Monday, May 11, 2009

Ten Things Nonprofit Boards Should Think About (Soon)

I am still reeling over the Verret v. USA decision. If you read the previous blog on this subject by Stephen L. Tatum, you will remember that the Fifth Circuit held a Board Chair personally liable for not paying payroll taxes. It reminds me of what I know so well, many people get on nonprofit boards and don't realize they have liability for the actions of the organization. If you are a Board Member, make sure you heed Stephen's advice! And, by the way, make sure you know exactly how much Director's and Officer's Insurance the organization is carrying! Bunnie

Ten Things Non-Profit Boards Should Think About (Soon)

by Stephen L. Tatum, Partner, Cantey Hanger

Most members of non-profit boards are unaware of the potential for personal liability that became apparent in the recent case of Verret v. U.S.A., 542 F. Supp. 2d 526 (E.D. Tex. 2008) affirmed by the U.S. Court of Appeals for the Fifth Circuit on February 26, 2009. The lower court opinion gave a very detailed account of the reasons why the board chairman of a non-profit hospital was held personally liable for payroll taxes the hospital owed but did not pay. It also provides some good ideas for at least minimizing the risks of board members being personally responsible for a potentially large bill from the IRS.

Review Your Bylaws

Most non-profits’ bylaws were likely derived from a form that provides that the Board has ultimate and final responsibility for the operation of the organization, or words of similar meaning. That wording should be changed to place the responsibility for daily operations on the paid staff, rather than volunteer board members, who are not present on a day to day basis and who therefore lack the capability, much less the competence, to manage the operations of an ongoing business. Boards are there for strategic oversight, not day-to-day management. The designation of the Board as the “final authority” should not be unlimited.

Maintain a Bright Line Between Board and Staff Responsibilities

Verret was a paid consultant of the hospital in addition to being its Board Chairman. Those types of relationships can only serve to blur the boundary between those only responsible for strategic oversight and those responsible for day-to-day operations. Because the tax code has a very broad view regarding “responsible persons” for the purpose of imposing liability for unpaid tax obligations, volunteer Boards should be careful to draw a bright line between themselves and the employees of the organization regarding areas of responsibility.

The Board Should Not Involve Itself in Financial Transactions Between the Organization and Anyone

One reason why Verret was held liable for the hospital’s unpaid payroll taxes was that “the Board” itself secured a loan to purchase certain equipment in order to meet the demand of a physician who threatened to move his practice to another hospital. Such direct involvement in an organization’s business affairs can lead to “responsible person” designation under the tax code and should be avoided. Approval of what an employee does is still risky but in some cases necessary.

Individual Board Members Should Avoid Getting Too Involved in Day to Day Operations

Verret apparently spent part of almost every day at the hospital he chaired. That should be avoided. Even if those visits did not involve actually conducting hospital business, their frequency blurred the distinction between strategic and operational, as did the frequency (daily) of their phone conversations. When there is something important to discuss, discuss it. When there isn’t, give your cell phones a rest.

Unless Required To Do So, Don’t Sign Tax Returns

Another reason why Verret was found to be responsible is that he signed the hospital’s IRS Form 990 for two years as “Chairman.” He also took the initiative to contact a management company and discuss a plan to get the delinquent payroll taxes paid. As for the former, while Board chairs are required by law to sign or attest to the accuracy of financial statements, they are not required to sign tax forms and that should be avoided. As for taking the initiative to try to determine how to make up the tax delinquency, making Verret pay for doing what any dedicated Board chair might do when the CFO had failed twice to make the payments, is just a hazard of the office. Hopefully that one fact, by itself, is not enough to support a claim by the IRS.

Do Not Get Signatory Authority on Company Checking Accounts

Verret could and did sign hospital checks for various things. That is a bad idea for a number of reasons, including the appearance of responsibility for day to day operations. If asked, just say “no.”

Avoid Authority to Hire and Fire

The District Court explained that there was no evidence that the Board lacked the authority to hire and fire employees by noting that the board chose not to terminate the recalcitrant executive director who had twice failed to pay the taxes at issue. Most boards of stand-alone businesses have the authority to hire and fire at least the Chief Executive Officer of the organization. That is as far as that authority should reach. If you are on a board of an organization that is part of a system of like organizations, consider a structure where the authority to hire and fire employees specifically and explicitly rests with the system and not the individual boards.

Do Not Take Yes For an Answer

If you have direct oversight responsibility, exercise it carefully. If that oversight responsibility involves ensuring that something has been done, verbal assurances, as Verret learned, are not enough to satisfy the Board’s duty of care. Ask for tangible proof up to and including cancelled checks.

Forgiveness Is A Sin

If the Board becomes aware of a failure to follow the law, make tax payments or any other business malfeasance, the Board must consider termination of the responsible employee as the first alternative. Based on the reasoning in Verret, Boards apparently get one free pass from being found reckless or grossly negligent in their oversight of employees. If, after an act inconsistent with law or organization policy, the employee is permitted to remain with the company and is not adequately supervised regarding his or her past and potential for future transgressions, a second instance of malfeasance will likely result in a finding of recklessness on the part of the board. As Verret discovered, that can lead to all kinds of problems. When deciding how to discipline an employee, consider whether the continued risk of responsibility for a second bad act is worth keeping the employee on the payroll.

Make Sure You Are Compliant

Non-profit status is granted by the United States Government for a price, i.e., compliance with all of the statutory and regulatory requirements that the Tax Code and regulations impose. For example, non-profit hospitals are required to provide a certain amount of charity care in exchange for not having to pay an income tax. Foundations are required to give a certain percentage of their worth to charitable or philanthropic causes each year. The Federal Government is paying closer attention to compliance than it has for quite some time. Make sure to determine whether your organization is meeting the government’s mark, or suffer the potential loss of your tax exempt status.

This necessarily brief discussion is meant to make board members aware of things they should look out for and things they should and should not do to try and avoid personal liability. It is not exhaustive, and if in doubt, consult an expert.

Stephen L. Tatum is a partner with Cantey Hanger L.L.P. He can be reached at (817) 877-2829 or by email at statum@canteyhanger.com.

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