Association Legal Experts on Form 990, UBIT, Intellectual Property, and More

By: Andrew S. Lang

What motivates the IRS to audit an association? When do you need to be concerned about staff use of social media? When are you vulnerable to UBIT tax? A group of top association legal experts speak candidly on these issues and more. (Titled "What's Next in Association Law" in the print edition.)

While some association executives can tap top legal experts to help them address thorny legal challenges, others, due to the size or location of their organizations, do not have ready access to skilled advisors. Associations Now assembled a roundtable of association legal experts, led by Andrew S. Lang, CPA, president, LangCPA Consulting, LLC, to discuss issues that all associations are likely to face in the upcoming year. Read on to find out what's next in association law.

Andrew S. Lang: What might we expect from the IRS in the coming months? For instance, what are the agency's concerns in terms of private inurement and executive compensation?

Jeffrey S. Tenenbaum, Partner, Venable LLP: The IRS has really been zeroing in on what they believe is excessive compensation. Not just salary, but all sorts of benefits—deferred compensation, other perks, et cetera—trying to make sure that what's being paid, particularly to chief executive officers, does not rise to a level of being excessive. It's an area that they've really focused on in IRS audits. Many if not most associations and other nonprofits utilize compensation studies, for instance, to help their boards, executive committees, and compensation committees set compensation for CEOs. Those compensation studies are being challenged by the IRS regularly in audits.

Cindy Lewin, Executive Vice President, General Counsel, AARP: In terms of benefits, rather than having this battle about whether they're taxable or not taxable, I think there's a trend to just increase the salary and not have all these separate perks—a car, spousal travel, special expense accounts—because they all have to be disclosed on the [IRS Form] 990 now and may be red flags for audit. There's also so much public relations risk, especially for (c)(3)s and (c)(4)s, that it's probably better just to make the salary a little higher as long as it's still in a reasonable range.

The 990 has gone through a maturation process in terms of disclosures. What concerns and issues have you seen there?

Mallory Duncan, Senior Vice President, General Counsel, National Retail Federation: One of the areas it caused us to focus on was conflicts-of-interest policy support. The board always understood what their responsibilities are, but in terms of formalizing it for the purpose of the 990, that was a good step.

Jerald A. Jacobs, Partner, Pillsbury Winthrop Shaw Pittman LLP: Most organizations have now been through two cycles with the new version. The next wave is considering and using the Form 990 as a marketing tool for the organization in your legislative and advocacy or regulatory goals, in selling memberships or sponsorships or exhibit booths or the public on what your organization does. It's a wonderful opportunity to tell your story in the Form 990. Within a relatively short time I'm going to be able to sit across a lunch table from you with my PDA, and if you're an association executive I'm going to know if you have an employer-paid cellphone. That's how detailed the information is going to be, and that's how easy it's going to be to access.

Paula Cozzi Goedert, Partner, Barnes & Thornburg LLP: The biggest problem that I see with Form 990 is that some outside accountants prepare it primarily from the financial statements. They transfer information into the 990, and management is not taking the time to look at every line. They assume their accountants understand their business and that they put the right information in there, and then a year later, when questions are raised, they go back and say, "Well that's not how we do it."

I know the IRS is interested in unrelated business income tax (UBIT). Paula, I think you have seen situations within associations where it's caused tension.

Paula Cozzi Goedert: Constant tension. The finance department wants nontaxable revenue streams. They explain the UBIT rules to the marketing department. The marketing department wants to bring in dollars. So when they have a vendor or a sponsor in front of them, they bend the rules, and then at the end of the year the accounting department is surprised to see the income has become taxable, and they haven't budgeted for the tax. The finance department is trying to rein in the marketing department, and the marketing department says, "Don't shackle me. We're trying to bring in money for the organization."

Jeffrey S. Tenenbaum: The law on royalties and what sorts of things the association can do without turning it into taxable marketing-services income or administrative-services income is fairly clear. But what we see a lot and where it becomes complicated and difficult is where you get these marketing arrangements with for-profit companies that are a hodgepodge of endorsement and royalties, marketing services, advertising, tradeshow income, corporate sponsorship income, all these things mixed together.

What other IRS-related issues do you think folks should be looking at in the year to come?

Jerald A. Jacobs: Joint ventures. The law remains very unsettled on the issue of joint ventures of exempt organizations with taxable entities. Worse than that, the new Form 990 tax return requires that these joint ventures be disclosed. Taxability of revenue to the exempt organization may depend on the size of the venture in relationship to the exempt organization. But there are inadequate criteria and principles to evaluate whether it's ancillary, a minor part of the income of the exempt organization, or nonancillary. That law is not settled, and it's a challenge to give advice in that area.

Cindy Lewin: The IRS has announced that they're going to have a special audit focus on 501(c)(4), (c)(5), and (c)(6) organizations. I think they're concerned about political activities, particularly the use of 501(c)(4)s as political organizations to conduct political activity without having to disclose donors publicly. The Citizens United case has left that whole area in flux. It's definitely not an area where the law is settled, and we'll see a lot of developments coming out of that Supreme Court case.

Mallory Duncan: It's a longstanding and increasingly complicated issue. The reporting that's required for federal lobbying and the IRS reporting are based on different definitions. Trying to keep track of that is going to become an increasing nightmare, I think.

Paula Cozzi Goedert: Another issue that I see coming down the pike is that so many of our (c)(6) associations focus on service to members. If you look at their self-description, it says, "We provide services to members." Well, that's not a (c)(6) purpose. Serving the industry or serving the profession is a (c)(6) purpose. The distinction is providing the benefit on a group basis rather than an individualized basis. More and more nonprofits are going to individualized consulting services for their members, saying, "We'll come out to your plant. We'll show you how to make a better widget." Those are the kinds of things that are individualized services that are fully taxable, and if that's your main focus you're going to lose your exemption.

Moving on to another increasingly important issue, what concerns have you seen regarding staff and social media?

Mallory Duncan: Working with the marketing and PR department, we've developed internal guidelines and regularly sit down with the staff and give them guidance to what they should and should not be doing. On the personal side, we've advised them that, "Look, we have provided you a certain platform and a certain prominence with the association, and you have to recognize that when you're speaking, people impute back to the organization." So we try to encourage them to put what they say into that context.

Paula Cozzi Goedert: I think the bigger problem is really staff and volunteers getting onto blogs, often late at night, on a topic they are passionate about, and using hyperbole and using humor perhaps in a way that ultimately reflects poorly on the organization they are representing, even if it's not on the topic in which the association focuses. I tell my clients to tell their staff that "the badge is always on." If you don't want that kind of limitation, you shouldn't be working for an organization that depends on its reputation for its life.

I know the economy is having an unfortunate effect on a great many associations. Are you seeing an increase in mergers within associations?

Jerald A. Jacobs: I think the data will show that there have been more nonprofit mergers in the last few years than previously. There are simply too many nonprofit membership organizations in many fields; trade, professional, and social welfare groups often have several "competitors." Combinations of one kind or another start with the volunteers' interest in having a larger organization that can better represent the field to the public and the government, as well as to reduce their dues and volunteer commitments. Sometimes the retirement of a CEO drives them. Sometimes it's the recession, where one is financially weak—those are often acquisitions that look like mergers.

Paula Cozzi Goedert: Where I see the pressure coming from is companies or individuals paying dues to two organizations. That's where you get the pressure to merge. Members say, "I don't want to be paying these two sets of dues anymore. You two organizations get together and have more efficiency and service."

Jeffrey S. Tenenbaum: To make a merger work, you have to have the right combination of synergies, especially between the leadership teams that are negotiating the deal and bringing it together. But you also have to bring the membership at large into the process throughout. I've seen situations where the deal gets negotiated, the boards vote unanimously, and then the members end up voting down the merger because they weren't on board. The leadership team was going full steam ahead, but they weren't bringing the membership along, and the members had a lot of distrust and ended up voting it down. That can be an absolute disaster for both organizations.

What about other examples of the recession's impact?

Paula Cozzi Goedert: I'll tell you the biggest that I have seen, and that is an increase in abuse of nonprofit assets. In the last several years, employee and volunteer theft of assets has dramatically increased as economic pressure on people has increased.

Jeffrey S. Tenenbaum: Very true. It doesn't matter whether it's large organizations or small organizations. Most large organizations have better internal controls in place so it's more difficult but not impossible to embezzle. But it's especially true with the small- to medium-sized organizations that don't have those controls in place.

Paula Cozzi Goedert: The problem with nonprofits is that they tend to be trusting souls and they tend to look at their staff as mission driven, good people who want the organization to thrive. So they are not suspicious in nature, and sometimes they find to their detriment that their internal controls are insufficient. What I advise all my CEOs to do is get a good internal control audit and follow every piece of advice that the report contains, so that if something bad happens, at least they can say to the board, "We did everything we could possibly do to prevent this."

Cindy Lewin: Many nonprofit organizations went through layoffs. So you're seeing an increase in temporary employees when organizations can afford that but aren't ready to commit to rehiring. If they're truly temporary employees, that's one thing, but if they are brought on as independent contractors, there's a potential tax issue.

Jeffrey S. Tenenbaum: It raises issues of "employees" versus "independent contractors." When you fire an employee and then outsource the job function, but then you bring in one particular person who's going to sit in the office, have an association business card, have an office phone number, and basically have the same job that the prior person had, you may be treating that new person as an independent contractor, but they really may effectively be an employee, with all of the rights and benefits of employees. And on top of it, if the person you let go was an African-American woman over 40 and the person you bring on is a 25-year-old white man, you may get hit with an age-, race-, and gender-discrimination lawsuit as well.

Governance for most associations is a major challenge. What issues in this area might an executive need to consider?

Mallory Duncan: Talking with my peers in this field, one of the private complaints that I hear is the efforts of some of the more influential volunteers or members to use the association for their own competitive advantage, to try to influence policies in a way that, rather than looking at the broad industry, would provide a particular benefit to that member.

Cindy Lewin: It's important that you have all the policies that you need, but where the rubber meets the road is how you educate your board. Board orientation, ongoing training for the board, defining responsibilities of the board, helping them find that impossible line between management and governance are all essential. At some organizations, boards do a board self-assessment. And at some organizations, boards, as a group, assess every member. That's a very high level of accountability. Not every board is going to get to that level, but governance is incredibly important, and having educated board members who understand what they're there to do is the most important thing.

Mallory Duncan: That includes having a [conflict-of-interest] policy that people actually understand and giving examples of potential conflicts. For instance, "I'm serving on the committee of this other organization and they have some competing program," or "I'm dealing with a potential advertiser or sponsor or donor and suggesting that they make a contribution to another organization instead of this one." I do this a lot for boards and they'll say, "Really? I didn't think that was a conflict."

Andrew S. Lang, CPA, is president of LangCPA Consulting, LLC, in Potomac, Maryland. Email: [email protected]

Online Extra: More From the Legal Roundtable

Jeffrey S. Tenenbaum on IRS concerns with executive compensation and foundations:

Let's say you have an association-provided automobile that's being provided to the executive as part of his or her compensation package, but none of the value of the car is being treated as income to the executive; it's all being treated as a working condition fringe benefit. If the IRS comes in and determines that at least 50 percent of the car's use was personal—commuting to and from the office, use on the weekend, and the like—then if the association is a 501(c)(3) or (c)(4) organization, the IRS can treat it as an automatic excess-benefit transaction. In that case, it can levy a 25 percent (or 200 percent, if not paid right away) penalty tax on the executive for the amount that was not treated as income when it should've been, as well as requiring the executive to immediately repay the excess benefit amount to the organization.

Private benefit is a federal tax doctrine that's limited to 501(c)(3)s and (c)(4)s, and that has recently been "rediscovered" and is being aggressively enforced by the IRS. What's notable for associations is that the IRS has now been applying it in connection with related foundations of trade and professional associations, saying, in effect, “Is the foundation really being utilized for true publicly beneficial purposes, like public education and research to benefit the general public, or is it primarily being used to benefit and further the cause of the the association, its members, and the underlying industry or profession?” If it's the latter, the foundation can lose its tax-exempt status.

Paula Cozzi Goedert on the line between outsourcing and joint ventures:

The classic example is outsourcing your publication to a commercial company. The IRS says that even if you call the revenue stream you take back a royalty, they won't treat it as a royalty if you're still actively involved in producing the content. Therefore it is a joint venture and therefore the part of the revenue that's taxable, the advertising income, is still taxable to you, even if it's called a royalty.

Jerald A. Jacobs on protecting intellectual property:

An association that owns intellectual property—most often trademarks and copyrights—should understand the basics of protecting that property. Obtaining federal registrations when they are available, providing notice of ownership when the property is used, and dealing effectively with infringers are all keystones of effective IP protection. 

Ultimately the names, programs titles, designations, and content that associations utilize—and indeed its reputation—are the most valuable and lasting assets that associations have. Seen in that light, conscientious and persistent efforts to protect intellectual property are well warranted.

The laws and procedures that support these efforts are usually fairly well settled and inexpensive. Trademark registrations require the assistance of expert outside legal counselors, but copyright registrations can usually be accomplished by trained clerical employees within the association. When and how to use notices in both instances, for trademarks and copyrights, is also straightforward. And when possible or actual third-party infringement is identified, it costs little to write a cease-and-desist letter demanding that the infringement be terminated (obviously, if that is not successful, litigation against infringers can be lengthy and costly).

Associations need a sense of diplomacy in dealing with infringement of their trademarks and copyrights. Sometimes in the vast exchange of information today, especially via the Internet, IP violations are inadvertent. Using a lighter hand, a more educational than enforcement mode, will be more effective. 

Finally, it is worth noting, by contrast, that securing effective IP protection in other countries is sometimes challenging and often expensive; but for associations operating increasingly abroad, these may simply be necessary endeavors.

Andrew S. Lang