Each situation will call for a careful review of the facts and circumstances in order to determine the appropriate confrontation strategy. in either event, the organization should consider limiting the employee’s access to funds prior to the confrontation.

Report the Incident to the Authorities

Once the board has concluded that there has been a defalcation, it should consider contacting the appropriate legal authorities.  This could be the local police precinct or the District Attorney’s office. The FBI and U.S. Attorney should be notified if the alleged criminal activity occurred in more than one state or if it violates a federal law.

Organizations need to carefully consider any decision to report the incident to governmental authorities. Such disclosure could potentially lead to significant negative media publicity for the organization. Some organizations have been able to quietly have the stolen funds returned by the perpetrator, averting the risk of bad press and undue harm to the organization’s reputation. In situations where there are no funds available to be returned, the board or executive staff may have no choice but to report the crime.

Even if the organization does decide to report the incident to a legal authority, it may find the agency to be unresponsive or unwilling to take on the case.  This could be due to the difficulty in prosecuting these types of cases, the limited resources available within the agency, the relatively small amount of money stolen (too low to devote resources), or any other number of reasons. If no criminal charges are filed,  the organization may have to hire a lawyer to sue for the return of the stolen funds, which can be an expensive and time-consuming process.

Aside from reporting the incident to law enforcement and criminal prosecutors, the organization will also need to disclose in its annual Form 990 whether it became aware during the year of any significant diversion of the organization’s assets.   The organization will need to disclose the nature and amounts of the diversion, and corrective actions taken, although the person who diverted the assets should not be identified by name.

Attempt to Recover the Misappropriated Funds

The board has a fiduciary responsibility to attempt to have the funds returned.  But it is also incumbent on the board to do its best to determine which of the following options make sense, given the facts and circumstances at issue. Some of the common considerations include:

• The cost of seeking the return of the funds outweighs the amount of funds that were stolen;
• There is significant risk that filing a lawsuit or otherwise speaking publicly about the incident may lead to negative media coverage, and cause significant reputational harm; or
• The likelihood of recovery is very small.  The board’s conclusion that recovery is unlikely should follow appropriate due diligence to determine whether the perpetrator has any assets to go after.

After considering all of the facts and circumstances, and the various options for recovering the funds, the board may, in good faith, elect not to pursue expensive options such as bringing a lawsuit, hiring investigators, etc. The board may instead choose to take alternative reasonable, private, and/or cost-efficient actions to recover the stolen funds, such as by offering the perpetrator a repayment plan.

Most organizations, thankfully, will never face the unfortunate situation of embezzlement. Good governance and board oversight can go a long way to protect against that remote possibility.  But should it befall your organization, moving systematically and cautiously may significantly improve your organization’s chances of recovery.

The post When funds go missing – what can you do, what must you do? first appeared on Perlman Sandbox.

Of significance for nonprofits is the reinstatement of a limitation on itemized deductions for high earners, including that for the charitable contribution deduction for individuals with incomes over $250,000 and married couples filing joint returns with incomes over $300,000.

While many believe the higher taxes and deduction limitations will negatively affect charitable giving, the Chronicle of Philanthropy, quoting a study by the Urban Institute, recently reported that the “income-tax provisions adopted by Congress to avert the year-end ‘fiscal cliff’ will increase charitable giving by an estimated 1.3 percent, or $3.3-billion, in 2013.”  According to the Chronicle, “The study also took into account the decision to raise the capital-gains tax from 15 percent to 20 percent. That provides an additional incentive for people to donate stock or other property that has risen sharply in value. Not only will they escape the higher capital-gains tax, they will also get the bigger 39.6-percent tax savings on their gift.”

The Urban Institute study suggests that the new limitations on deductions will have “negligible effects” on charitable giving.

Among the other provisions of the law that may impact charities is an extension of the limit on IRA contributions to charitable organizations. That provision imposes a limit for taxpayers age 70 1/2 or older of $100,000 from a Roth or traditional IRAs to certain charitable organizations to permit excluding the withdrawal as part of gross income. Taxpayers can make a rollover in January 2013 and have it treated as if made in 2012.

The post Fiscal Cliff Legislation – Good or Bad for Nonprofits? first appeared on Perlman Sandbox.

Employers seeking amnesty must satisfy eligibility requirements, submit an application to the IRS, and enter into a closing agreement with the IRS.  The agreement that the employer enters with the IRS need not include all of the workers that the employer is treating as independent contractors.  If an employer chooses to participate in the program, it will be required to pay 10% of the amount of the employment taxes that would otherwise have been due on compensation paid for the most recent tax year to the workers. This amounts to about one percent (1%) of the wages paid to the reclassified workers during the prior year and  the IRS will not impose interest or penalties on the amount paid, and the employer will not be subject to an employment tax audit with respect to these workers for prior year

A caveat – the program covers only federal taxes and not unpaid local state payroll taxes.

The IRS did not set a deadline yet for businesses (or charities)  to apply.

The post IRS Continues Amnesty Program for Misclassified Workers first appeared on Perlman Sandbox.