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ROCK IN EXEMPTION

July 25, 2006

The Des Moines Register reported on the local anti-drug group "Rock in Prevention" this week. The organization works to keep kids off drugs using a pop-rock band that plays positive, anti-drug songs. The article focused on the compensation paid to the groups executive director and payments made to him for producing the group's compact disks.

The article brings to light some of the pitfalls of running an exempt organization. The first pitfall is that your tax returns are available on demand or on the internet (www.guidestar.org; free registration required). That means your friendly local paper might write an article showing how much you get paid.

TAX RULES FOR EXEMPT ORGANIZATIONS

It also gives us a chance to note the tax issues that arise in compensating employees of exempt organizations (note- these are issues that apply to all charities; we aren't looking specifically at Rock in Prevention's taxes here).

As a price of being tax-free, charities must operate "exclusively" for their charitable purpose. If the IRS says an executive is overpaid, they can argue that the organization is not operating exclusively for charity. If the courts agree, the organization can lose its exemption and get clobbered with back taxes.

Until a few years ago, revocation of exemption - sort of a death penalty for charities - was the only remedy the IRS had in dealing with exempt organizations. They were understandably reluctant to impose that penatly, so Congress stepped in with a new set of "intermediate sanctions." These allow the IRS to impose a 25% excise tax on the charity on any "excess benefit." This can be imposed instead of revoking the organization's tax exemption, or in additon to a revocation.

RESPONSIBILITIES OF MEMBERS OF CHARITY BOARDS

If you are on a charity board, you should examine your compensation and benefits packages with these rules in mind. You should take an especially close look at any non-salary business deals with employees or major contributors; the IRS will look closely at these, and if they find that things aren't being done at arms-length, the consequences could be unpleasant.

You also should make sure your organization is filing complete and accurate forms with the IRS. The IRS will cheerfully hit organizations with a $50 per day penalty for late filing of form 990, and that can add up in a hurry.

Related coverage: State 29.

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