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.

Stephen K. Verret v. United States of America

I've said it before, I'll say it again, many Board Members of large and small nonprofits do not understand the full extent of their liability. As Stephen Tatum of Cantey Hanger, LLP, illustrates from a a recent Fifth Circuit case, officers of an organization are equally responsible for, among other things, tax liability. It's simply not good enough to "urge" the executive to do something, Board Members must follow through, ask for proof or even take matters into their own hands. Maybe it's time for a liability check-up for your organization? Bunnie

Stephen K. Verret v. United States of America

by Stephen Tatum, Attorney, Cantey Hanger, LLP

Doctor’s Hospital in Groves, Texas was a 501(c)(3) tax-exempt organization, the Board of Trustees of which were specified by the Hospital’s By-Laws as voluntary and unpaid members of the community. Stephen K. Verret was on the board for almost 26 years. From 1999 until his resignation in 2002, Verret served as Chair of the Hospital’s board.

In early 2001 and again at the end of 2001, the hospital’s executive director David Cottey told the board that the hospital had failed to pay withholding taxes. Funds were found to satisfy the first tax liability.

Other than urging Cottey to pay the taxes and initiating a search for his replacement, Verret and the board did nothing to see that the second tax delinquency was paid.

The IRS found Verret, Cottey and the Hospital’s Chief Financial Officer, Angela Massey, to be “responsible parties” under § 6672 of the Internal Revenue Code. Among other things, the IRS assessed a penalty against Verret totaling $407,097.66 (equaling the amount of unpaid taxes), plus interest in the amount of $1,821.00. Verret paid the penalty and brought this lawsuit to recover the money. The District Court granted the government’s summary judgment and the Fifth Circuit affirmed.[1]

Section 6672 of the Internal Revenue Code (“IRC”) imposes a penalty on any “person required to collect, truthfully account for, and pay over any tax . . .” If someone willfully fails to collect and pay a tax, a penalty equal to the amount of the unpaid tax, itself referred to as a “tax” is assessed on “persons” deemed responsible for paying the tax under the IRC. A “person” includes “an officer or employee of a corporation … who as such officer [or] employee . . . is under a duty” to account for, collect and pay the tax. Courts view the concept of “responsible person” very broadly.

Among other findings, the Court found the following facts to establish that Verret was a responsible person subject to liability for the Hospital’s unpaid payroll taxes.

· The Bylaws of the hospital provided that its Board had final responsibility for administration.

· The Executive Director was required to make reports to the Board regarding personnel, staff and budget matters at each Board meeting.

· After the first failure to pay withholding taxes, the Board received oral assurances by Cottey that taxes were paid.

· Verret instructed Cottey to pay the payroll taxes before he paid anyone else.

· Verret was frequently present at the hospital and spoke with Cottey almost every day.

· The Board could hire and fire employees, specifically Cottey.

· Verret had the authority to sign company checks.

Despite testimony from Hospital employees that the responsibility for tax payments lay with senior management, the trial court found that Verret was a responsible person along with Cottey and Massey.

Next, the District Court found Verret to have acted willfully after the first delinquency, “Verret failed to take responsible steps to ascertain whether the taxes had in fact been paid and to resolve any uncertainty regarding the issue.”[2]

Does this sound familiar? The alarming thing about this opinion is that with a few exceptions like the consulting contract, Verret’s activities are not much different from what any Board chair would do in these circumstances.

The Court’s reliance on the language of the bylaws is also of concern. My suspicion is that most bylaws place ultimate responsibility for the operation of any organization with a board of directors, which can delegate authority. Further, Board chairs are likely on most CEO’s phone call list at least once a week.

Board Chairs of not-for-profits should consider having bylaws and tax payment procedures audited if there is any doubt at all regarding dealing with the IRS. Otherwise, they may be rudely awakened with a tax bill.

[1] The single paragraph appellate court opinion largely adopted the trial court’s reasoning in Verret v. United States, 542 F. Supp. 2d 526 (E.D. Tex. 2008), so for purposes of looking more deeply into the potential for personal liability arising from board service, read the trial court’s opinion.
[2] i.e., Failing to ask for canceled checks to show that taxes had been paid.

Contact Stephen Tatum at http://www.canteyhanger.com/