1. Taming the Legal Lion: Critical
Compliance Issues For Smart
Nonprofits
Texas Nonprofit Summit
September 2012
Frances Leos Martinez, Texas C-BAR

2. Purpose of Training
• Identify potential issues to avoid liability or loss of tax exempt
status
• Address strategies to handle these issues
• Discuss basic laws applicable to nonprofits

3. What’s Our Potential for Risk?
• Our assets
• Our activities
• Who could be liable
• To whom could we be liable

4. Critical Areas
• Legal Compliance
• Human Resources
• Insurance Protection

5. Legal Compliance

6. Board Governance
• An active, attentive
board may be the most
important way to avoid
major threats to an
organization. Board
members should have
a wide range of skills
and perform duties.
• Board members are
legally responsible for
the management of
the affairs of the
organization.

7. Fiduciary Duties of Board of
Directors
• Duty of Care
• Duty of Loyalty
• Duty of Obedience

8. Duty of Care
• Good faith
• Ordinary care
• Best interest of the corporation

9. Duty of Loyalty
• Undivided allegiance to the corporation and its
mission
• Conflict of Interest
• Corporate opportunity
• Confidentiality

10. Duty of Obedience
• Mission and purposes of the corporation
• State and federal laws
• Governing documents
• Implementing donor restrictions
• Appropriate using of charitable assets
• Compliance with laws and regulations imposed
on tax-exempt non-profit corporations

11. Excess Benefits
• Paying someone for
personal benefits in
excess of the value of
services they give to
the organization.
• 25% tax on excess
benefits and return
excess payment.
• 200% tax if excess
returned too slowly.

12. Reasonable Compensation
• Approval by authorized body
• Independent persons
• Comparisons to other organizations
• Documentation of process

13. Board Liability for Excess Benefits
• Decision makers who permit the excess benefits payments
must pay 10% tax on excess benefits.
• Decision maker includes a person who by her silence allows
excess benefits to be paid to a person.

14. Personal Liability of Board
Members
• Loans to directors;
• Excess benefits/private inurement;
• Employment taxes;
• Distribution of assets if insolvent; and
• Actions not taken in good faith, with ordinary care, or in the
best interests of the organization. 22.235

15. Protections for Board Members
Follow Basic Governance Practices
Maintain Engaged Officers and Directors
Conduct Meetings Properly
Know How and When to Take Action Without a
Meeting
Adopt Corporate Resolutions When Necessary

16. Protections for Board Members
• If the director relied in good faith and with
ordinary care on information supplied by others
including:
• Officers and employees;
• Accountants;
• Attorneys (22.228);
• Investment bankers;
• Persons reasonably believed to have professional
expertise; and
• Duly authorized board committees acting within the
scope of their authority of which the director is not a
member.

17. Protections for Board Members
• BUT-a director cannot rely on this information if the director has
knowledge of a matter that makes the reliance unwarranted.
• A director who dissents to an action must have the dissent
entered into the minutes of the meeting or send a written dissent
to the organization. Sec. 22.226

18. Financial Practices

19. Build a Strong Foundation for Financial
Oversight
• Organizations that sell merchandise should take periodic
inventories.
• Establish internal controls for cash and deposits.
• Adopt a gift acceptance policy.
• Document all donations at the time they are received.
• Establish policies for in-kind donations and
acknowledgements.
• Budget fundraising expenses.

20. REMEMBER!
• It is the opportunity that gives rise to fraud.
• Do not become lax because you trust the person in charge of
finances.
• Conduct surprise audits.
• Reward employee reporting.
• Have a hotline for whistleblowers.
• Monitor lifestyle changes-don’t ignore the Mercedes and the
boat.

21. Red Flags
• Financial information is incomplete or confusing
• The management letter notes serious areas of improvement or is
not included with the audit report
• The board does not know the agencies overall budget without
looking it up
• The organization claims goodwill as an income item
• The budget does not match past actual expenditures
• There is not two month’s operating capital of reserves
• There is not mandatory vacations for employees performing key
control functions

22. Notification
• Notify the Attorney General if the nonprofit faces
possible financial mismanagement issues.
• Notify funders
• Notify insurance carriers

23. Written Policies
Nonprofits should adopt written policies addressing key danger
zones:
• Conflict of Interest
• Expense Reimbursement
• Executive Compensation
• Board reimbursement
• Whistleblower
• Document Retention
• Public Availability of Documents

24. Conflicts of Interest
• Have a conflicts of interest policy.
• Disclose material facts.
• Obtain more than one bid for an interested director
transactions.
• Interested director should abstain.
• Majority of disinterested directors should approve in good
faith and with ordinary care.
• The policy should be reviewed by each board and staff
member annually.

25. Expense Reimbursement Policy
• Approval by an independent person
• Contemporaneous receipts
• Restrictions on first class travel
• Restrictions on companion travel
• Restrictions on personal services and alcohol

26. Executive Compensation Policy
• Use of comparability data
• Review and approval by independent persons
• Contemporaneous substantiation of the decision and a
description of the process.

27. Board Reimbursement Policy
• Approval by an independent person
• Contemporaneous receipts
• Restrictions on first class travel
• Restrictions on companion travel
• Restrictions on personal services and alcohol
• All expenses should be found necessary for the organization’s
tax exempt purpose.

28. Whistleblower Policy
• Federal law imposes criminal liability against whistleblowers.
• The policy should establish procedures for the communication
of and response to employee complaints regarding any misuse
of the organization’s resources or a violation of the internal
rules of operation.
• No Retaliation

29. Document Retention Policy
• The policies should include guidelines for maintaining, storing
and destroying electronic and paper copies of documents.
• Backup policies also protect the organization in the event of a
computer malfunction.
• Keep in mind existing or potential legal obligations

30. Public Availability of Documents
Policy
• Federal and state law require that certain documents be made
available to the public.
• A written policy helps avoid confusion over these
requirements.
• Failure to comply with these laws may have criminal
consequences.

31. Fiscal Policies
• Financial Reporting to Board of Directors
• Annual Audit
• Annual Budget
• Bank Account Authorized Signatures
• Control Procedures for Cash Receipts
• Donated Goods, Materials, Equipment or other Assets
• Purchasing

32. Employment Risks

33. Personnel/Volunteer Risks
• Hiring;
• Background checks;
• Handbooks;
• Sexual harassment;
• Terminations; and
• Whistleblower issues.

34. Hiring
• Nonprofits should carefully scrutinize new hires.
• Obtain an information release.
• Check references, including former supervisors
not listed as references.
• Background checks may be helpful in a small
percentage of cases.

35. Hiring
• Prepare a written job description, identifying
minimum qualifications including: necessary
education, skills, experience and essential job
functions.
• For staff with financial responsibilities include a job
qualification that the employee obtains a fidelity
bond.

36. Background Checks
• Many nonprofits do not regularly conduct background checks.
• ACFE found that 87% of fraud perpetrators had never before
been convicted of a crime. It is not the new hire, but
someone with an average tenure of 6 years with the
organization.
• When the Family Connections director was hired in 1990, she
was still on parole for two theft convictions in the 1980’s.

37. Key Role Employees
• Make sure someone else understands the person’s job duties.
• Create current job descriptions and how-to lists.
• Prepare regular status reports.
• Mandate vacation or job rotation

38. Records and Computers
• Make sure more than one person knows how to access the
information.
• Keep records in central location and labeled.
• Follow document retention schedules.
• Keep passwords in a secure location.
• Backup computers regularly and keep disk offsite.
• Keep blank checks and bank records in a secure location.

39. Modifying Risk: Hiring
• Prepare a written job description, identifying
minimum qualifications including: necessary
education, skills, experience and essential job
functions.
• Prepare a job advertisement and distribute the ad to
a variety of distributors.
• Develop an application form that includes important
information and avoids questions that raise
discriminatory issues.

40. Modifying Risk: Hiring
• Review applications for minimum qualifications.
• Schedule interviews for best candidates.
• Prepare interview questions to ask of all candidates.
• Use a panel to conduct interviews.
• Obtain an information release.
• Check references.

41. Avoid Claims of Negligent Hiring
• Conduct interviews
• Check references
• Have written job descriptions
• Screen volunteers like employees

42. Best Practices Tip
• Employment decisions should be based on job-
related criteria.

43. True or False?
• An organization is not liable for
sexual harassment committed
by managers as long as it is not
aware of the conduct.
• An organization is not liable for
sexual harassment of an
employee committed by a client
of the company.
• A person cannot make a claim of
sexual harassment against a
person of the same gender.

44. Sexual Harassment
• Unwelcome sexual advances, requests for sexual favors where
submission to the conduct becomes a term or condition of
employment;
• Unwelcome sexual conduct that creates a hostile work
environment;
• Express or implied demands for sexual favors.

45. Establishing an Anti-
Discrimination Program
• Adopt and communicate a policy of no tolerance.
• Train supervisory and non-supervisory employees.
• Adopt grievance procedures.
• Investigate complaints promptly and confidentially.
• Monitor compliance with policies.

46. Why should nonprofits care about
the difference between employees
and independent contractors?
Because penalties for making the wrong determination are
severe. Employers may be liable for past employment taxes and
penalties. Microsoft settled for $97 million for misclassified
workers.

47. Background Checks
• A conviction, by itself, cannot be an absolute bar to
employment.
• However, an employer may consider the relationship between
a conviction and the applicant’s fitness for a particular job.

48. Factors to Consider
• The nature, gravity, and number of the applicant’s criminal
acts;
• The length of time since the convictions; and
• The nature of the job sought.

49. Employment Policies
• Provide to all employees and apply policies
consistently.
• Provides employees with useful and necessary
information.
• Include a disclaimer that the handbook is not a
contract, may be changed at any time, does not
create a property interest in continued
employment.

50. Questions to Ask Before
Termination
• What is the reason for termination?
• How has the employer treated similar situations?
• Is there a policy that adversely impacts a protected
group?
• Is there a procedure in a handbook that governs
terminations?
• Has the employer documented the reasons for
termination at the time the behaviors occurred?

51. All the Wrong Reasons to Fire an
Employee
• Refuses to take a lie detector test
• Is subject to court-ordered garnishment
• Is pregnant
• Is black, a woman, or from a foreign country
• Has AIDS
• Filed a discrimination complaint
• Is a veteran

52. All the Wrong Reasons to Fire an
Employee
• Is called to jury service
• Complies with a subpoena
• Attends a political convention
• Complained about safety rules
• Refused to commit an illegal act
• Joined a union

53. Terminating an Employee Over 40 Years
Old
• Under the OWBPA, if a nonprofit seeks a release of
claims from a terminated employee, the release
must be knowing and voluntary and contain specific
language.
• The release must include:
• a 21-day review period and a seven-day revocation period;
• be understandable; and
• advise that the employee has the right to consult an attorney
prior to signing the release.

54. Safe Termination Procedures
• Document, document, document
• Don’t withhold money owed from final pay
• Obtain written authorization for employment references
• Provide COBRA information

55. Employment References
• Obtain waiver of liability before providing information to
prospective employers.
• Otherwise, give dates of employment and position.
• Good references are not something an employer would
usually get sued for giving.

56. Affordable Health Care Act
• Number of
employees
determines:
• Obligations
• Resources
• Penalties

57. Best Practices Tip
• Be fair and consistent with all employees
• Confine comments to job-related criteria
• Let the employee respond
• Document performance
• Give employee reasonable time to correct
• Follow policies and procedures

58. Main Insurance Issues
• Broad definition of insured.
• Requirement to advance defense costs.
• Broad coverage for employment practices.

59. Common Exclusions
• Intentional acts
• Physical abuse
• Sexual abuse
• Abuse

60. Types of Insurance
• Commercial Liability:
• Protects against negligent wrongful acts causing
personal injury or property damage;
• Pays for legal defense and money damages;
• Need minimum coverage for state cap on liability to
apply.

61. D&O
• Protects against intentional wrongful acts if not illegal or
actions beyond authority;
• Pays for legal defense and reimburses nonprofit for amounts
paid to indemnify directors; and
• Pays directors for amounts not covered by indemnification.

62. Employment Practices Liability
• Protects nonprofits,
directors, and
employees for
employment-related
actions; and
• Pays for legal defense
and damages.

63. Workers’ Compensation Insurance
• Protects nonprofit and provides benefits to workers injured on
the job; and
• Limits recovery.
• If nonprofit doesn’t carry insurance
there is no limit on amount of
damages an injured worker can
recover.

64. Other Important Insurance
• Property
• Automobile
• Special Event

65. Best Practices Tip
• Have the board annually review the nonprofit’s
insurance policies and scope of coverage.

66. Income Generating Activities
• UBIT concerns
• Alliances with for profits
• Role of corporate sponsorships

67. Internet Fundraising
• Most states regulated solicitation by charities.
• 39 states regulate solicitation; 35 states accept a
uniform registration form (URS).
• Requirements vary, but most require:
• Registration required before solicitation begins.
• Annual reporting with an emphasis on fundraising outcomes and practices.
• Disclosure to potential donors about where to find more information or file
complaints.
• Charleston Principles: Organization whose place of business is not
in the State must register if:
• Specifically targets persons physically in state; or
• Receives contribution from individuals in state on a repeated
and ongoing basis or on a substantial basis.

68. Intellectual Property
• Copyright
• Make sure you own what you think you own
• Be careful to understand other’s rights
• Trademark
• Do your research before naming and branding

69. Transportation Risks
• Vehicle safety and
maintenance;
• Screening and supervision of
drivers;
• Licensing requirements/15
person vans; and
• Insurance and accident
reporting.

70. Lobbying and Political Campaigns
There is an absolute prohibition against
endorsement or participation in any political
campaign on behalf of a candidate.

71. Advocacy
• Certain activities will not count as political campaign
activities:
• Inviting a candidate to speak to nonprofit members, as
long as the opposing candidate is invited to speak as
well.
• Organizing nonpartisan voter registration or voter
education drives; and
• Publishing voting records on certain issues as long as
there is no intent to target an election campaign.

72. Lobbying
• Definition of Lobbying:
• Any intent to influence specific legislation in any legislative body
• City council;
• State legislature;
• Congress;
• Administrative agency.

73. Lobbying by the Rules
The IRS has two tests to
measure whether a
nonprofit’s amount of
lobbying is at a
permissible level:
• Substantial Part Test
• 501(h) Expenditure Test

74. 501(h) Election
• A nonprofit can spend resources to influence legislation
without jeopardizing tax-exempt status if:
• It makes a 501(h) election, and
• Expenditure test not exceeded.

75. Exclusions Under 501(h)
• Technical advice to a governmental body in response to a
written communication;
• Nonpartisan analysis that presents all sides of an issue;
• Support or opposition to proposals that would change the
organization’s rights or impact its right to exist;
• Discussions about broad social or economic problems; and
• Informing your members of issues without a call to action.

76. Record Keeping and Filing Requirements

77. Books and Records
• Keep accurate and complete
meeting minutes and resolutions
for board and committees having
board authority.
• Keep records at registered office
or principal place of business.
• On written demand stating the
purpose of the demand, a
member has the right to inspect
and copy the books and records of
an organization relevant to the
purpose. Sec. 22.351

78. Financial Records and Annual
Report
• An organization must maintain current and accurate financial
records in accordance with GAAP.
• The board must annually approve an annual financial report
for the preceding year to conform with the American Institute
of Certified Accountants. Sec. 22.352

79. Public Inspection
• If over $10,000 in outside contributions, an
organization must keep records, books, and annual
reports of the financial activity at the registered or
principal office for at least 3 years.
• The public has a right to inspect these records during
normal business hours. An organization may charge
a reasonable copy fee.
• Failure to do so is a Class B misdemeanor. Sec.
22.354

80. Other Penalties for Failure to
Provide Access
• A member or director may file suit to have access to the books
and records of an organization.
• A court may award attorney’s fees and any other relief to
permit the inspection.
• The Attorney General may inspect at any time to insure that
an organization is operating in accordance with the law and
governing documents of organization.
• Failure to permit inspection by AG may result in termination,
criminal offense, and lien on all property of organization.

81. State Filing Requirements
• SOS: Form 802 every 4 years(22.357).Failure to file
this report can result in forfeiture.
• SOS: Changes to the name, address, registered
agent, and articles of incorporation.
• SOS: Articles of Dissolution.
• Comptroller: Changes to the address and that affect
tax exempt status.
• Comptroller: Sales tax permits.

82. Employment Filings
• Texas New Hire Report
• Employee Status Report: Form C-1
• Workers’ Compensation coverage: notify employee
and TWCC (Insurance Dept)
• Workplace injuries: TDI and OSHA
• Over 4 employees: Form C-3 and election to pay
reimbursements
• Over 15 employees: Drug abuse policy

83. Other State Laws
• Special requirements to hold raffles or obtain a
bingo license.
• Notify the Attorney General if the nonprofit is
involved in a lawsuit.
• Pay property taxes or obtain an exemption.
• Obtain charitable solicitation permits from selected
cities.
• Obtain a sales tax permit and collect taxes.

84. IRS Filing Requirements
• Annual Form 990 (Organizational
changes)
• Income tax-Form 941
• W-2s,W-3s, & 1099 Misc
• Tax for unrelated business income-
Form 990-T
• Lobbying expenditures-Form 5768
• Donee information return-Form 8282
• Cash donations over $10,000-Form
8300

85. Best Practices Tip
• Create a checklist of different reporting
requirements and annually review compliance with
the requirements.

86. Other Tips
• Keep track of filing requirements
• Monitor employment practices and compensation
• Comply with good board governance policies and internal
financial controls
• Maintain safe facilities and operations
• Read the fine print
• Respect copyrights

87. Don’t risk it!
• Anticipate events
• Plan a response
• Obtain insurance
• And remember-by promoting safety, following procedures,
complying with regulations, and protecting your assets, your
organization can maximize efforts to fulfill its mission.

88. www.texascbar.org
texascbar@trla.org