Panel Final Report

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Congress and

the Nonprofit Sector

a final report to

Strengthening

TransparencyGovernance

Accountability

of Charitable Organizations

June 2005


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PANEL ON THE NONPROFIT SECTOR

Co-Conveners

Paul Brest, President,

William and Flora Hewlett Foundation,

Menlo Park, California

M. Cass Wheeler, Chief Executive Officer,

American Heart Association, Dallas, Texas

Panel Members

Susan V. Berresford, President, Ford Foundation,

New York, New York

Linda Perryman Evans, President and CEO,

The Meadows Foundation, Dallas, Texas

Marsha Johnson Evans, President and CEO,

American Red Cross, Washington, D.C.

Brian Gallagher, President and CEO,

United Way of America, Alexandria, Virginia

Kenneth L. Gladish, National Executive Director,

YMCA of the USA, Chicago, Illinois

Robert Greenstein, Founder and Executive Director,

Center on Budget and Policy Priorities,

Washington, D.C.

Stephen B. Heintz, President,Rockefeller Brothers Fund, New York, New York

Wade Henderson, Executive Director,

Leadership Conference on Civil Rights,

Washington, D.C.

Dorothy A. Johnson, President Emeritus,

Council of Michigan Foundations,

Grand Haven, Michigan

Paul D. Nelson, President, Evangelical Council for

Financial Accountability, Winchester, Virginia

Jon Pratt, Executive Director,

Minnesota Council of Nonprofits, St. Paul, Minnesota

William C. Richardson, President and CEO,

W.K. Kellogg Foundation, Battle Creek, Michigan

Dorothy S. Ridings, President and CEO,

Council on Foundations, Washington, D.C.

John R. Seffrin, Chief Executive Officer,

American Cancer Society, Atlanta, Georgia

Sam Singh, President and CEO,

Michigan Nonprofit Association, Lansing, Michigan

Edward Skloot, Executive Director,

Surdna Foundation, New York, New York

Lorie A. Slutsky, President and Director,

New York Community Trust, New York, New York

William E. Trueheart, President and CEO,

The Pittsburgh Foundation, Pittsburgh, Pennsylvania

William S. White, Chairman, President and CEO,

Charles Stewart Mott Foundation, Flint, Michigan

Timothy E. Wirth, President,

United Nations Foundation and Better World Fund,Washington, D.C.

Gary L. Yates, President and CEO,

The California Wellness Foundation,

Woodland Hills, California

Raul Yzaguirre, Immediate Past President and CEO,

National Council of La Raza, Washington, D.C.

Executive Director

Diana Aviv, President and CEO, INDEPENDENT SECTOR,

Washington, D.C.


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1 Report to Congress and the Nonprofit Sector on Governance, Transparency, and Accountability

This report is the culmination of a remarkable collaboration. Since October 2004, when it was convened atthe encouragement of the Chairman and Ranking Member of the Senate Finance Committee, the Panel on theNonprofit Sector has brought together thousands of people involved with charities and foundationsstaff, boardmembers, volunteers, and donors, along with government officialsfor a thorough examination of the sectorsgovernance, transparency, and ethical standards. The participation of people from organizations of widely varyingsizes and programs has reflected both the charitable communitys long-standing commitment to accountability andthe increased attention to these issues stimulated by congressional concerns. The focus on ethical conduct alreadyhas produced substantial changes, as organizations have examined and revised their existing policies and standards.

While the Panel has invited input from diverse representatives of the nonprofit sector, it has made a special effortto listen to the views of the broader public. In addition to holding hearings in 15 locales and inviting comments onits website, the Panel discussed its recommendation with a committee of distinguished advisors from outside thesector. And Panel members have paid heed to the issues raised by those in the media who effectively serve ascitizens fourth branch.

Accountability is crucial to our sector. Charitable organizations are an indispensable part of American society,offering relief from disasters, nurturing our spiritual and creative aspirations, caring for vulnerable people, protectingour natural and cultural heritage, and finding solutions to medical and scientific challenges. But they can fulfill thesemissions only by maintaining the trust of the public. Meeting the ethical standards that will justify this trust requiresa series of ongoing commitments: from each charity and foundation, which must set standards and implementpractices that manifest its dedication to transparency and governance; from the charitable community as a whole,which must share recommended practices and educate its members; and from the government, which muststrengthen the law and dedicate the resources necessary to enforce it.

We hope this report, which includes and expands the ideas contained in the Panels March 1, 2005, InterimReport, will intensify this effort. It begins with an overview of the charitable community, including its achievements,scope, and existing programs to improve ethics and accountability. It then describes the Panel on the NonprofitSector, focusing on the collaborative process we have been using and the principles on which we have based ourwork. The heart of the report is its recommendations, which offer a comprehensive approach to improving trans-parency and governance. The recommendations provide approaches that maintain the crucial balance betweenlegitimate oversight and protecting the independence that charitable organizations need to remain innovativeand effective. The final section outlines the issues that the Panel will examine during the summer as it concludesits work.

PAUL BREST M. CASS WHEELERPresident Chief Executive OfficerWilliam and Flora Hewlett Foundation American Heart Association

Co-Conveners, Panel on the Nonprofit Sector

Preface


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Table of ContentsExecutive Summary 4

SECTION I Introduction 9

The Scope of the Nonprofit Sector 10Government Regulation of Charitable Organizations 12Ethical Concerns about the Nonprofit Sector 13Efforts within the Charitable Community to Improve Practice 14The Panel on the Nonprofit Sector 15

Composition of the Panel on the Nonprofit Sector 15The Panel on the Nonprofit Sector Process 17

SECTION II Principles to Guide Improving Accountability of Charitable

Organizations 20

SECTION III Recommendations 23

1. Federal and State Enforcement 242. Internal Revenue Service Reporting 263. Periodic Review of Tax-Exempt Status 334. Financial Audits and Reviews 355. Disclosure of Performance Data 376. Donor-Advised Funds 39

7. Type III Supporting Organizations 458. Abusive Tax Shelters 499. Non-Cash Contributions 53

a. Appreciated Property 53b. Conservation and Historic Faade Easements 56c. Clothing and Household Items 58

10. Board Compensation 6111. Executive Compensation 6612. Travel Expenses 7313. Structure, Size, Composition and Independence of Governing Boards 7514. Audit Committees 7915. Conflict of Interest and Misconduct 81


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SECTION IV Work to be Completed by the Panel in a Supplemental Report 83

SECTION V Summary of Recommendations for Congress, the Internal Revenue

Service and Charitable Organizations 85

SECTION VI Glossary 92

SECTION VII Appendix 99

Citizens Advisory Group 99Expert Advisory Group 100Governance and Fiduciary Responsibility Work Group 100Government Oversight and Self-Regulation Work Group 101Legal Work Group 102Transparency and Financial Accountability Work Group 103Small Organizations Work Group 104Form 990 Reform Advisory Group 106Form 990-PF Reform Advisory Group 106Panel on the Nonprofit Sector Staff and Advisors 107Pro Bono Assistance to the Panel on the Nonprofit Sector 108Funding the Work of the Panel on the Nonprofit Sector 109Letter from the Senate Finance Committee Leadership to INDEPENDENT SECTOR,

September 22, 2004 110Letter from INDEPENDENT SECTORto the Senate Finance Committee Leadership,October 12, 2004 112


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Executive SummaryThe Panel on the Nonprofit Sector is dedicated to ensuring that Americans continueto benefit from the richly varied programs provided by the charitable community.Formed at the encouragement of the leaders of the Senate Finance Committee, thePanel has led to an unparalleled collaboration on how to strengthen the sectorsaccountability, transparency, and governance. The participants in this effortthou-sands of people representing diverse organizations from every part of the countryrecognize that to serve their missions effectively, they must demonstrate that they areethical, responsible stewards of Americans generosity.

The Panel developed eight overarching principles toguide its recommendations:

The Role of Charitable Organizations

in American Life

1. A vibrant charitable community is vital for a strongAmerica.

2. The charitable sectors effectiveness depends on itsindependence.

The Responsibilities of the Charitable Community

3. The charitable sectors success depends on its

integrity and credibility.4. Comprehensive and accurate information about thecharitable sector must be available to the public.

5. A viable system of self-regulation and education isneeded for the charitable sector.

The Need for Balanced Government Oversight

6. Government should ensure effective enforcement ofthe law.

7. Government regulation should deter abuse withoutdiscouraging legitimate charitable activities.

8. Demonstrations of compliance with high standards

of ethical conduct should be commensurate with thesize, scale, and resources of the organization.

Recommendations

The recommendations of the Panel on the NonprofitSector are a carefully integrated package that calls forimprovement within the sector, more effective over-sight, and changes in the law. No single action can

achieve the necessary results by itself. The recommen-dations underscore the importance of transparency, ofproviding the information that allows the public tomake informed choices and government officials to rootout problems. Most important, the recommendedactions offer a guide to maintaining the essential bal-ance between adequate oversight that keeps potentialabusers from using the sector to benefit themselves andsafeguarding the independence of organizations in facil-itating the opportunity for them to contribute to thewellbeing of society.

Summary of RecommendationsThe detailed discussions in the report note importantexceptions for organizations of particular types andsizes and other conditions that must be considered inthe implementation of these recommendations.*1. Federal and State EnforcementEffective oversight

of the charitable sector requires vigorous enforce-ment of federal and state law. Congress shouldincrease the resources allocated to the InternalRevenue Service for overall tax enforcement andoversight of charitable organizations, and it shouldcreate a federally funded program to help states

establish or increase oversight and education

* Recommendations for changes in the law or regulations would

primarily apply to organizations required to file a Form 990 or

990-PF, and thus smaller organizations or religious congregations

would generally be exempt. The discussion contained in the

report gives further details.


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programs for charitable organizations. Congressshould also eliminate statutory barriers that preventthe IRS from sharing information about investiga-tions of possible wrongdoing with state charityofficials. (page 24)

2. Internal Revenue Service ReportingThe annual

information returns filed by charitable organizations(Forms 990, 990-EZ, and 990-PF) should beimproved so they provide more accurate, complete,and timely information for federal and state regula-tors, managers of charitable organizations, and thepublic. Electronic filing will increase accuracy andcompliance in completing the returns, and Congressand the IRS should remove the legal barriers torequiring electronic filing of the returns by all chari-table organizations. Congress should impose penal-ties on preparers who willfully omit or misrepresentinformation on the returns. Congress also shoulddirect the IRS to require the organizations highestranking officer to sign and certify the Form 990, aswell as institute a new, brief annual reportingrequirement for organizations with less than $25,000in annual revenues. The IRS should make a numberof changes in the format and instructions for Form990 series returns, and suspend the tax-exempt statusof any charitable organization that fails to correctincomplete or inaccurate returns for two consecutiveyears. The board of a charitable organization, or anappropriate committee, should review its organiza-

tions Form 990 series return. (page 26)

3. Periodic Review of Tax-Exempt StatusCongressshouldnot implement a new periodic review systemto verify that a charitable organization continues tomeet the qualifications for tax-exemption. The IRSshould focus its resources on review and investiga-tion of the current returns filed by charitable organi-zations. In addition, boards of directors areencouraged to undertake a full review of their organ-izations governing documents and policies at leastonce every five years. (page 33)

4. Financial Audits and ReviewsHaving financialstatements prepared and audited in accordance withGenerally Accepted Accounting Principles andauditing standards improves the quality of financialinformation available to governing boards, govern-ment officials, and the public. Congress should

require charitable organizations with at least $1 mil-lion or more in annual revenues to conduct an auditand attach audited financial statements to their Form990 series returns, and those with annual revenuesbetween $250,000 and $1 million to have theirfinancial statements reviewed by an independentpublic accountant. (page 35)

5. Disclosure of Performance DataEvery charitableorganization should, as a recommended practice,provide more detailed information about its opera-tions, including methods it uses to evaluate the out-comes of programs, to the public through its annualreport, website, and other means. The Form 990returns are not useful as a tool for reporting complexprogram evaluation information. Congress shouldnot require charitable organizations to report moredetailed statements of program evaluations or per-formance measures as part of their Form 990 seriesreturns. (page 37)

6. Donor-Advised FundsLaws and regulations gov-erning donor-advised funds should be strengthenedto ensure that donors or related parties do notreceive inappropriate benefits from these funds.Congress should amend tax laws to define and regu-late donor-advised funds, including requiring spon-soring charities to make minimum distributions of 5percent of aggregate donor-advised fund assets andenforcing minimum fund activity requirements.

Congress also should prohibit sponsoring charitiesfrom making payments to a private foundation ordirectly or indirectly to the funds donors, advisors,or related parties. Further, tax deductions for contri-butions to donor-advised funds should be allowedonly ifthe donor has a written agreement with thesponsoring charity clarifying these restrictions.Penalties should be imposed on donors, advisors,and managers who violate these prohibitions. Moreinformation about the assets held by and disburse-ments made from donor-advised funds will improveboth enforcement and understanding of these funds,

and each sponsoring charity should be required todisclose aggregate information about its donor-advised funds on its Form 990. Sponsoring charitiesare encouraged to provide further information abouttheir donor-advised funds to help others learn moreabout how the funds are distributed. (page 39)


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7. Type III Supporting OrganizationsType III sup-porting organizations add value to the charitablesector that cannot and should not be replaced byother types of organizations. To curb abuse in theseorganizations, Congress should establish minimumdistribution requirements, prohibit payments to orfor the benefit of donors or any related party, and

institute rules to increase the voice of the supportedorganizations in the governance of the Type IIIorganization. A Type III supporting organizationshould be prohibited from supporting more thanfive qualified entities or from supporting any organi-zation that is controlled by the donor or a relatedparty. It should be required to provide certaindocuments to, and confirm the agreement of, itssupported organizations at the time it files for recog-nition as a 501(c)(3) organization and when it filesits annual Form 990 returns. Every supporting organ-ization should be required to indicate on its Form990 whether it is operating as a Type I, II, or IIIsupporting organization. (page 45)

8. Abusive Tax SheltersCongress should make clearthat all tax-exempt organizations, including thosenot currently required to file tax returns, are subjectto the same requirements as taxable entities withregard to reporting their participation in potentiallyabusive listed and other reportable tax sheltertransactions, and should impose penalties on organi-zation managers for failure to report if they knew or

had reason to know that the transaction was areportable transaction. Congress should imposepenalties on taxable participants and material advi-sors who fail to notify tax-exempt participants thatthey would be engaging in a reportable transaction,and should ensure that appropriate sanctions areimposed on tax-exempt entities that knowingly par-ticipate in abusive tax shelters. Education will be keyto both compliance with and enforcement of taxlaws governing these complex transactions, and theIRS should be required to provide the clear, up-to-date, readily accessible information that charitable

organizations need to determine whether a transac-tion is potentially abusive and whether they areunder an obligation to disclose participation in atransaction. (page 49)

9. a. Non-Cash Contributions: AppreciatedPropertyCongress should strengthen the rulesfor the appraisals taxpayers can use to substantiatedeductions claimed for property donated to charita-ble organizations and increase penalties on (1) tax-payers who claim excessive deductions based onan overstated value for the donated property and

(2) appraisers who knowingly provide overstatedappraisals. The Forms 8282 and 8283, which arefiled, respectively, by taxpayers who claim taxdeductions for donated items valued at $5,000 ormore and by charitable organizations that disposeof those items within two years of the donation,could be a useful enforcement trigger for the IRS,and Congress should require those forms to be filedelectronically. (page 53)b. Non-Cash Contributions: Conservation andHistoric Faade EasementsA conservation ease-ment or historic faade easement donation requiresongoing enforcement of the terms of the easementagreement by the charitable organizations whoaccept such donations. Congress should increasepenalties on taxpayers who claim excessive deduc-tions for donations of conservation or historic faadeeasements and should only permit a deduction foran easement if it is made to a qualified charity orgovernment entity under the terms of a writtenagreement that specifies the restrictions the ease-ment imposes on future use of the property. A chari-table organization that accepts easement donations

should be required to provide more information onits annual Form 990 about the easements it holdsand to certify that it has implemented reasonableprocedures for monitoring compliance with theterms of its easement agreements. Congress shouldimpose penalties on charities that fail to enforceconservation or historic faade easement agree-ments. (page 56)c. Non-Cash Contributions: Clothing andHousehold ItemsCongress should not limitdeductions for contributions of clothing or house-hold items to an arbitrary ceiling without a clear

basis for establishing the amount of the ceiling andan assessment of the impact of the change on thelevel of charitable contributions. To assist taxpayersin valuation, the IRS should establish a list of thevalue that taxpayers can claim for specific items ofclothing and household goods, based on the saleprice of such items identified by major thrift storeoperations or other similar assessments. (page 58)


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bursement. With the exception of de minimisexpenses of those attending an activity of the organ-ization (such as a meal function), charitable organi-zations should not pay for nor reimburse travelexpenditures for a spouse, dependents, or otherswho are accompanying an individual conductingbusiness for the organization unless the additional

person is also conducting business for the organiza-tion. Charitable organizations should be required todisclose on their Form 990 series returns whetherthey have a travel policy. The IRS should provideinformation in the instructions to the Forms 990about travel costs that are not permitted or thatshould be reported as taxable income. (page 73)

13.Structure, Size, and Composition of GoverningBoardsTo qualify for recognition as a 501(c)(3)tax-exempt organization, an organization shouldgenerally be required to have a minimum of threemembers on its governing board. Further, to qualifyas a public charity (rather than a private foundation),at least one-third of the members of the organiza-tions governing board should be independent: thatis, individuals who have not received compensationor material benefits directly or indirectly from theorganization in the previous 12 months, whose com-pensation is not determined by other board or staffmembers, and who is not related to someone whoreceived such compensation from the organization.Every charitable organization should be required to

disclose on its Form 990 series return which of itsboard members are independent. Individuals barredfrom service on corporate boards or convicted ofcrimes related to breaches of fiduciary duty shouldbe prohibited from serving on the boards of charita-ble organizations. Federal tax laws or regulationsshouldnot set a maximum number of members forthe governing boards of charitable organizations.Every charitable organization should, as a matterof recommended practice, review its board sizeperiodically to determine the most appropriate sizeto ensure effective governance and to meet the orga-

nizations goals. All boards should establish strongand effective mechanisms to ensure that the boardcarries out its oversight functions and that boardmembers are aware of their legal and ethicalresponsibilities in ensuring that the organizationis governed properly. (page 75)


10.Board CompensationCompensation to boardmembers of charitable organizations is discouraged.Charitable organizations that do provide compensa-tion to board members should be required todisclose the amount of and reasons for the compen-sation, as well as the method used to determine itsreasonableness. Congress should prohibit public

charities from providing loans to board members(such loans are already illegal for private founda-tions). Congress should also increase penalties onboard members of charitable organizations whoreceive or approve excessive compensation.(page 61)

11. Executive CompensationCharitable organizationsshould be required to disclose more clearly the com-pensation paid to their chief executive officer andother disqualified persons and to the five highestcompensated employees. Congress should requireofficers and other disqualified persons who receivecompensation that the IRS alleges is excessive todemonstrate that their compensation is reasonable,and should increase penalties imposed on individualswho receive and managers who approve excessivecompensation. Members of boards or other author-ized bodies who followed the rebuttable presump-tion procedures in determining the reasonablenessof compensation should not ordinarily be subjectto penalties, even if the compensation is later foundto be excessive, but penalties should be imposed on

board members and managers who approved suchcompensation if they did not follow those proce-dures nor otherwise exercised reasonable care inapproving the transaction. As a matter of goodpractice, the full board of charitable organizationsshould approve any change in the compensationof the CEO annually and in advance and reviewthe organizations full staff compensation programperiodically. (page 66)

12.Travel ExpensesCharitable organizations that payfor or reimburse travel expenses of board members,

officers, employees, consultants, volunteers, or oth-ers traveling to conduct the business of the organi-zation should establish and enforce policies thatprovide clear guidance on their travel rules, includ-ing the types of expenses that can be reimbursedand the documentation required to receive reim-


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14.Audit CommitteesCharitable organizationsshould include individuals with some financial liter-acy on their boards of directors in accordance withthe laws of their state or as a matter of recom-mended practice. Every charitable organization thathas its financial statements independently audited,whether legally required or not, should consider

establishing a separate audit committee of the board.If the board does not have sufficient financial liter-acy, and if state law permits, it may form an auditcommittee comprised of non-staff advisors who arenot board members. (page 79)

15. Conflict of Interest and MisconductAs a matterof recommended practice, charitable organizationsshould adopt and enforce a conflict of interest pol-icy consistent with its state laws and organizationalneeds. The IRS should require every charitableorganization to disclose on its Form 990 seriesreturn whether it has such a policy. Charitable

organizations should also adopt policies and proce-dures that encourage and protect individuals whocome forward with credible information on illegalpractices or violations of adopted policies of theorganization. There should be a vigorous sector-wide effort to educate and encourage all charitableorganizations, regardless of size, to adopt andenforce policies and procedures to address possibleconflicts of interest and to facilitate reporting ofsuspected malfeasance and misconduct by organiza-tion managers. (page 81)



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Charitable organizations make a difference in every Americans life. Sometimes peoplebenefit without being aware of the reach of this countrys unique nonprofit sector.Visitors can enjoy a great urban park and never realize that charitable organizationsare major contributors to the gardens, playgrounds, paths, and programs. Parents ofchildren receiving polio shots may not know that one charitable group led the cam-paign to develop and distribute the vaccine and another funded much of its develop-ment. And people may not remember that the air and water that surrounds them is farcleaner because of how nonprofits have worked with government to reduce pollution.

Most of the time, Americans do appreciate howcharitable organizations are improving lives across thecountry and around the world. They know that privatesupport helps universities prepare youth for lifelongcontributions to society, and that victims of disastersare helped in profound ways by nimble and timelyintervention from charitable relief agencies.Communities across America are grateful for themuseum, theater, dance, and music programs that gracetheir lives and for the assistance community day careprograms offer to the very young and very old.

What make these organizations distinctive are not

just the indispensable services they provide, but alsohow they do their work. Charities and foundations arecreated and sustained by people who want to give theirtime and resources to solve problems and enrich theircommunities. Nearly half of all adults volunteer eachyear, and nine out of 10 households make charitablecontributions.1 Individual donations total more than$207 billion, which comes on top of the $41 billion2

given each year by corporations and foundationscreated from private money. These contributions oftime and money reflect the publics commitment to andappreciation of this distinctive feature of American life:

people coming together through charitable organiza-tions to improve the lives of others and meet needs thatgovernment and business do not.

The Panel on the Nonprofit Sector is dedicated toensuring that Americans continue to benefit from the

Introduction

richly varied programs of the charitable community.Formed at the encouragement of the leaders of theSenate Finance Committee, the Panel has led to anunparalleled collaboration on how to strengthen thesectors accountability, transparency, and governance.The participants in this effortthousands of peoplerepresenting diverse organizations from every part ofthe countryrecognize that to serve their missionseffectively, they must demonstrate that they are ethical,responsible stewards of the publics generosity.

This report is a vital part of the charitable commu-nitys commitment to keeping the public trust.

Developed with the input of nonprofit leaders, experts,and volunteers, it offers a comprehensive approach tostrengthening accountability. Its recommendations are acarefully integrated package that calls for improvementwithin the sector, more effective oversight, and changesin the law. No single action can achieve the necessaryresults by itself.

These recommendations underscore the importanceof transparency, of providing the information thatallows the public to make informed choices and gov-ernment officials to root out problems. Most important,

SECTION I

1 INDEPENDENT SECTOR, Giving and Volunteering in the United States

(2001).2 Giving USA Foundation/Center on Philanthropy

at Indiana University, Giving USA (2005).



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the recommended actions offer a guide to maintainingthe essential balance between adequate oversight thatkeeps potential abusers from using the sector to benefitthemselves and safeguarding the independence oforganizations in facilitating the opportunity for them tocontribute to the wellbeing of society.

The Scope of the Nonprofit Sector

Americas charitable community produces its resultsbecause of the commitment and talent of the peoplewho have dedicated their lives to helping others. Partof that service comes from volunteers, who collectivelyprovide the equivalent of 9 million full-time staffmembers. The sectors programs also are supported byits 11.7 million paid employees, 9 percent of the entirenational workforce and a number greater than thefinance, insurance, and real estate industries combined.3

The organizations that these Americans work forcontinue a three-century tradition. In the colonialperiod, groups who found themselves in the minorityScotsmen and women in Massachusetts, for example,or the Jewish community in South Carolinacreatedtheir own social service organizations. After theRevolutionary War, the number of churches, schools,and other charitable organizations grew so rapidly thatafter his 1831 tour of the United States, Frances Alexisde Tocqueville identified voluntary associations as oneof the features that distinguished American society from

those in Europe. This growth accelerated through thecentury, leading to thousands of new organizations suchas Hull House established by Jane Addams and theinsurance cooperatives founded by new immigrants.The first part of the 20th century witnessed furtherexpansion in the number and variety of charitableorganizations, from private universities to community

centers, from foundations to health care providers.Nonprofits contribute to every community in

America. Some programs started by nonprofitsinclud-ing libraries, local schools, fire stations (many of whichstill use volunteers), and parkshave been expanded bygovernment, enabling the broader community to enjoytheir benefits. Philanthropic institutions have incubatednew ideas that now seem commonplace, such as rocketscience and the 9-1-1 emergency response system.Charitable organizations have also been the partnersthrough which government effectively and efficientlydelivers services such as early childhood educationprograms, health clinics, drug counseling, and afterschool programs.

This tradition of collaboration and innovationcontinues today, and the United States is now hometo an estimated 1.3 million public charities, private

Table 1. Breakdown of Charitable Organizations by Budget Size

Over $10 million3.8%

$5 million$10 million2.7%

$0$500,00073%

$1 million$5 million11.8%

$500,000$1 million8.7%

3 Lester M. Salamon (editor), The State of Nonprofit America

(Washington, D.C.: Brookings Institution Press, 2002)

Source: National Center for Charitable Statistics, Urban Institute (2003).


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Changing Education As We Know It:

Jobs for the Future

Education is more critical today than ever before.

Yet because of financial barriers or inadequate

preparation for college, too few young people

complete a postsecondary education. Jobs for

the Future is pioneering a new concept of early

college high schools: small, autonomous schools

with programs designed for young people who

might otherwise fail to advance to college.

Students leave within four to five years of entering

ninth grade with a high school diploma and an

associates degree or two years of college credit

toward a bachelors degree. In partnership with

some of the worlds leading foundations and

education organizations4, 25 early college high

schools across the country have already opened

their doors and 100 more plan to over the next

seven years.

foundations, and religious congregations. Thoughthe public is most familiar with larger groups, only4 percent of all charitable organizations have annualbudgets of more than $10 million. Most are small,with nearly three-quarters operating with budgets ofless than $500,000.

What is most impressive about Americas charitable

community is the variety of programs it offers. Itsorganizations fall into eight major categories: Arts, culture, and humanities, such as museums, sym-

phonies and orchestras, and community theaters; Education and research, such as private colleges and

universities, independent elementary and secondaryschools, and noncommercial research institutions;

Environment and animals, such as zoos, bird sanctuaries,wildlife organizations, and land protection groups;

Health services, such as hospitals, public clinics, andnursing facilities;

Human services, such as housing and shelter providers,organizers of sport and recreation programs, andyouth programs;

International and foreign affairs, such as overseas reliefand development assistance organizations;

Public and societal benefit, such as private and commu-nity foundations, civil rights organizations, and civic,social, and fraternal organizations; and

Religion, such as houses of worship and their relatedauxiliary services.

Table 2. Breakdown of Charitable Organizations by Mission*

Arts, culture, and humanities10.4%

Religion5.6%

Human Services33.7%

Public and societal benefit11.9%

International1.8%

Education18.1%

Environment3.8%

Health13.2%

Unknown1.5%

*Includes 501(c)(3) organiza-tions with over $25,000 in

annual revenues that file a

Form 990 information return

with the IRS. Many religious

congregations, which are not

required to file a Form 990,

are excluded from this chart,

and only those that have filed

voluntarily are represented.

Source: National Center for Charitable Statistics, Urban Institute (2003).


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Though funding for individual organizations variessubstantially, the majority of support for the sector as a

whole comes from consumers of services and voluntarycontributions: 38 percent from dues, fees, and othercharges for goods and services, 17 percent from indi-vidual contributions, and an additional 3 percent fromprivate foundations and corporate giving programs.Government grants and contracts provide 31 percent ofthe sectors revenues, and other sources, such as incomefrom assets, supply the remaining 11 percent.

Government Regulation of

Charitable Organizations

Despite the charitable communitys enormous diversity,

its organizations share one attribute: a commitment toadvancing the common good. Congress and state legis-latures have long recognized this special purpose bymaking charitable organizations tax-exempt, whichenables them to dedicate their funds to fulfilling theirmissions. To encourage the American people to makecontributions, federal and state governments haveallowed taxpayers to deduct charitable contributionswhen calculating their income taxes.5

Charitable organizations receive their tax-exemptstatus under section 501(c)(3) of the Internal RevenueCode. A group interested in obtaining this designationmust submit an application to the Internal RevenueService that details its charitable purposes, its sources offunding, the members of its board of directors, itsbylaws, and other information. (Religious congregations

are an exception to these requirements: in keeping withconstitutional protection separating church and state,religious congregations automatically receive 501(c)(3)status.) Organizations must file separate forms withtheir state or local government agencies to be exemptfrom local property and sales taxes.

There are two types of organizations under Section501(c)(3): public charities and private foundations.Generally, a public charity must document that itreceives at least one-third of its annual income from thepublic in the form of contributions and grants, whereasa private foundation derives its primary financial sup-port from the contributions of an individual, family, orcorporation. Foundations are subject to substantiallymore restrictive rules governing their operations, andtheir donors receive less favorable tax treatment fordonations.

4 Initiative funders and partners include The Bill & Melinda

Gates Foundation, Carnegie Corporation of New York, The

Ford Foundation, The W.K. Kellogg Foundation, AntiochUniversity Seattle, City University of New York, Foundation

for California Community Colleges, KnowledgeWorks

Foundation, Middle College National Consortium, National

Council of La Raza, Portland Community College, SECME,

Inc., Utah Partnership Foundation, and the Woodrow Wilson

National Fellowship Foundation.5 The Internal Revenue Code defines more than 25 categories

of organizations that are exempt from federal income taxes,

including private country clubs, business associations such

as Chambers of Commerce or the National Association of

Manufacturers, labor unions, fraternal organizations, and many

others. Where other types of nonprofit organizations benefitthe private, social, or economic interests of their members,

charitable organizations must benefit the broad public interest

and Congress has therefore provided, with very limited

exceptions, that only those charities organized under section

501(c)(3) are eligible to receive tax-deductible contributions.

Building Arts and Economic Development:

Mississippi Cultural Crossroads

A rural, economically poor area in southwestern

Mississippi, Claiborne County seems an unlikely

home for an award-winning arts program. But for

more than 25 years, the nonprofit Mississippi

Cultural Crossroads has been using quilting, the-

ater, and other types of art to promote the educa-

tional, cultural, and economic development of the

countys 12,000 residents. MCC brings together

professional artists and community members, and

it celebrates the achievements of skilled local

artists, including making it possible for them to

share and sell their work within and outside the

community. These programs, many of which focus

on children, also educate people of all races about

African American heritage, particularly in the arts.

One type of recognition for MCCs success came

in 2000, when it received the Governors Award for

Excellence in the Arts and the Coming Up Taller

Award from the Presidents Committee; another is

the funding it has attracted from local, state, and

federal governments, from private foundations, and

individuals and businesses.


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Several government agencies are charged with moni-toring and regulating charitable organizations. At thefederal level, the IRSs Division on Tax Exempt andGovernment Entities reviews applications for tax-exempt status, audits a sample of the informationreturns (the Forms 990) filed annually by nonprofits,and enforces the requirements imposed by the tax code

on charitable organizations. The IRS is also authorizedto assess fines and penalties and, as a last resort, torevoke tax-exempt status.

Most states have their own laws governing the cre-ation, operation, and dissolution of charitable organiza-tions. In most states, attorneys general bear the primaryresponsibility for enforcing these laws and investigatingcomplaints of fraud or abuse of tax-exempt status. Statecharity regulators monitor adherence to charitablesolicitation laws, investigate complaints of fraud orabuse of tax-exempt status, and maintain lists of regis-tered nonprofit organizations.

Although this system of oversight has proven effec-tive in identifying and deterring some individuals ororganizations that violate the law, a serious shortage ofresources has often made it difficult for governmentofficials to identify and punish most violators. Thenumber of charitable organizations has more than dou-bled since 1974, but the staff in the IRS exempt organi-zations division has increased by only 3 percent duringthis same period.

Ethical Concerns about the Nonprofit Sector

Starting in 2002, news outlets that had been followingcorporate scandals also began to examine the charitablesector. They have subsequently identified practices thatare illegal or not in keeping with standards typical ofthe charitable sector. The leadership of the U.S. SenateFinance Committee expressed deep concern over suchpractices and began to take a closer look at charitiesand foundations. In June and July of 2004, theCommittee conducted a hearing and a roundtable dis-cussion on oversight and reform, and the staff released adiscussion draft6 of possible solutions. The Committeefollowed with additional hearings in April and June of

2005.In testimony before the Committee, IRS

Commissioner Mark Everson identified a number ofissues: Misuse of charitable entities, such as donor-advised

funds and Type III supporting organizations, so theybenefit the donor rather than the receiving organiza-tion or the public;

Abusive credit counseling organizations, many ofwhich may have been set up not to assist debtors butto enrich the organizations for-profit partners;

Overstated charitable deductions by taxpayers,most often involving non-cash contributions;

Widely varying methods for determining thecompensation of executives; and

Inconsistent and limited disclosure of governance

practices.7

6 Senate Finance Committee staff discussion draft, 108th Cong.,

Tax-Exempt Governance Proposals 7 (2004).7 Mark W. Everson, Commissioner of Internal Revenue, testi-

mony before the U.S. Senate Finance Committee, June 22,

2004, and April 5, 2005.

People Helping People: Faith in Action

Over the past decade, the Robert Wood Johnson

Foundations Faith in Action program has funded

over 1,000 interfaith community coalitions, mobiliz-

ing volunteers from local congregations and com-

munities to provide assistance with daily activities

to people who are homebound because of long-

term health problems, enabling them to maintain

their independence. In a typical year, more than

34,000 Faith in Action volunteers from across

the spectrum of religious faiths in America

Protestant, Catholic, Jewish, Muslim, Hindu and

otherssupport more than 51,000 people in

need.

Keeping the World Safe: Center for

International Security and Cooperation

The Center for International Security and

Cooperation at Stanford University is experiment-

ing with ways to prevent, detect, and react to

biological terrorism, with an emphasis on improve-

ments in risk assessment, disease surveillance,

communications, and response. The project brings

experts in the life sciences together with counter-

parts in the field of public health, and is one of

several initiatives to strengthen security around

the globe funded by the John D. and Catherine

T. MacArthur Foundation.


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Commissioner Everson pointed out that this listincluded only current violations of the law; the IRS isalso concerned about areas where the law has not keptup with questionable practices.

Some of those who testified urged caution whenconsidering new legislative options, particularly giventhe diverse way in which the charitable sector is organ-

ized. They noted that while a particular remedy maysolve the targeted problem, it may also have an unin-tended adverse consequence for a great many otherorganizations. Moreover, legislation should not be soonerous as to stifle the generous inclination ofAmericans to give and to volunteer. Sector leaderspointed out that the charitable sector has a long tradi-tion of self-regulation, and serious efforts ought to bemade to strengthen such initiatives and to enforce exist-ing law, in addition to proposing possible new legisla-tive remedies. They urged lawmakers to recognize thatone size does not fit all and that nearly three-quarters

of charitable organizations have such limited resourcesthat over regulation is likely to jeopardize their veryexistence.

The U.S. House Ways and Means Committee, underthe leadership of Chairman Bill Thomas (R-CA), alsobegan an examination of the charitable community in2004. The Committee is examining the legal history ofthe tax-exempt sector; its size, scope, and impact on theeconomy; the need for congressional oversight; andwhat the IRS is doing to improve compliance with the

law.Taken together, the examinations underway by

Congress, the IRS, and the sector itself constitute themost comprehensive review of the governance, regula-tions, and operations of the charitable community inthree decades. Leaders of charities and foundationshave viewed these developments as a clarion call toimprove the operations of the sector and work withpolicymakers to strengthen oversight.

Efforts Within the Charitable Community

to Improve Practice

The charitable community has long recognized that itsorganizations can deliver their services more effectivelyif they have strong systems of governance and account-ability.8 The sectors first major effort to strengthen itsperformance in this area began in 1918, when a coali-tion of nonprofits established the National CharitiesInformation Bureau to help the public learn about theethical and stewardship practices of organizations thatraised money.

Current methods of self-regulation run along acontinuum. On one end are systems of accreditation

that delegate the authority to determine complianceof charitable organizations but still carry the force oflaw and sanctions for violations. At the other end arepurely voluntary approaches in which organizationsare encouraged, but not required, to follow a certainset of standards.

Several types of charities, including hospitals, institu-tions of higher education, and nursing homes, fit intothe first category. Though the specific requirementsvary by field of service and by state, the organizationsin these fields must meet well-defined standards inorder to receive insurance coverage, recognition of

Making a Difference: The Conservation Fund

The Conservation Fund has worked with three of

the nations largest energy suppliers to offset the

environmental impact of fossil fuel. In 2002,

The Conservation Fund purchased 600 acres of

non-productive land along the Red River, one of

Louisianas most degraded watersheds. Entergy

Corporation planted more than 180,000 native

trees to scrub the air of 275,000 tons of carbon

dioxide over the next 70 years. As a result of this

collaboration, the company is providing reliable,

affordable, clean energy, and the nonprofit was

able to restore important bottomland hardwood

habitat for assorted wildlife. The land was later

transferred to the U.S. Fish and Wildlife Service

to create the Red River National Wildlife Refuge,

and The Conservation Fund has since worked with

American Electric Power Company and Chevron

Corporation on similar projects.

8 The Panel is in the process of studying the various systems

of self-regulation and will offer recommendations on how to

improve self-regulation in a supplemental report to Congress

in the fall.


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degrees conferred, access to government funding, andother benefits required for successful operation. Failureto meet these standards will result in substantial penal-ties, which even can include being prohibited fromoperating.

In the middle of the continuum are those organiza-tions that have developed mandatory standards for their

members. Land trusts, international relief and develop-ment organizations, some religious organizations,and fundraising professionals, among others, all areexpected to meet standards laid out by an associationwithin their field. A national organization with localaffiliates may use a similar approach. In each of thesesituations, the organization or individual must complywith the standards in order to retain their membershipor affiliation. While the failure to do so may not forcean organization to close or an individual to leave thefield, it can have severe repercussions: the loss of trustfrom members of the public who recognize the value ofthe membership, the inability to operate as an affiliate,and the decline of prestige within the peer group. Thisapproach is likely to succeed where organizations areclosely affiliated or belong to a homogeneous groupwhere social sanctions have a strong impact.

On the voluntary end of the continuum are standardsof conduct that an association encourages, but does notrequire, its members to meet. Sub-sectors using thisapproach include museums, foundations, and stateassociations of charitable organizations. The associationor coalition typically provides guidance to its members

on how to meet its standards or how to adapt them to aparticular situation. Some organizations have no com-pliance procedure in place while others implement dis-ciplinary action for violations by those organizationsthat subscribed to the standards. Though there is nodirect sanction for not participating, those who do maybenefit substantially from the positive awareness of thepublic, of peers, and of funders.

Two other initiatives within the charitable commu-nity encourage accountability. First are the so-calledwatchdog groups or those committed to increasedtransparency that provide information to the public

about whether or not a charitable organization meetscertain standards. A number of these groups set theirown criteria and what areas of practice to concentrateon, and some may choose which organizations to eval-uate, regardless of whether organizations want to berated. Though these groups cannot impose sanctions

directly, they can be influential if their ratings affectthe giving decisions of the public. Some organizationswithin this group make no judgment about practices,but rather concentrate on ensuring that the publichas access to information about the organizations.

Second, there are programs that improve ethicswithin the charitable community through training and

education. Some of the organizations offering instruc-tion focus exclusively on a discrete area, such as boardgovernance or fundraising practices, while others havea broader mandate to assist with a range of issues. Theuse of these groups resources is purely voluntary, butthe demand from individuals and organizations for theirservices, often for a fee, indicates the value they provideat least to those who are aware of or able to afford theirservices.

The Panel on the Nonprofit Sector

On September 22, 2004, the chairman of the SenateFinance Committee, Senator Charles Grassley (R-IA),and the ranking member, Senator Max Baucus (D-MT),sent a letter to INDEPENDENT SECTOR9 encouraging it toassemble an independent group of leaders from thecharitable sector to consider and recommend actions tostrengthen governance, ethical conduct, and accounta-bility within public charities and private foundations.The Senate Finance Committee leadership requested aninterim report in February 2005 and a final report in thespring.

Composition of the Panel on the Nonprofit SectorINDEPENDENT SECTORresponded on October 12, 2004,by announcing the creation of the Panel on theNonprofit Sector. Its members are 24 distinguishedleaders from public charities and private foundationsfrom around the country. Collectively they reflectorganizations both large and small; that work in a singlecommunity, across a state, or around the world; andthat pursue the spectrum of causes that characterizethe sector.

9 INDEPENDENT SECTOR is a nonprofit, nonpartisan coalition ofapproximately 500 national public charities, foundations, and

corporate philanthropy programs, collectively representing

tens of thousands of charitable groups in every state across the

nation.


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The Panels initial steps established the collaborativeand inclusive approach that has characterized its work.To make sure it benefited from the expertise and view-points of those who have studied the sector as well ascivic leaders outside of the sector, the Panel created two

advisory groups. The members of the Expert AdvisoryGroup, who come from academia, law, and nonprofitoversight, add extensive knowledge about the issuesthe Panel has considered. The members of the CitizensAdvisory Group are leaders of Americas business,educational, media, political, cultural, and religious

institutions who provide a broad perspective on howthese issues affect the public at large.

The Panel also formed five Work Groups toexamine key issues in governance and accountability.Volunteering their time and talent to serve on thesegroups are more than 100 experts on nonprofits,including academics, lawyers, accountants, former state

oversight officials, and executives of public charities,foundations, and corporate giving programs. Drawnfrom an array of national, regional, and local organiza-tions, they offer a range of perspectives that reflect thediverse needs and situations within the sector.

Each Work Group focused on a specific area: Governance and Fiduciary Responsibilities: compo-

sition, responsibilities, and compensation of boardsof directors;

Government Oversight and Self-Regulation: enforce-ment of existing laws and systems of self-regulation;

Legal Framework: gaps in current laws and regula-tions governing charitable organizations;

Transparency and Financial Accountability: improvedreporting of financial and program information; and

Small Organizations: impact of existing and pro-posed laws and reporting requirements on smallercharities and foundations.

The Panel has also drawn on the knowledge of dozensof other professionals. It invited a research project onmodels of self-regulation, accreditation, and standard-setting within the nonprofit sector, and it has convened

two groups to study and recommend changes to theIRS Form 990 and 990-PF that would improve theirvalue as a reliable and credible source of public infor-mation. Supporting all of this work was a staff underthe leadership of the Panels executive director and alegal team with expertise in nonprofit law. The Panelalso consulted with technical advisors on the revisionof the IRS Form 990 series, as well as with communica-tions and research experts.

Funding for the Panel provides another indication ofthe breadth of support it has received from the charita-ble community. More than 90 organizations, including

private foundations, community foundations, publiccharities, and corporate giving programs, have madefinancial commitments to support its work. The Panelalso has benefited from invaluable pro-bono contribu-tions by individuals throughout the sector and thecommunity at large.

Collaborating to Improve Accountability:

New Hampshire Officials and Charitable

Organizations

Proud of their traditions of service and ethical

conduct, leaders of New Hampshires charitable

organizations joined with state officials in 2004 to

develop approaches to accountability that would

maintain the public support that makes their work

possible. This group developed recommendations

and then tested them in six listening sessions

with nonprofit leaders across the state. The

resulting program, announced by the governor,

attorney general, and the Excellence in Nonprofit

Governance Committee at a press conference in

February 2005, features workshops presented by

the attorney generals office, a guidebook for board

members describing their responsibilities, and

tools and resources to help nonprofits understand

how to carry out their missions as effectively as

possible. At the center of the effort is the New

Hampshire Nonprofit Checklist, which for the first

time compiles in one place all legal requirements

for the state's charitable organizations. Thirteen of

the states most prominent corporate, community,

health conversion, and family foundations now only

consider applicants who provide completed and

signed checklists, and numerous other funders are

considering adopting the same rule. Well underway

are the development of best practice models for

charitable organizations, and development of someform of accreditation or certification for agencies

as they demonstrate mastery of these best

practices.


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The Panel on the Nonprofit Sector Process

The Panel began its scope of work with the recommen-dations made in the Finance Committee staff discussiondraft but also expanded its examination to related issuesand considered a range of solutions. Its work was con-ducted in two primary phases, each leading to one ofthe reports the Senate Finance Committee leadership

requested. It has also planned a third stage that willoffer supplementary comments in the fall of 2005.

The Panel used a similar process during each of thephases. To help the Work Groups begin their discus-sions, the staff and legal team provided analyses of thekey issues. Through a series of conference calls and theuse of electronic listservs, the Work Groups analyzed

LIST OF FIELD HEARINGS AND THEIR CONVENERS

Atlanta

Co-Conveners: American Cancer Society; Boys andGirls Clubs; CARE; Community Foundation of GreaterAtlanta; Georgia Center for Nonprofits; SoutheasternCouncil of FoundationsChicago

Co- Conveners: YMCA of the USA; ChicagoCommunity Trust; Donors Forum of Chicago;United Way of Chicago; Chicago Chapter of theAssociation of Fundraising ProfessionalsDallas

Co-Conveners: The American Heart Association;The Meadows FoundationDenver

Co-Conveners: The Daniels Fund;The United Nations FoundationDes Moines, Iowa

Co-Conveners: Greater Des Moines CommunityFoundation; Minnesota Council of Nonprofits;

United Way of Central IowaDetroit

Co-Conveners: Michigan Nonprofit Association;Council of Michigan Foundations; W.K. KelloggFoundation; Charles Stewart Mott FoundationDuluth, Minnesota

Co-Conveners: Minnesota Council of Nonprofits;Minnesota Council on FoundationsHelena, Montana

Co-Conveners: Montana Nonprofit Association;Montana Community Foundation; Montana Society ofCPAs; The Governors Task Force on Endowments and

PhilanthropyMinneapolis

Co-Conveners: Minnesota Council of Nonprofits;Minnesota Council on Foundations

New York

Co-Conveners: Alliance for Nonprofit Governance;The Ford Foundation; New School University;New York Community Trust; New York RegionalAssociation of Grantmakers; Rockefeller Brothers Fund;The Surdna FoundationPhiladelphia

Co-Conveners: The Pennsylvania Association ofNonprofit Organizations; Nonprofit Center at LaSalleUniversity; Delaware Valley Grantmakers; United Wayof Southeastern PennsylvaniaSan Diego

Co-Conveners: Council on Foundations;California Association of Nonprofits;INDEPENDENT SECTOR; San Diego Associationof NonprofitsSan Francisco

Co-Conveners: The William and Flora HewlettFoundation; CompassPoint Nonprofit Services;

Northern California GrantmakersSeattle

Co-Conveners: Nancy Bell Evans Center on Nonprofits& Philanthropy, University of Washington; SeattleUniversity Center for Nonprofit and Social EnterpriseManagement; The Nonprofit Center; NorthwestNonprofit Resources; Nonprofit Network; ExecutiveAlliance; Philanthropy Northwest; United Way of KingCounty; Association of Fundraising ProfessionalsWashington ChapterWashington, DC

Co-Conveners: INDEPENDENT SECTOR; Council on

Foundations; Center for Nonprofit Advancement;Nonprofit Roundtable of Greater Washington;Washington Regional Association of Grantmakers;Maryland Association of Nonprofit Organizations


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both the existing problems and possible solutions. The

Expert Advisory Group conducted separate discussionson the same topics.Though they shared many features, there were

important differences between the first and secondphases. The second phase included an in-person meet-ing for all the Work Groups, and a longer time periodallowed more extensive discussion among the Panel, theWork Groups, and Expert Advisory Group on theissues.

The Panel encouraged feedback from the broadercharitable community throughout both phases. It usedits website to communicate about its work and to

encourage comments and suggestions. During theperiod leading up to the Interim Report, it convenedtwo national conference calls during which hundreds ofparticipantsstaff, volunteers, and board membersheard from Panel members and asked questions aboutthe ongoing work.

Building International Communities and

Strong Accountability: InterAction

InterAction, the largest alliance of U.S.-based inter-

national development and humanitarian organiza-

tions, has long been at the forefront of improving

governance and accountability. It has for many

years required its members to certify their compli-

ance with its Private Voluntary Organization

Standards that cover practices in financial man-

agement, fundraising, governance, and program

performance. These standards, which strengthen

public confidence in InterActions members, have

even become a model for comparable groups in

other countries. Recently, its members have

decided to make their process even more rigorous

by launching two pilot projects. The first new pro-

gram, known as Self-Certification Plus, requires

members to gather evidence that documents their

compliance. In the second, five leading child-spon-

sorship agencies are using a private, independent

accrediting agency to certify compliance of their

sponsorship programs with the PVO Standards

through a comprehensive audit of their headquar-

ters and a random sampling of their field opera-

tions in other countries.

Though both the website and phone calls demon-strated the sectors widespread interest in the Panelswork and, more broadly, in improving accountabilityand governance, the most vivid indication of the com-mitment to addressing these issues came from 15 fieldhearings the Panel held around the country betweenlate March and May. While attendance varied accord-

ing to the size of the city in which the hearing washeld, virtually all of the meeting rooms were full and, insome cases, overflowing. In total, an estimated 2,500people participated in the field hearings, and another2,200 attended professional meetings during the sameperiod that covered similar issues.

Each hearing was dedicated to giving communitymembers the opportunity to share their thoughts andconcerns about possible reforms. Despite widely vary-ing locations and backgrounds of the speakers, sevenpoints consistently came through in their comments: Most organizations operate ethically and responsibly; Recommendations must consider the limited

resources available to small organizations; Steps to prevent abuses must not be so cumbersome

that they undermine the ability of organizations todo their work;

Religious groups should be held to the same stan-dards of ethical conduct;

The use of independent auditors and accountants is apowerful way to improve the operations of organiza-tions of all sizes;

Charitable organizations must, as they usually do,

reject requests and proposals from potential donorsor vendors that are illegal or unethical; and Nonprofit staff and board members are hungry for

knowledge about methods of improving their opera-tions and are willing to implement new policiesimmediately.

Towards the end of each phase, the ideas of WorkGroups with feedback from the Expert Advisory Groupwere combined into a series of draft recommendations.The Panel posted these recommendations on its websiteand invited feedback from the nonprofit community

during two comment periods; these responses wereshared with the 24 Panel members. As it was develop-ing its two reports, the Panel considered the draftrecommendations along with the comments from theconference calls or the field hearings and the ideas ofthe Citizens Advisory Group.


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The Panel presented its Interim Report to SenatorGrassley and Senator Baucus on March 1, 2005, andthen shared it with members of the Senate FinanceCommittee, members of the House Ways and MeansCommittee, and IRS and Administration officials, aswell as the charitable community itself. The InterimReport was endorsed by nearly 300 organizations.10

In the report that follows, the Panel combines itsrecommendations from the Interim Report with itsnew recommendations to offer a comprehensiveapproach for strengthening governance, transparency,and accountability. While these recommendationshave drawn upon the wisdom and expertise frommany sources, they represent the collective views ofthe Panel.The Panel will offer supplementary commentson remaining issues (as described on page 83) in anaddendum report in fall of 2005.

10 A listing of endorsing organizations can be found

on the Panel on the Nonprofit Sectors website,

www.NonprofitPanel.org.

Communicating Transparency:

The David and Lucile Packard Foundation

The David and Lucile Packard Foundation is a

40-year-old family foundation that has long pro-

vided information about the impact of its grantees.

As part of its commitment to transparency and

effectiveness, it recently added extensive informa-

tion on governance to its online presence. The

foundations website now offers grantseekers,

media, and the public access to its bylaws, com-

mittee charters, code of conduct and statement of

values, conflict of interest policy, and whistleblower

policy. It also features the foundations 990-PF for

the previous five years and results from its two

most recent surveys of grantees about the founda-

tions performance. An easily accessible place for

public access to these policies, financial informa-

tion and grantee perceptions, the website hashelped educate the public about the foundations

operations, ensured greater accuracy in media

reports, and saved staff time in responding to

requests from reporters or other interested

people.


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The Panel on the Nonprofit Sectors wide-ranging examination of how to strengthenthe governance, accountability, and ethical standards of charitable organizations ledto broader discussions about the essential qualities of the sector. The Panel developedthe following principles in three key areas to guide its recommendations:

take into account the sectors diversity and complexityand avoid the unintended consequence of stifling itsability to serve and innovate. Further, any policychanges must be aimed at strengthening the greatAmerican traditions of giving to, volunteering in, andserving as leaders, directors, and trustees of charitableorganizations.

2. The Charitable Sectors EffectivenessDepends on its Independence

The power of the charitable community grows from itsability to bring together people who share a commit-ment to improving lives. They select the charitablecommunity to make those changes because it offers thefreedom to experiment with new ideas, to respond toneeds without delay, to hold government accountable,and to encourage all efforts, both large and small, thatwill improve the quality of life for people across thecountry and around the world. America must continueto encourage such innovation and creativity by preserv-

ing the independence, within a broad range of publicpurposes the law defines as charitable, of charitableorganizations to choose and pursue their mission asthey deem best. Government appropriately sets therules for the use of government funds by charitableorganizations, but should resist intruding into policyand program matters best determined by the charitableorganizations themselves.

Principles toGuide Improving theAccountability ofCharitable Organizations

THE ROLE OF CHARITABLE ORGANIZATIONS

IN AMERICAN LIFE

1. A Vibrant Charitable Community

is Vital for a Strong America

Americas voluntary spirit has shaped the history andcharacter of our country since its inception. That greattradition of collaboration, generosity, and participation

continues today in the form of public charities, privatefoundations, and religious congregations.Our countrys expansive network of charitable organ-

izations enriches Americas communities by providingvital services in such fields as health, education, socialassistance, community development, and the arts. Thenonprofit sector provides the means for people toengage collectively and collaboratively in criticalresearch, community-building, and advocacy effortsthat strengthen democracy, advance freedom of expres-sion, and add richness and diversity to community life.U.S. nonprofit organizations assist victims of disasters,

provide educational and economic opportunities, allevi-ate poverty and suffering at home and abroad, and fos-ter worldwide appreciation for democratic values ofjustice and individual liberty.

Today, the charitable community remains a creative,vibrant, and unique feature of American life, with tensof thousands of organizations, large and small, workingtogether to advance the public good rather thanincrease private gain. Any effort to address issues must

SECTION II


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THE RESPONSIBILITIES OF THE

CHARITABLE COMMUNITY

3. The Charitable Sectors Success Depends

on its Integrity and Credibility

Public trust is essential to a viable nonprofit sector.Because federal and state laws provide tax exemption

and other privileges unavailable to for-profit entities,and because Americans contribute their resources andtime to nonprofit organizations, government officialsand the public have a right to expect these organiza-tions to conduct themselves in an ethical manner.Strengthening this trust depends on the extent to whichcharities and foundations operate transparently, preventfraud and the enrichment of insiders and other abuses,and serve the purposes for which they have been cre-ated. Board members have the primary responsibility,through their governance and oversight, to ensure theseobligations are met.

4. Comprehensive and Accurate Information

About the Charitable Sector Must be Available

to the Public

To encourage participation and confidence in the non-profit sector, the public must have access to accurate,clear, timely, and adequate information about the pro-grams, activities, and finances of all charitable organiza-tions. Government regulation should promote suchtransparency while providing sufficient flexibility toaccommodate the wide range of resources and capabili-

ties of nonprofit organizations, particularly of smallorganizations.

5. A Viable System of Self-Regulation and

Education is Needed for the Charitable Sector

The vast majority of charitable organizations are com-mitted to ethical conduct and responsible governanceand are willing to conform to commonly accepted stan-dards of practice. The development and disseminationof these practices are an important component of theeffort by the charitable sector to encourage all charita-ble organizations to embrace the highest possible stan-

dards of conduct. Whether it be peer review andfeedback, coupled with transparency in practice, ormore complex systems of accreditation, such initiatives,if actively embraced by the sector, are likely to bringabout positive change.

Although self-regulation is unlikely to work withthose who deliberately violate standards of ethicalpractice and are immune to peer pressure, the charitablesector nonetheless must be actively involved in identi-fying and promoting best practices and stronglyencouraging compliance within relevant sub-sectors.The sector must offer educational programs that reachthe entire sector, especially the board members andprofessional leaders who may not otherwise be awareof the expectations and requirements imposed on them.Both the sector and government should provide theresources necessary to disseminate best practices and todevelop and sustain ongoing education efforts to helpboard members to govern and CEOs to operate in aresponsible, transparent, and accountable manner.

THE NEED FOR BALANCED

GOVERNMENT OVERSIGHT

6. Government Should Ensure Effective

Enforcement of the Law

Abuse of the privileges granted charitable organiza-tions, while perpetrated by a small number of individu-als and organizations, threatens the work of the entiresector and may diminish the generosity of donors.Accordingly, government should authorize and appro-priate sufficient resources to facilitate full implementa-tion of the law designed to prevent such abuses. Therealso should be greater coordination between federal andstate oversight officials in order to make best use of lim-

ited resources and avoid duplication of work. In addi-tion, government should support sound educational andtechnical assistance programs to ensure that charitableorganizations are familiar with the law and appropriatestandards of practice.

7. Government Regulation Should Deter Abuse

Without Discouraging Legitimate Charitable

Activities

Regulation is necessary for those situations where thesector cannot reasonably be expected to deal withthose who deliberately abuse the public trust and

exploit nonprofit organizations for personal gain, andnew regulation may be needed where current legal stan-dards have proven inadequate. However, regulation thatis not responsive to the diversity of the nonprofit sectorhas the potential to increase the administrative and


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financial obligations of compliance to a level that willforce some organizations to curtail or even cease theirlegitimate charitable activities. Particular considerationshould be given to any actions that might deter donorsor discourage responsible volunteers from serving onboards.

8. Demonstrations of Compliance with High

Standards of Ethical Conduct Should be

Commensurate with the Size, Scale, and

Resources of the Organization

All organizations should be expected to operate ethi-cally and serve as worthy stewards of the public andprivate resources entrusted to them. Fraud or abuse can-not be condoned in any organization for any reason,since each breach of the public trust damages the repu-tation of the entire sector. At the same time, it may notbe possible or desirable for small organizations, giventheir limited human, technical, and financial resources,to demonstrate their ethical and accountable operationby complying with some of the more complex legalrequirements appropriate for larger charitable organiza-tions. Lawmakers must consider the varying situationsof organizations to which regulations may apply, andmust refrain from adopting regulations where the costsof demonstrating compliance outweigh the benefitsgained.


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SECTION III

Recommendationsof the Panel on theNonprofit Sector


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1 Marion R. Fremont-Smith, Governing Nonprofit Organizations:

Federal and State Law and Regulation (Cambridge, Massachusetts:Belknap Press of Harvard University Press, 2004), p. 267.

1. FEDERAL AND STATE ENFORCEMENT

Introduction

Effective oversight of the charitable sector requires vig-orous enforcement of the law at both the federal andstate level. State attorneys general and other state char-

ity officials have long held significant responsibility forestablishing and enforcing regulations on the gover-nance and management of charitable organizations andfor overseeing solicitations of charitable contributionsin their states. Federal officials as well as many stateoversight officials also play a role in educating boardand staff members of charitable organizations aboutlegal responsibilities and requirements to the extent thatresources will permit.

Statement of Problem

Funding for federal and state oversight of tax-exemptorganizations has become increasingly inadequate asthe size and complexity of the exempt sector hasgrown. Federal laws only permit the Internal RevenueService to share relevant information with state revenueofficers. The inability to share information about ongo-ing investigations with attorneys general and other stateofficials charged with overseeing charitable organiza-tions increases the cost of oversight and enforcementand impedes the efforts of state officials to weed outwrongdoing efficiently and effectively.

Recommendations for Congressional Action1. Congress should increase the resources allocated to

the IRS for oversight and enforcement of charitableorganizations and also for overall tax enforcement.

2. Congress should authorize funding to be provided toall states to establish or increase oversight and educa-tion of charitable organizations. Congress shouldauthorize additional supplemental funding for stateswilling to provide matching dollars for furtherimprovements in oversight and education. Statematching funds should be new funding for regulationof charitable organizations that is not derived from

fees imposed on charitable organizations. To qualifyfor matching funds, states should be required toadopt uniform state filing requirements and meet

minimum standards for oversight and enforcementof regulations governing charitable organizations.

3. Congress should amend federal tax laws to allowstate attorneys general and any other state officials

charged by law with overseeing charitable organiza-tions the same access to IRS information currentlyavailable by law to state revenue officers, under thesame terms and restrictions.

Recommendation for

Charitable Organization Action

Charitable organizations should encourage state legisla-tures to incorporate federal tax standards for charitableorganizations, including prohibitions on excess benefittransactions, into state law.

Background

Over the past 20 years, funding for Internal RevenueService oversight of exempt organizations has remainedessentially constant while the sector has nearly doubledin size and become even more complex. Funding ofoversight at the state level varies substantially amongstates, but all lack sufficient resources to provide ade-quate oversight of the charitable sector. The legislativehistory to the Tax Reform Act of 1969 indicates thatthe excise tax on the net investment income of privatenon-operating foundations was intended to fund the

exempt organizations oversight function within the IRS.Those funds, to the disappointment of many, havenever been designated for that purpose.

States currently have the authority to pursue federaltax violations if federal laws are incorporated into statelaw. Since 1975, 48 states and the District of Columbiahave passed laws imposing the restrictions on privatefoundations in Chapter 42 of the Internal RevenueCode as a matter of state law.1


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Rationale

The shortage of resources for oversight and enforce-ment extends beyond the charitable sector to manyareas of tax enforcement. While the Panel believes it is

critical to increase the resources allocated to exemptorganization oversight, any such increase should not beat the expense of other vital areas of tax enforcement.

Revenues collected annually from the excise tax onprivate foundationsnearly $500 million in fiscal year2002now greatly exceed the current budget of theIRS exempt organizations division. The Panel recog-nizes the fiscal challenges facing Congress today, butbelieves that, without adequate resources for oversightand enforcement, those who willfully violate the lawwill continue to do so with impunity. The Panel wouldbe strongly supportive of efforts by Congress to ear-mark funds derived from a variety of sources includingexcise taxes and penalties imposed on charitable organi-zations for improved oversight and education activitiesof the exempt organization division of the IRS.

The proposed new revenue sharing program musttake into account that regulation of charities at the statelevel is quite diverse, and many states and territories donot currently regulate charitable activities and organiza-tions beyond charitable solicitations. The programshould be designed to encourage states that do not reg-ulate, as well as states with insufficient state regulation,

to adopt uniform state filing requirements for charitableorganizations operating within the state. Each stateshould be required to have sufficient review and/oraudit procedures and enforcement programs in place toensure compliance with applicable laws and regulations.

Education of charitable organizations about changes infederal and state laws and reporting requirements willbe critical to increased compliance and should be incor-porated into the new funding program requirements.

Responsible sharing of relevant information betweenfederal and state officials will enable these officials toperform their duties more effectively. It also will assistcharitable organizations by reducing the burden theyoften face in responding to duplicative federal and stateinquiries for information.

The Panel has some concern about the potential forimproper disclosure of shared information by state offi-cials but assumes that there will be sufficient protectionif current legal safeguards against such disclosure bystate revenue officers are applied to state officialscharged with oversight of charitable organizations.

If states incorporate federal tax standards into statelaw, enforcement of federal standards will likelyincrease and opportunity for collaboration between fed-eral and state enforcement efforts will likely improve,resulting in more uniform federal and state standards.The Panel believes this approach is preferable to grant-ing the states authority to enforce federal tax laws withthe approval of the IRS.2 Incorporating federal taxstandards into state law grants greater flexibility to thestates, while at the same time not burdening thealready-stretched IRS with another task.

2 This approach offered in the Senate Finance Committee staff

discussion draft, 108th Congress (June 2004)


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4. Amend federal tax laws to require all

Documents

Panel Final Report