In a recent webinar, “Executive Review Guidelines for the IRS Form 990,” we addressed some of those nuances and how nonprofit executives can effectively evaluate their Form 990 prior to filing with the IRS. During the webinar, which can be accessed online at any time, attendees were provided with helpful guidelines around performing a top level review of the Form 990, including how to assess the overall financial stability of their organization and how to adhere to industry best practices. Attendees of the presentation asked several questions about particular sections of the Form 990.

Here are a just a few of those inquiries:

How much information should be provided in the “Summary of Program Service Accomplishments” section?
Part III of the Form 990 goes into further detail about the mission of the organization, changes during the year that affected its ability to realize certain goals, and specific accomplishments tied to program revenue and how it was spent. Given this is a public document accessed by many people including funders and potential donors, it in the organization’s best interest to use this opportunity to showcase a bit of “PR” and elaborate on the organization’s story.

Is it advisable to establish a full audit committee that devotes it’s time to managing the audit process and reviewing the Form 990?
While establishing an audit committee is not required, the IRS has specified that it is a governing best practice. In the Form 990, you will be required to disclose whether or not your organization has established an audit committee and what their work entailed. If you are considering adopting this best practice and need additional guidance, we recommend visiting our microsite Effective Audit Committees for Nonprofit Organizations.

What is the most common mistake you see organizations make on the Form 990?
The Form 990 should be prepared and finalized by a CPA and/or a licensed audit firm, which will greatly decrease any discrepancies in reporting. The most common error we see on the Forms 990 is very minor – board members’ names are spelled incorrectly. This will have no effect on your filing status, but as a good rule of thumb, be sure to closely proofread your work.

If you missed the initial presentation or would like to share it with other executives at your organization, you may access the on-demand webinar and podcast anytime. A full list of questions and answers is available here. You may also want to download and save our full guide, Executive Review Guidelines for the IRS Form 990.

The webinar and podcast recordings are complimentary and are intended for our valued blog readers, clients and contacts serving the nonprofit community. CPE credit is not available for these recordings at this time.

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In his opening statement to the hearing, Representative Charles Boustany (R-LA), the subcommittee chairman, indicated that the colleges and universities have been at the forefront of a trend of exempt organizations growing more and more complex in their organizational structure and operations. According to Boustany, higher educational institutions also generate a disproportionate level of tax-exempt revenue and hold a disproportionate amount of assets, since they “represent just 0.5 percent of the tax-exempt sector, but generate more than 11 percent of the revenue of charitable organizations, nearly $160 billion in annual revenue. And they hold over $150 billion in assets, which is more than 21 percent of the entire charitable sector’s assets.”

As the hearing continued, the issue of unrelated business income (UBI) took center stage. A number of the Congressional representatives suggested they could not believe that noncompliance with tax laws—a key finding in the IRS report—could be so widespread and wondered aloud whether legislation was needed to address the problem. They also questioned whether similar noncompliance was pervasive throughout the broader exempt organization community.

In response to those concerns, Ms. Lerner, the IRS director, said the IRS would need to look at a broader segment of the sector before making suggestions for legislative changes. She added that the IRS is currently examining other organizations that reported substantial gross UBI for three consecutive tax years but reported no income tax due, in order to determine the scope of the problem.

On the role of auditors, one member of Congress asked whether a college or university’s auditors typically certify the accuracy of the tax return. Lerner indicated that auditors become involved with the accuracy of the return when they had been engaged to be the tax preparers.

The CUCP report’s findings on executive compensation—which were unveiled just a few weeks before the Chronicle of Higher Education released its own, widely reported executive compensation study—were another point of contention during the hearing. Several subcommittee members expressed concern at the high salaries reported, particularly as schools continue to raise tuition.

As the IRS reported, average compensation for the highest-paid officials including the following:

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An editorial aside: As part of most organizations’ audits, there must be verification that there are no material uncertain income tax positions.  Exemption itself is a tax position as is unrelated business income tax.  This accounting requirement, ASC 740-10, previously known as FIN 48, requires an organization to look at all tax positions to see whether it is more likely than not that they would prevail upon audit and assumes that tax authorities are examining the organization and all the facts are known.  One wonders whether the universities in question had done adequate inventorying and documentation of their tax positions.  Documentation and analysis are always important when it comes to taxes.  Organizations that think they are at risk should consider having a UBIT study, compensation analysis or even a mock IRS audit done.

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Overall, it appears that the public believes the charitable deduction should not be tampered with in any manner that would reduce charitable giving. In fact, one suggestion was to exclude charitable contribution deductions from the reach of the most recent tax legislation that imposes overall limits on itemized deductions of the wealthy. Other ideas that had been floated and commented on include:

• Limiting the value of the charitable deduction to 28 percent.
• Dollar caps on deductions for charitable contributions.
• Conversion of the charitable deduction into a credit.
• Allowing a deduction only for charitable contributions in excess of a specified amount, or “floor.”

Other charitable giving comments expressed were:

• Concerns about treating contributions to some 501(c)(3) organizations, such as cultural organizations, differently than contributions to humanitarian relief organizations.
• Expansion of the rules for augmented deductions for contributions of inventory used for “the ill, needy or infants” to inventory used for “fundraising events and campaigns that benefit the ill, needy and/or minors within a local community.”
• Repeal or modification to 2004 legislation that amended the charitable deduction rules for contributions of automobiles and other vehicles.

Among the provisions in the unrelated business income tax (UBIT) arena, suggestions included:

• Eliminating UBIT for payments from controlled corporations when the transaction is at fair market value, regardless of when the contracts were made.
• An across the board exception to the unrelated debt-financed income rules for any organization where the transaction involves real estate. Currently, only certain qualified organizations such as schools and qualified pension organizations have this exception.
• Extending the UBIT rules to employee stock ownership plans (ESOPs).

Interestingly, the report also includes a suggestion that Congress legislate that the gift tax not apply to contributions given to 501(c)(4) organizations. In the recent past, there have been concerns regarding the political activities of 501(c)(4) organizations. The IRS has indicated that it had the authority to impose the gift tax on contributions made to these organizations, but subsequently said they would not pursue the tax.

While this article only makes mention of a few proposed ideas, there are several more that have been suggested as options regarding charitable giving and other exempt organization issues. Read the report and let us know your thoughts on these proposed ideas in the Comments section below.

Stay tuned to the Nonprofit Standard blog for more coverage around charitable deduction changes!

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At each of these gatherings, we have had the pleasure of meeting higher education professionals from across the United States; we have exchanged ideas about how best to address the myriad challenges—like declining enrollment, skyrocketing tuition, heightened financial scrutiny and scarce public funding—that institutions are grappling with each and every day; and we have explored some of the hottest trends in public education and the technologies and innovative ideas driving them.

Regular readers of this blog will find many of these topics familiar—we have written before about the importance of internal audits, the necessity of a careful look at executive compensation and the promise of MOOCs and other online tools—so we thought we’d use this post to share some fresh and exciting lessons we learned at the SACUBO gathering that could have a huge impact on higher education in the months and years ahead:

• Information Security is Paramount: Theresa Payton, formerly the chief information officer at the White House, offered a stark picture of the vulnerabilities all institutions face to cyber crime and hacking during her plenary presentation. With smartphones and laptops in the hands of every student and faculty member, colleges and universities are among the most susceptible to a data breach. Payton urged administrators to review their IT security policies, to ask how institutions would respond to losing intellectual property, and to put protection policies and risk-mitigation plans in place as soon as possible.
• Students are Gathering Online, Not On the Quad: We have all seen how social media has revolutionized our lives, both personally and professionally. This transformation, as you might expect, is being led by young people—the students of today and tomorrow. Michael Pursell, an associate vice president at ARAMARK, shared some revealing statistics during his SACUBO presentation: Americans are now spending an average of 441 minutes each month on Facebook’s mobile app; and 46 percent of people on Facebook are students. Pursell stressed the importance for higher education institutions to service their current students effectively in the social media space and to market to future students online. That’s where conversations are happening, reputations are being formed and important decisions are being made—and if institutions ignore the trend, they’re bound to be left behind.
• These are Challenging Times—But There are ‘No Excuses’: Without a doubt, the most inspiring session of this year’s conference was the keynote address by Kyle Maynard. Kyle was born with a rare condition known as congenital amputation, which left him without complete arms or legs. But with uncanny determination, he has become a record-setting weightlifter, champion wrestler, martial artist and, recently, “the first man to crawl on his own to the summit of Mt. Kilimanjaro.” Sharing his extraordinary story, Kyle told all of us that there are no excuses, that no obstacles are insurmountable. As we had each sat through session after session about the immense difficulties that lay ahead for higher education institutions, Kyle’s speech reminded us that any of these challenges can be overcome.

What was your favorite moment of this year’s SACUBO conference? Leave us a note in the Comments section below—and we hope to see you in San Antonio next year!

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The IRS took a closer examination of 34 selected schools. Upon completion of the examinations, the IRS issued its final report which focuses on two main areas:  underreporting of unrelated business taxable income (UBTI) and compensation practices of the selected organizations. Although the focus of the project was colleges and universities, the conclusions of the report are clearly not limited to these institutions. In fact, the IRS Workplan also contains projects to review the compensation practices and the unrelated business income of organizations where a large amount of gross unrelated business income has been reported on the Form 990, but no unrelated business income tax is due.

Below are the key findings of the IRS’ CUCP Final Report:

Unrelated Business Taxable Income (UBTI):

Underreporting of UBTI resulted in an increase in UBTI for the schools totaling approximately $90 million in the aggregate and disallowance of more than $170 million in losses and net operating losses (NOLs) due to:

• Disallowing expenses that were not connected to unrelated business activities because either consistent losses from the activities pointed to a lack of profit motive, which is a fundamental requirement for an activity to constitute a trade or business. If there is no trade or business, then the activity does not rise to the level of being an unrelated trade or business.
• Improper expense allocations, including where expenses for related activities were used to offset unrelated income or where an allocation of overhead to unrelated activities was unreasonable.
• Errors in computations or substantiation of NOLs.
• Misclassification of an activity as exempt when it was really unrelated.

The main areas that the IRS looked at for UBTI was fitness and recreation centers, sports camps, arenas, golf courses, and advertising and facility rentals – two sources of revenue that are more common to other exempt organizations. For organizations that engage in these activities, documentation is essential and a UBIT study could go a long way to ensure proper reporting before the IRS knocks on the door.

Executive Compensation:

Compensation of the most highly paid executives and staff was also under the microscope, especially coaches, investment managers, faculty and other administrators.

In the compensation area, organizations such as colleges and universities cannot pay more than reasonable compensation to individuals who can substantially influence the organization or the Intermediate Sanctions provisions could apply (IRC 4958). Organizations can establish the “rebuttable presumption of reasonableness” that shifts the burden of proof to the IRS to prove that compensation is unreasonable. In order to establish the rebuttable presumption, an authorized independent body must approve compensation decisions based on appropriate comparability data and contemporaneously document the compensation-setting process. The CUCP Final Report indicates that although most of the private institutions attempted to establish the rebuttable presumption, the comparability data fell short of what was required as a result of the following:

• Schools were not similarly situated based on factors such as location, size of endowment, revenue, total net assets or number of students.
• Compensation studies did not document the selection criteria for the schools compared or why the schools were deemed comparable.
• The compensation studies relied upon did not specify whether the compensation amounts included benefits other than salaries, which must be taken into account for purposes of IRC 4958.

So it sounds like some compensation studies may be deficient.

The IRS also reviewed employment taxes and retirement plans of the colleges and universities. As a result of the project, there were wage adjustments totaling approximately $36 million and resulting taxes and penalties of $7 million. Also, with regard to retirement plan adjustments, there were increases in wages of more than $1 million and the assessment of more than $200,000 in taxes and penalties.

Coming at the heels of the CUCP Final Report, the Subcommittee on Oversight of the Committee on Ways and Means announced that they will be holding a hearing on May 8^th to explore the root of the report’s findings and examine the causes for the widespread noncompliance. Check back for additional posts on the outcomes of the Ways and Means hearing.

If you have a comment or question about the CUCP Final Report, please comment below or send me an email at lkalick@bdo.com.

However, in light of the pressures that are mounting in the sector, nonprofits are doing what they can to mitigate risks that could come out of these trying times. One way organizations are bracing themselves for change is by focusing more on their audit committees. While audit committees can appear as a mere formality dictated by reporting bodies, an effective committee can be of significant help to boards of directors.

The current climate has shifted the focal point for governing bodies from just overseeing operations to assessing strategies and risk management processes, understanding the complexity of operations, and being prepared to handle any crisis – big or small – that might arise. Both established and emerging organizations have a great need for independent oversight to ensure reliable financial reporting, reducing risk, and maintaining donor and public confidence. Below are the top three reasons why every nonprofit should consider forming an audit committee:

1. Compliance – While the IRS asks on the Form 990 whether the organization has an audit committee, it is noted as a best practice, not a requirement. However, many states do require an organization have a committee if the organization solicits charitable deductions. By not having an audit committee, current and potential funders may wonder why the organization is shying away from an IRS best practice.
2. Risk Management – Financial debacles and alleged fraudulent activities can easily go viral, and many have resulted in devastating financial losses to nonprofit organizations. With proper oversight, an audit committee can exercise vigilance and help foresee and mitigate possible risks that could be detrimental to an organization’s balance sheet as well as their reputation.
3. Public Perception – As donors look to “invest” in the greater good, many are looking for organizations that have sound operational and financial structures. Nonprofits that have solid governance structures and practices, including an audit committee, are often looked upon more favorably than those that do not.

Establishing and maintaining an effective audit committee takes time and requires proper planning and oversight from management and the board of directors. The best audit committee members are those that set the appropriate “tone at the top” by focusing on ensuring the organization acts in accordance with the best interests of its stakeholders. Fundamentally, this can only occur in environments where in-depth knowledge, integrity and an unbiased perspective pervade and are brought to bear at the board and audit committee, senior management and leadership levels. For more on selecting the best members for an effective audit committee, read Laurie Arena Rocha’s article, “Who Makes the Best Nonprofit Audit Committee Member?”

Whether an organization is just starting out or is more established, financial reporting and oversight best practices are instrumental to overall success. Building and maintaining an effective audit committee is just one of the many ways nonprofits can prepare to meet the challenges that lie ahead.

To learn more about establishing your committee, visit our microsite, “Effective Audit Committees for Nonprofit Organizations.” You can also watch an in-depth webinar and listen to a podcast on the subject by clicking here.

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IRC Section 501(r) sets forth certain requirements for tax-exempt hospitals that are now required to “justify” their tax-exempt status. Recently, the IRS has proposed two sets of regulations on financial assistance, billing and collection actions, charges policies, community health needs assessments (CHNA) and the consequences of noncompliance. The new rules and regulations apply to all US 501(c)(3) hospitals including government hospitals that have 501(c)(3) status. In addition, a hospital that is operated through a disregarded entity such as a limited liability company is also subject to the rules.

The proposed regulations will significantly increase the level of specificity and the amount of requirements that a hospital must follow in order to remain compliant. Among the proposed changes, hospital executives can expect more clarity around compliance-related topics such as community health needs assessments (CHNAs), implementation strategy deadlines, financial assistance policies (FAP) and what constitutes an extraordinary collection action.

Here are a few key takeaways from the recently proposed regulations:

• Omissions and errors, if minor, inadvertent and due to reasonable cause, can be excused if disclosed and corrected promptly and in accordance with future IRS guidance.

• Facts and circumstances — size, scope, nature and significance of any failure to meet 501(r) requirements — will be considered by the IRS prior to revocation of 501(c)(3) status.

• Taxation of noncompliant hospital facilities will occur through taxing their gross income derived from that hospital during the taxable year, less deductions allowed by chapter 1 of the Code.

• A facility-level tax imposed as a direct result of failure to comply with Section 501(r) will not, in and of itself, have an adverse impact on the hospital’s tax exempt bonds.  But a hospital should continue to be diligent here because the bond covenants may be of concern.

The Financial Assistance Policy (FAP)

IRC 501(c)(3) hospitals must have a financial assistance policy (FAP) that includes guidelines on who is eligible for assistance, how to apply, how those eligible will be charged and what the billing and collection policies are for those eligible.

The proposed regulations make it very clear that the FAP must be widely publicized in a way that allows it to reach those who might need it the most. Publicity includes distributing written communication in “plain” language, informing public agencies and nonprofit referral organizations and posting it clearly throughout the hospital and online.

• Persons who are eligible for the FAP cannot be charged more than the amounts generally billed (AGB) to individuals who have insurance. The proposed regulations provide that to determine the AGB, hospitals must use one of two methods – the look-back or prospective Medicare method.

• Reasonable efforts should be made to notify patients of their FAP-eligibility in a pre-determined length of time before the hospital can engage in extraordinary collections including civil action suits, liens on property, reporting to credit agencies, wage garnishment, bank account seizures, etc.

These are just some of the very explicit rules.  Under new law, tax-exempt hospitals are being reviewed every three years as a means to regulate and evaluate their level of compliance based on many areas including those outlined in this post.  As a result, hospital executives should take the necessary steps to review key policies, evaluate whether they are actively addressing proposed regulations and effectively communicate the policies to hospital leaders, personnel and patients.

To read more about 501(r) provisions and the proposed regulations, read Laura’s extended article in the BDO Knows Healthcare Newsletter – Spring 2013 issue or visit the IRS website. If you have specific questions regarding these new regulations, include them in the comment section below or email me at lkalick@bdo.com.

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As we have discussed on this blog before, politicians on both sides of the aisle are considering whether the tax deduction for charitable donations should be limited or even eliminated. With the nation’s financial challenges, they reason, we cannot continue to give tax breaks to the wealthy for charitable giving.

The charitable sector has responded forcefully, pointing out that it is faced with severe challenges of its own: donations are down, while demand for services is up; and financial investments have not fully recovered. Any reduction in the incentive for charitable giving, they say, will have catastrophic consequences.

All of this discussion begs the question: Where did the idea of a charitable tax deduction come from, and how did it become so deeply entrenched in tax policy?

THE PAST

While tax exemptions go at least as far back as ancient Egypt, the modern concept of charity finds its roots in 16^th-century England. Concerned that social upheaval was imminent after a series of agricultural crises and a corresponding migration of the poor from rural to urban areas, Queen Elizabeth I helped to shepherd the Charitable Uses Act and the Elizabethan Poor Law, which were designed to promote and encourage philanthropy amongst the country’s aristocracy and burgeoning merchant classes. The measures identified deserving individuals, including widows, orphans, wounded veterans and the disabled. Those able to work were employed, while the “impotent” would be cared for in poorhouses. Idles, drunkards and vagrants were treated as criminals.

In early America, relief for the poor largely followed the English model until the Sixteenth Amendment was ratified in 1913, permitting the federal government to levy an income tax. The Income Tax Act was passed that October, providing a notable exception for any corporation “organized and operated exclusively for religious, charitable, . . . or educational purposes, no part of the net income of which inures to the benefit of any private stockholder or individual,” words familiar to everyone who works with charitable organizations.

In 1917, Congress turned its attention to charitable donors. The War Revenue Act provided that taxpayers could deduct, limited to 15 percent of taxable net income, gifts and contributions to organizations operated exclusively for religious, charitable or educational purposes. This early concept is still a fundamental one: a person shouldn’t be taxed on money they give away to charity.

The deduction has been adjusted frequently over the years. By 1974, the ceiling for donations to most public charities was set at 50 percent of adjusted gross income (AGI), considerably higher than the original ceiling of 15 percent. In the early 1980′s, Congress experimented with allowing “nonitemizers,” persons who take the standard deduction instead of itemized deductions, to deduct charitable donations from gross income “above-the-line.” In 1993, the written substantiation requirements were refined, requiring a written acknowledgement for any gift over $250 and a written disclosure from the charity of a quid pro quo provided in return for a donation of $75 or more.

THE PRESENT

After nearly 100 years in effect, why has the charitable donation deduction suddenly become controversial?

Imagine three individuals, each of whom writes a check for $100 to the Save the Whales Foundation, a 501(c)(3) organization.

Mrs. Fishtown’s donation truly costs her $100, because there would be no tax consequences if she pocketed the $100. If Mr. Bellevue pocketed the $100, however, he would owe an additional $40 in tax. Effectively, his $100 donation only costs him $60, with the other $40 coming at the expense of the U.S. Treasury. Itemized deductions have a regressive effect on tax rates, conferring a greater benefit on the wealthy than on the poor.

The primary argument for maintaining the status quo is that income that is given away to charity shouldn’t be taxed. Furthermore, the deduction may encourage philanthropy. A survey conducted in 2010 by Indiana University concluded that 66 percent of wealthy donors were likely to give less to charity if the tax deduction were eliminated. Charitable donations may benefit wealthy donors, but they primarily benefit society by reducing income inequality and providing an efficient means for wealth to be transferred from the rich to the poor.

One rationale for allowing tax exemption for charities is that their activities reduce the burdens on government. If the charitable sector did not exist, feeding the hungry and sheltering the homeless would be the responsibility of the government. If the activities of charities reduce the expenditures of the government, it is logical that the government has less need of the corresponding revenue. Critics of the deduction seem to imply that the charities can bear the expense while the government should still collect the revenue.

Finally, the deduction permits donors to direct their resources in ways that reflect their own priorities and values. For example, if Mr. Bellevue wants to save the whales, but Mr. Maplewood wants to feed the hungry, each is able to make an individual choice and direct the funds as he sees fit.

Critics argue that in a constitutional republic the people elect representatives to make decisions for them. If Mr. Bellevue’s candidate runs on a platform to save the whales, and Mr. Maplewood’s candidate runs on a platform to feed the hungry, then the winning candidate has the right to collect the tax revenue and expend it on his promised endeavor. A freely elected government should be empowered to direct the funds, not each individual.

According to a recent report by the Joint Committee on Taxation (JCT), over $217 billion was donated to charities by individuals in 2011 and it appears that those deductions disproportionately benefit the wealthy. For example, late last year, the Wall Street Journal reported that only 13.5 percent of tax returns report AGI over $100,000, yet such returns claim 81 percent of the charitable deduction. Only 3 percent of tax returns report AGI over $200,000, yet such returns claim 55 percent of the charitable deductions.

Critics point out that charitable giving has remained stable at approximately 2 percent of GDP, regardless of changes to the tax incentive. Donors are generous when the economy flourishes, and they cut back during times of uncertainty, without regard to the tax consequences. Additionally, donors have motives for charitable activity apart from the tax consequences: a person who is committed to giving 10 percent of her income to her church or to underwrite a play at the local theater is not likely to change her behavior, even if the deduction is eliminated entirely. Indeed, charitable donations made primarily for tax purposes may be of dubious merit.

Various solutions are being proposed, including the complete elimination of the deduction. The JCT report mentioned above claimed that individuals give to charity partly because they receive a personal  benefit or ‘warm glow’ from helping others and that under a comprehensive income tax system, there is no rationale for allowing deduction of these contributions, at least to the extent they provide a personal benefit. Such a position would directly contravene the notion that income given away to charity should not be taxed.

Some proposed limits are designed to make the deduction less beneficial to the wealthy, including a lower AGI limitation, a floor under which charitable donations would not be deductible or a cap on the value of the benefit that would limit the tax benefit of the deduction to 28 percent of its value even if the taxpayer is in a higher bracket.

Other proposed changes are meant to increase the benefit to middle- and lower income taxpayers, including an idea that was tried in the 1980′s: allowing an above-the-line deduction for charitable donations so nonitemizers could receive a tax benefit for charitable giving. Other suggestions include reducing the paperwork and record-keeping for small donations by allowing employees to donate through payroll deductions reported on Form W-2, and allowing donations through April 15 to be deducted on the prior year’s return. One proposal would create a non-refundable tax credit of up to 12 percent of AGI, which would simultaneously limit the benefit to the wealthy and increase the potential benefit to everyone else.

THE FUTURE

While not limiting the deduction for charitable donations directly, The American Taxpayer Relief Act of 2012 re-instituted the “Pease Limitation,” which raises revenue by limiting some common itemized deductions among high-income taxpayers. Named after Representative Don Pease, a Democrat from Ohio who served eight terms, the limitation was first imposed in the Omnibus Budget Reconciliation Act of 1990. It was phased out as part of the Bush-era tax cuts. As currently implemented, the limitation applies to charitable contributions, mortgage interest, state taxes, property taxes, and miscellaneous deductions. The limitation isn’t applied to medical expense deductions, the investment interest deduction, casualty, theft or gambling loss deductions. Most of these exempted deductions are less common or they are difficult to qualify for, due to high AGI hurdles. For example, qualified medical expenses are only deductible to the extent they exceed 10 percent of an individual’s AGI.

The Pease Limitation affects individual taxpayers with AGI of $250,000 or more, and married taxpayers filing jointly with AGI of $300,000 or more. Once the threshold has been crossed, the affected itemized deductions are reduced by 3 percent of the amount that the taxpayer’s AGI exceeds the threshold, but the taxpayer’s itemized deductions will not be reduced by more than 80 percent.

Returning to the example of Mr. Bellevue, his AGI of $19,000,000 exceeds the threshold by $18,750,000. The limitation on his $100 charitable donation is the lesser of $562,500 (3 percent of 18,750,000) or $80 (80 percent of 100). Since his charitable donation is limited by $80, he can only deduct $20. At a federal income tax rate of approximately 40 percent, his $100 donation now reduces his tax burden by only $8, a $32 tax increase over the $40 in tax savings he would have enjoyed without the limitation. This violates the fundamental principle that income given away to charity should not be taxed, because income tax is being imposed on $80 of the $100 charitable donation. Note that Mr. Maplewood and Mrs. Fishtown have not been affected.

Besides reviving the Pease Limitation, The American Taxpayer Relief Act also raised the top marginal rate from 35 percent to 39.6 percent. Some analysts have concluded that this increased incentive for charitable giving will offset the Pease Limitation. So what effect might it have on Mr. Bellevue?

In 2012, Mr. Bellevue’s marginal tax rate was 35 percent, so his $100 donation cost him $65. Mr. Bellevue is content to see his personal fortune reduced by $65 each year, knowing that he is preserving the whales for the enjoyment of future generations. In 2013, Mr. Bellevue’s marginal tax rate is 39.6 percent, so he anticipates that the donation will cost him about $60. However, because of the Pease Limitation, the donation actually costs him $92. Mr. Bellevue is not pleased, because his $100 donation has cost him $27 more in 2013 than it did in 2012. Although very fond of whales, Mr. Bellevue decides that a $65 sacrifice on his part is adequate, and decides he will adjust his donation to the Save the Whales Foundation so that his after tax consequences in 2014 are the same as they were in 2012. As a result, in 2014 he will only write a check for $71. The limitation on his $71 charitable donation will be $57 (80 percent of 71), allowing him to only deduct $14. At a federal income tax rate of 39.6 percent, his $71 donation now reduces his tax burden by $6, so he experiences an after-tax cost of $65.

The above examples assume that Mr. Bellevue’s other itemized deductions do not exceed $703,125. If they do, the limitation on itemized deductions would already be met. Since 3 percent of 18,750,000 is $562,500, and 80 percent of $703,125 is also $562,500, and the limitation is the lower of the two calculations, the limitation will not increase even if the itemized deductions are higher than $703,125. That means Mr. Bellevue’s additional $100 donation to Save the Whales will not be limited. It will cost him $60 after taxes in 2013, even lower than the $65 it cost him in 2012.

The charitable donation deduction encourages an otherwise selfless act. Most other deductions generally reward spending that benefits the taxpayer (mortgage interest, property taxes, medical expenses, miscellaneous expenses) or offset other payments that the taxpayer must make, e.g. state taxes. Congress has been promising–some might say threatening–a major overhaul of the tax code for some time. If nothing else, the debate surrounding the charitable donation deduction and the re-institution of the Pease Limitation indicate a willingness on the part of lawmakers to diminish the tax benefits of charitable giving. Congress and the President now seem willing to consider whether a simpler tax system with transparent progressive rates should at least consider eliminating deductions of all kinds, even the one for generosity.

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With scores of recent high-profile scandals gripping the nonprofit community—think allegations of misappropriated funds and worries over how small charities could effectively manage and disburse record donations following Hurricane Sandy—investigative due diligence has become more important than ever for nonprofit organizations.

Investigative due diligence is an essential process for nonprofits concerned about the unknown scope of a potential investment or business relationship. By conducting due diligence on the individuals or entities with which you do business, a nonprofit can expose and mitigate hidden risks.

For nonprofits, investigations should focus on two areas and remain both proactive and reactive:

• Employees and volunteers. The people who are the face of your organization need to promote the ideals of your mission. Yet sometimes individuals are hired that do not meet those requirements. Proactive due diligence is critical in all hiring decisions made by nonprofits. From background checks on employees to the vetting of potential board members, due diligence investigations can uncover any potential red flags before they impact your organization. Beyond employees, volunteers, who often serve on the front lines of your organization, should also be subjected to background checks. While a basic background check on entry-level volunteers and employees will suffice, deeper investigations into individuals involved in handling money or publicly promoting your organization should be considered at the time of hire.
• Financial due diligence. Every nonprofit should immediately begin an investigation if there is fear of misappropriation of funds. Whether it is a board member taking a cut of the fundraising or working with a third-party that has recently come under the microscope, it is important to investigate and remain transparent before an issue is made public. While the misrepresentations or omissions might raise red flags and spark an investigation, proactively researching board members and senior leadership’s business associations can uncover fraudulent transactions or troubling relationships before they become a financial or reputational risk.

Reputational risk presents its own set of challenges for nonprofits. When third-party funding and government grants rely on a mix of business acumen and commitment to your nonprofit’s mission; bad press about a financial scandal or previous internal issues can hinder your chance to receive critical funding.

Investigative due diligence is both a proactive and reactive tool. The most highly regarded nonprofits deploy investigations to protect themselves and also uncover potential wrong doing within their organizations. If the latest news about nonprofit scandals has taught us anything, it is that understanding who is working for your organization and how the funds you raise are being used is extremely important for public perception, future fundraising and your overall mission.

Tim Mohr is a partner at BDO Consulting, where he leads the firm’s Investigative Due Diligence practice.

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