Advising Nonprofit Organizations
The CPA’s Role in Governance, Accountability, and Transparency

By Claudia L. Kelley and Susan Anderson

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AUGUST 2006 - The nonprofit sector plays a major role in the U.S. economy, encompassing, according to an April 2005 statement by IRS Commissioner Mark Everson before the Senate Finance Committee, more than 1.8 million organizations, with assets totaling $2.5 trillion and revenues of $1.25 trillion. The importance of nonprofits has become especially evident in the relief efforts for victims of Hurricane Katrina in 2005 and the Asian tsunami of 2004. Federal, state, and local governments increasingly rely upon nonprofits’ services after natural and manmade disasters. Nonprofit organizations (NPO) must maintain the public’s confidence in order to raise the funds necessary to fulfill their missions.

Unfortunately, many NPOs have been found to engage in financial improprieties. Highly regarded organizations—including the United Way of America, the Nature Conservancy, and Adelphi University—improperly diverted funds to insiders. The Red Cross was criticized for diverting donations specified for victims and victims’ families of the September 11, 2001, terrorist attacks to other uses. When NPOs are perceived as acting irresponsibly, the public can quickly feel that its trust has been violated. Reports of unsavory behavior in one NPO can cause a decline in giving to other charities. In response to these problems, stakeholders of charitable organizations are demanding more accountability and transparency.

The Senate Finance Committee is considering tax-exempt reform containing provisions similar to those found in the Sarbanes-Oxley Act (SOX). The Panel on the Nonprofit Sector, an independent group of NPO leaders convened by the Independent Sector (, a nonpartisan leadership forum for charities, foundations, and corporate-giving programs, recommended more than 120 separate actions to strengthen accountability and governance. State attorneys general are pursuing allegations of abuse in the nonprofit sector more vigorously. California enacted the Nonprofit Integrity Act of 2004, which applies provisions similar to SOX to nonprofits. New Hampshire passed a law requiring charities with annual revenues greater than $1 million to have audited financial statements. Massachusetts and New York are considering similar requirements.

The demand for greater NPO accountability provides opportunities for CPAs. As reported in Association Management (April 2004), 77% of the participants at the AICPA’s first National Consensus Conference on Nonprofit Governance strongly agreed that the nonprofit community must act to affirm its integrity to members, donors, the government, and the public. CPAs, in their roles as NPO employees, volunteers, directors, auditors, and advisors, can provide help to improve NPO governance and transparency. This article describes weaknesses in a nonprofit’s operations and policies. By identifying these potential problems, CPAs can help NPOs improve organizational effectiveness.

Board Responsibility

The well-publicized scandals and increasing government scrutiny demonstrate the need for due care on the part of NPO board members and senior managers. Nonprofit directors and officers have three fiduciary duties under current law: the duty of care, the duty of loyalty, and the duty of obedience. If directors do not exercise these duties, they may be personally liable for their actions.

The duty of care requires that directors be informed and act in good faith. This duty addresses the manner in which the directors exercise their responsibilities, rather than the correctness of a decision. The duty of care requires that directors be informed, attend board meetings, and have access to organizational data.

The duty of loyalty requires directors to exercise their powers in the best interest of the organization rather than in their own or anyone else’s interest. Avoiding conflicts of interest, in appearance or in fact, is a prime element of this duty. Directors are prohibited from self-dealing unless there is full disclosure to the board and the transaction is clearly in the organization’s best interests. To prevent the appearance of a conflict of interest, directors and officers should avoid all self-dealing activities.

The duty of obedience requires that directors adhere to the organization’s mission. The directors’ decisions and oversight must be in accordance with, and in furtherance of, the organization’s mission.
CPAs can assist NPOs by reviewing board members’ activities. Exhibit 1 contains a checklist of issues involving directors. These questions assist CPAs in identifying areas to improve board effectiveness and reduce liability exposure.

Organization. CPAs advising nonprofits must understand the requirements for obtaining tax-exempt status. NPOs must be organized and operated for an exempt purpose described in IRC section 501(c), and this purpose must be stated in the organization’s articles of incorporation. If an NPO is to receive tax-deductible contributions, it must be organized and operated for religious, charitable, scientific, safety, literacy, or educational purposes, or to prevent cruelty to children or animals. To qualify as a charitable organization, entities other than churches must file Form 1023 with the IRS. Other NPOs must submit Form 1024.

Exhibit 2 contains questions pertaining to an NPO’s formation, several of which address state law. While the IRC governs the tax status of nonprofit entities, their formation and operations are regulated by the states and generally enforced by the state attorney general.

Operations. Exempt organizations must adhere to several restrictions to maintain their exempt status. In 2004, the IRS revoked the status of 379 organizations as public charities (Announcement 2004-103), demonstrating the importance of continually monitoring an exempt organization’s activities. Compensation, political activities, and fundraising are particularly complex areas.

Compensation. Most NPOs are subject to the prohibition against private inurement, meaning that no part of the net earnings unduly benefits a private shareholder or individual [Treasury Regulations section 1.501(c)(3)-1(c)(2)]. The IRS can revoke an organization’s tax-exempt status if its assets are used in a manner that benefits insiders [Treasury Regulations section 1.501(a)-1(c)]. Inurement can include unreasonable compensation, non–arm’s-length financial transactions, below–market-interest-rate loans, and certain joint ventures with for-profit entities.

NPOs must exercise care in transactions with a director, officer, substantial donor, or anyone in a position to exercise significant influence over its affairs. The IRC assesses excise taxes on excess-benefit transactions in which the economic benefit an organization provides is greater than the value of the consideration (including services) it receives. A 25% tax is levied on the recipient of the excess benefit, as well as on the organization’s managers who knowingly participate in the excess-benefit transaction (IRC section 4958). Unreasonable compensation is one type of excess benefit; however, if rebuttable presumption rules in the regulations are met, then the compensation is presumed to be reasonable. The regulations also describe a rebuttable presumption for property transactions.
Exhibit 3 contains questions that CPAs should consider to ensure that an organization is not in danger of engaging in inurement or an excess-benefit transaction.

Lobbying and political activities. Section 501(c)(3) charities may not engage in any political campaign on behalf of (or in opposition to) any candidate for public office. This is an absolute prohibition. The IRS may revoke the organization’s exempt status if any amount of political activity is conducted. Charities must also take care in trying to influence public opinion or legislation, because no substantial part of an NPO’s activities may be lobbying [IRC section 501(c)(3)]. Because the law does not define this “no substantial part test,” charities may choose to make a lobbying election under IRC section 501(h), which provides an objective test for determining permissible amounts of lobbying expenditures.

Leaders of charitable organizations cannot make partisan comments in the organization’s publications or at its functions. Political candidates can speak at charitable events, but the organization must meet the requirements of IRS News Release 2004-79. An organization that is exempt under section 501(c)(4), (5), or (6) can advocate a position on a policy, but it is subject to a tax on expenditures related to the election or appointment of a public official. Revenue Ruling 2004-6 provides additional details regarding these activities.

According to the Bipartisan Campaign Reform Act of 2002, section 501(c) organizations are not permitted to solicit “soft money” on behalf of, or to contribute soft money directly to, NPOs that make expenditures in connection with a federal election. NPOs engaged in issue advocacy and political campaign activity may be subject to both IRS and Federal Election Commission (FEC) rules. Organizations such as the Alliance for Justice and OMB Watch are available to help NPOs navigate through the rules of both statutes. Exhibit 4 lists questions that CPAs should ask regarding an exempt organization’s political and lobbying activities.

Fundraising and solicitation. Most states require registration of charitable soliciting organizations and paid fundraisers. CPAs can check the website for their state’s secretary of state to obtain the exact requirements. The National Association of State Charities ( and the National Association of Attorneys General ( have developed a unified registration statement in an effort to consolidate the information and data requirements of all states that require registration of nonprofit organizations soliciting charitable contributions. Many states now accept the unified registration statement rather than their own state form. (Exhibit 5 presents relevant questions about fundraising and solicitation.)

Unrelated-business income tax (UBIT). NPOs often attempt to raise money through means other than contributions. Tax-exempt organizations earning income from a trade or business that is regularly carried on, but is not substantially related to the organization’s exempt purpose, are subject to UBIT (IRC section 511). For example, a church that sells clothing bearing its name has unrelated business income, as do NPOs that receive advertising revenue from their websites. IRC section 513 provides for exemptions from UBIT of several types of income, including rent and royalties.

Disclosure of financial information. All section 501(c) organizations, except private foundations, churches, and government-related organizations, must provide copies of their annual information returns (Form 990) and exemption applications upon request [IRC section 6104(d); Treasury Decision 8818, 4/9/99]. The organization is excused from providing copies for documents that are posted online. Contributors’ names and addresses are not required to be disclosed. Penalties for failure to follow the disclosure rules apply to the person responsible rather than the organization. (Exhibit 6 is a checklist of questions on disclosure, internal controls, and tax requirements.)


Numerous resources are available to help CPAs learn more about issues facing NPOs. The AICPA has developed an Audit Committee Nonprofit Organization Toolkit (available for free download at; see The CPA Journal Book Review, February 2006) containing detailed guidance on 20 topics pertinent to NPOs. Subjects addressed include an audit committee charter matrix and self-evaluation, defining and obtaining financial expertise for audit committee members, fraud, internal control, hiring external experts, hiring independent auditors, evaluating the internal audit team, and independence.

The New York State Attorney General’s office has extensive information for charities on its website (, including a publication providing guidance for board members titled “Right from the Start:

Responsibilities of Directors and Officers of Not-for-Profit Organizations.” Exhibit 7 lists other websites that provide useful information for NPOs.

CPAs are in a position to help restore the public’s trust in NPOs and thereby enable the continued vitality of these socially desirable entities. They can assist NPOs in establishing strong oversight, governance policies and procedures, fiscal responsibility, and accountability. Whether as a director, employee, independent accountant, or volunteer, the CPA’s expertise is in demand.

Claudia L. Kelley, PhD, CPA, is a professor of accounting at Appalachian State University, Boone, N.C.
Susan Anderson, PhD, CPA, is an associate professor in the department of accounting at North Carolina A&T State University, Greensboro, N.C.

Note: The checklists in this article are intended as useful starting points for discussions on NPO governance. Because nonprofits differ widely, not all items in each checklist apply to every organization.

For more of this month's Special Focus on Nonprofit Management, see "Functional Expense Reporting for Nonprofits"





















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