Tuesday, May 6, 2014
Does Nepotism violate the Private Benefit Prohibition? The Case of International Relief and Development
The Washington Post published an interesting article Sunday perhaps exemplifying what we might label the "residual clause" of charitable tax exemption. The article describes a federally tax exempt nonprofit called International Relief and Development. The organization undertook difficult projects in worn torn Iraq, in the process of which raking in lots of money with which it paid generous salaries and bonuses to its founders (husband and wife) and various family members. It also served as a welcoming and lucrative job source for former executives of the federal agency from which it received most of its soaring gross revenue. The article suggests that those well-paying jobs were offered as reward for all the grant money the employees directed to IRD while serving in the government. The article describes the high salaries paid to various insiders, but it appears that the organization did its homework. It hired compensation consultants who must have done all that is necessary for the organization to avail itself of the presumption of reasonableness. And though the article points out that the insiders made more than top executives at some comparable organizations, it seems doubtful that those salaries are so far out of bounds as to constitute private inurement or excess benefit. What seems bothersome is that the organization (1) paid generous salaries and bonuses to founders and family members, and (2) hired many of its other executives from the USAID, a federal agency from which the nonprofit received so many contracts that its gross revenues went from $1.2 million to over $706 million in little more than 5 years:
International Relief and Development increased its annual revenue from $1.2 million to $706 million, most of it from one corner of the federal government — the U.S. Agency for International Development. IRD has received more grants and cooperative agreements from USAID in recent years than any other nonprofit relief and development organization in the nation — $1.9 billion. Along the way, the nonprofit rewarded its employees with generous salaries and millions in bonuses. Among the beneficiaries: the minister, Arthur B. Keys, and his wife, Jasna Basaric-Keys, who together earned $4.4 million in salary and bonuses between 2008 and 2012.
. . . .
The nonprofit organization, in turn, has hired at least 19 employees from USAID, the lead government agency for addressing poverty and supporting democracy worldwide. Several of them came directly from their desks at the agency to occupy important posts at the company. Some of those employees, including the former acting administrator of USAID, received substantial pay raises by crossing the Potomac and joining IRD at its new offices in Arlington, Va., collecting hundreds of thousands of dollars in annual salaries, bonuses and other compensation.
One observer asserts, with indignation, that IRD was formed for the primary purpose of getting grants from USAID and passing along some of those grants to insiders in the form of salaries. The article's tone suggests that it just isn't right that such an organization would be entitled to tax exemption.
In all, 38 IRD employees received more than $3.4 million in bonuses during the same period, according to the company’s tax filings.“This is not Wall Street,” said Doug White, an expert on nonprofit entities who teaches at Columbia University and reviewed IRD’s tax returns at the request of The Post. “This is an organization that is supposed to be helping people, not helping themselves.”
But who can object, and on what basis, if the organization embraces nepotism in the pursuit of its charitable goal but otherwise complies with the requirements in 501(C)(3)?
PRIVATE BENEFIT AS A CATCH-ALL PROHIBITION
By conceptualizing private benefit as a sort of "residual clause," I mean to say that we apply the doctrine to revoke or deny exemption even when the organization complies with the primary purpose requirement and violates no other explicit prohibition (inurement, excess benefit, intervention, substantial lobbying). In other words, the organization dots all its i's and cross all its t's but still stinks so much that we want to deny exemption. "It's just not right what they are doing with taxpayer subsidy!" I don't know if IRD represents such an instance where indignation should result in the revocation of tax exemption. Ultimately, though, the sentiment is all that applies when a charity is not paying too much to insiders or "disqualified persons," intervening in campaigns, or engaging in substantial lobbying. It's just that in the accomplishment of its public benefit -- something that nobody denies -- the organization is unnecessarily lining the pockets of a nepotistic group or individual, even if that group or individual is providing quid pro quo. Somebody has to benefit specifically if the public is to benefit generally. In other words, we can't all benefit unless somebody benefits in particular. But the specific benefit should not be directed towards any noncharitable beneficiary for nepotistic reasons. If an organization otherwise pursues an undeniably charitable purpose and does not pay its insiders or disqualifiied persons unreasonable salaries, what can be done if we think it intolerable that family members and other benefactors are especially benefitting from the oranization's pursuit of its charitable goal?
Applying an intellectual and theoretical lable to what seems a visceral reaction first occured to me some years ago when I read (and since then have re-read many times) Judge Posner's penultimate sentiment in United Cancer Council. You might recall that case wound its way through the federal judicial bureaucracy for ten plus years -- the government alleging private inurement (to the charity's exclusive fundraiser) and the taxpayer defending -- until Posner finally said the parties were arguing about the wrong theory and should, instead have been relying on the residuary effect of the private benefit doctrine Dean [of Illinois] Colombo talked about last week. "If nothing else fits," Posner said, "use the private benefit doctrine as the utility player of charitable tax exemption:"
And maybe tax law has a role to play in assuring the prudent management of charities. Remember the IRS's alternative basis for yanking UCC's exemption? It is that as a result of the contract's terms, UCC was not really operated exclusively for charitable purposes, but rather for the private benefit of W&H as well. Suppose that UCC was so irresponsibly managed that it paid W&H twice as much for fundraising services as W&H would have been happy to accept for those services, so that of UCC's $26 million in fundraising expense $13 million was the equivalent of a gift to the fundraiser. Then it could be argued that UCC was in fact being operated to a significant degree for the private benefit of W&H, though not because it was the latter's creature. That then would be a route for using tax law to deal with the problem of improvident or extravagant expenditures by a charitable organization that do not, however, inure to the benefit of insiders.
I have often found the first sentence regarding tax law's role in assuring the "prudent management" of charities reassuring somehow. Surely, we -- by that I mean the government because the government is us not them -- have a right to insist on the prudent management of entities we subsidize. And so the private benefit doctrine ought to apply when a charitable organization engages in nepotism. When its indirect benefit -- the particular benefit without which the public good could not be achieved -- is unnecessarily reserved for a particular noncharitable beneficiary, we can conclude that the organization is not operated for public good but private benefit. In other words, private benefit is a doctrine that assures the proper management of a public trust. That is why it may apply even when there is no excess benefit because the organization is not paying unreasonable compensation for goods or services.
Nepotism, by the way, is antithetical to prudent managment because by definition it prevents an organization from getting the best provider of goods or services necessary to the accomplishment of the public good. But nepotism, to one extent or another, is probably a fact of life in every business or nonprofit organization. We should expect and tolerate some level, lest we construct a rule that would be so broad as to destroy every organization. Perhaps that is the case with IRD. The trick is in determining when enough is enough. But that it is necessary to find that threshold only supports my conception of private benefit. Whatever its purpose, it has always been applied (unlike private inurement or excess benefit) in a way that tolerates some minimal amount of variance. A sort of "nobody is perfect" mantra for nonprofits. I doubt that IRD meets that threshold based on the facts in the article.