HRMN 408 Week 8: Considerations for HR Professionals

CHAPTER 23

• Tax-Exempt Status

• Political Activity and Lobbying

• Employee Compensation and Withholding

• Executive Compensation

• Benefit Plans

• Unemployment Insurance

• Volunteers

• Religious Organizations

• Tenure

Nonprofit Organizations

C o p y r i g h t 2 0 1 7 . S o c i e t y F o r H u m a n R e s o u r c e M a n a g e m e n t .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

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Book: The SHRM Essential Guide to Employment Law : A Handbook for HR Professionals, Managers, Businesses, and Organizations Author: Charles Fleischer Date: 2017

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A typical business corporation is formed by shareholders who invest their capital in the business with the expectation of earning a profit in the form of dividends or on the later sale of their stock. Share- holders hold ultimate power over the corporation by electing direc- tors and by deciding issues that are fundamental to the corporation’s existence, such as whether to change the company’s capital structure or to merge with another company. The directors, in turn, manage the company by setting broad policies and appointing and oversee- ing corporate officers.

A nonprofit organization, on the other hand, is not formed to make a profit. Typically, it is a corporation organized under spe- cial provisions of state law that prohibit issuance of shares and the payment of dividends. Nonprofit organizations therefore have no shareholders, and they do not distribute earnings to owners. (Non- profit organizations may have members who elect directors or trust- ees, but the members do not own the organization. In fact, nobody owns a nonprofit.)

Although not organized to make a profit, nonprofit organiza- tions are not required to operate at a loss. The point here is that any surplus of revenues over expenses must be retained or applied to nonprofit purposes and cannot be distributed to individual members.

TAX-EXEMPT STATUS The term nonprofit is often used synonymously with tax-exempt. The two concepts, though related, are distinct. Nonprofit refers to the organization’s purposes as expressed in its articles of incor- poration and as governed by state law. Tax-exempt, on the other hand, means that the organization’s net earnings are not subject to income tax. All tax-exempt organizations must be nonprofit, but just because an organization is nonprofit does not necessarily mean it qualifies for a tax exemption. Of course, the reason why an entity organizes as a nonprofit is usually to obtain tax-exempt status.

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Section 501(c) of the Internal Revenue Code contains a long list of organizations that qualify for tax-exempt status, including the following:

• corporations organized and operated exclusively for religious, charitable, scientific, testing-for-public-safety, literary, or educa- tional purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the ben- efit of any private shareholder or individual—so-called 501(c)(3) organizations

• civic leagues organized and operated exclusively for the promo- tion of social welfare

• labor, agricultural, or horticultural organizations • business leagues, chambers of commerce, real estate boards, and boards of trade

• recreational clubs

To achieve tax-exempt status, a nonprofit organization must submit an application to the Internal Revenue Service (IRS). If the IRS is satisfied that the organization is organized and is being oper- ated for one of the exempt purposes listed in the Internal Revenue Code, it issues a determination letter to that effect. Exemption from state income taxes can usually be obtained on the basis of the IRS determination letter.

Another distinction that is often blurred has to do with the deductibility of contributions. While a tax-exempt organization pays no income tax, it does not necessarily follow that contributions to that organization qualify for a charitable deduction. Deductibility of contributions to §501(c)(3) organizations are governed by §170 of the Internal Revenue Code. Payments to other types of nonprofit organizations, such as business leagues, may qualify as trade or busi- ness expenses under §162 of the Internal Revenue Code.

Although tax-exempt nonprofits receive special treatment for some purposes, with few exceptions federal and state employ- ment laws apply to nonprofits to the same extent as they apply to

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for-profit businesses. For example, nonprofits must withhold taxes from employee salaries, they must provide workers’ compensation, they cannot discriminate (except in limited circumstances involving religious organizations), and they must provide safe workplaces.

This chapter discusses the exceptions applicable to nonprofit organizations.

POLITICAL ACTIVITY AND LOBBYING Section 501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any politi- cal campaign on behalf of (or in opposition to) any candidate for elective public office. Contributions to political campaign funds or public statements of position (oral or written) made on behalf of the organization in favor of or in opposition to any candidate for public office clearly violate the prohibition against political campaign activ- ity. A violation of this prohibition may result in denial or revocation of tax-exempt status and the imposition of excise taxes.

Under the so-called Johnson Amendment to the Internal Reve- nue Code, 501(c)(3) organizations are prohibited from endorsing or opposing candidates for public office. In May 2017, President Trump issued Executive Order 13798 directing the secretary of the U.S. Department of the Treasury to “ensure, to the extent permit- ted by law, that the Department of the Treasury does not take any adverse action against any individual, house of worship, or other religious organization on the basis that such individual or organi- zation speaks or has spoken about moral or political issues from a religious perspective.” It is not clear what effect this order will have on the IRS’s enforcement policies.

Similarly, no substantial part of the activities of a 501(c)(3) orga- nization may be attempting to influence legislation (commonly known as lobbying). Legislation includes action by Congress, any state legislature, any local council, or similar governing body, with respect to acts, bills, resolutions, or similar items (such as legislative confirmation of appointive office), or by the public in referendum,

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ballot initiative, constitutional amendment, or similar procedures. It does not include attempting to influence executive, judicial, or administrative bodies.

Employees of 501(c)(3) organizations need to be familiar with the rules against involvement in political campaigns and lobbying on behalf of their organizations.

EMPLOYEE COMPENSATION AND WITHHOLDING The Internal Revenue Code allows for-profit corporations to deduct from gross income a reasonable allowance for salaries or other compensation for personal services actually rendered. As a result of this provision, every dollar a for-profit business corpo- ration pays out in salaries or employee benefits, so long as the amounts are reasonable, reduces the corporation’s federal and state tax liability by almost 50 cents, depending on the state. In effect, the government may pay almost half of a business corporation’s employment-related costs.

Because of its tax-exempt status, the same is not true for a nonprof- it organization. Salaries and benefits are borne 100 percent by the organization itself and reduce the amounts available for its nonprofit purposes on a dollar-for-dollar basis. The employees themselves pay tax on their incomes just like employees of for-profit companies, although special rules apply to clergy.

Ministers and members of religious orders are considered self-employed for Social Security purposes with respect to their ministerial duties. This means that the church or other ecclesiasti- cal organization they work for does not withhold FICA from their compensation or make matching FICA contributions. (FICA is discussed in Chapter 7.) In addition, ministers and members of religious orders who have taken a vow of poverty are automatically exempt from FICA tax on self-employment income. Even if they have not taken a vow of poverty, they may obtain an exemption if they are opposed to Social Security on conscientious or religious grounds.

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Ministers who are provided a parsonage or a payment specifically designated as a rental allowance do not need to include those items in gross income for income tax purposes.

EXECUTIVE COMPENSATION Organizations such as charitable, religious, or educational organi- zations that are exempt under §501(c)(3) of the Internal Revenue Code must be operated exclusively for the charitable, religious, or educational purposes for which they were organized. If they abuse their exempt status by engaging in nonexempt activities, the IRS has the power to revoke their tax exemption.

Revocation is a drastic remedy. It would often mean the end of the organization. So historically, minor abuses either went unpun- ished, or they got punished in a disproportionately severe way. Now the IRS has a less deadly weapon—an excise tax to punish abusers.

A 1996 amendment to the tax code, coupled with more recent IRS regulations, prohibit disqualified persons from receiving excess benefits from a tax-exempt organization. A disqualified person includes any person who is in a position to exercise substantial influence over the affairs of the organization. This would cover high-level employees, board members, and officers. Family mem- bers of those persons are also covered. An excess benefit is any economic benefit provided to a disqualified person in excess of the consideration received by the organization. For example, the board of a charitable organization cannot vote itself exorbitant directors’ fees, nor can senior managers pull down salaries far above the norm for comparable positions.

A disqualified person who receives an excess benefit is subject to an initial 25 percent excise tax on the amount of the excess. The management of the organization is also subject to a 10 per- cent tax. If the excess benefit transaction is not promptly cor- rected, then the disqualified person is subject to an additional 200 percent excise tax.

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BENEFIT PLANS With limited exceptions, the same array of benefit plans that are available to for-profit companies are also available to tax-exempt organizations. (Deferred compensation plans and other types of employee benefit plans are discussed in Chapters 8 and 9.) Tax-ex- empt organizations may even have a profit-sharing plan, although they do not have profits in the normal sense.

403(b) Plans Organizations that are exempt under §501(c)(3) of the Internal Revenue Code—such as educational organizations, churches, public and private schools—may adopt a special type of pension plan avail- able only to them, called a tax-sheltered annuity or 403(b) annuity. Although called annuity plans, the funding vehicle for these plans is not limited to annuity contracts issued by insurance companies. Other vehicles, such as bank custodial accounts, are also available.

Before 1958, employees of tax-exempt organizations could divert any or all of their compensation to an annuity on a tax-sheltered basis. In 1958, Congress imposed a ceiling on the amounts that could be diverted. Subsequent amendments to the Internal Revenue Code have made tax-sheltered annuities conform in many respects to other types of pension plans. Nevertheless, tax-sheltered annuities retain some attractive features. One feature is their portability. When the fund- ing vehicle is an individual annuity contract owned by the employee, the employee can leave one tax-exempt organization, go to work for another, and simply have his or her new employer make contributions to his existing plan.

Church Plans A church plan is a plan established and maintained for employees of a tax-exempt church or a convention or association of church- es. Unless a church plan voluntarily elects to be subject to the Employee Retirement Income Security Act (ERISA), it is exempt from most of ERISA’s requirements, including requirements relat-

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ing to coverage, vesting, benefit accrual, and funding. (ERISA is discussed in Chapter 9.)

QUICK TIP While being exempt from ERISA is generally considered beneficial from the employ-

er’s viewpoint, one downside is that ERISA’s preemption provision does not apply. This

makes nonelecting church plans subject to state laws, rather than uniform federal law.

As a result, church plans and their sponsors can be sued in state court, can be subjected

to jury trials, and can have compensatory and punitive damages awarded against them

if permitted under state law.

In a 2017 decision, the U.S. Supreme Court ruled that a plan main- tained by a “principal-purpose organization,” that is, by a church-as- sociated organization whose chief purpose or function is to fund or administer a benefit plan for the employees of either a church or a church-affiliated nonprofit, qualifies as a “church plan,” and thus is exempt from the requirements of ERISA, regardless of whether a church originally established the plan.

Since nonelecting church plans are generally exempt from ERISA, they do not have to provide health insurance continuation benefits under the amendment to ERISA known as COBRA. (COBRA is cov- ered in Chapter 10.)

UNEMPLOYMENT INSURANCE Some states allow tax-exempt organizations described in §501(c)(3) of the Internal Revenue Code the option of either contributing state unemployment tax just like other employers or reimbursing the state dollar for dollar for actual claims charged to their accounts. Electing to reimburse may improve a charity’s current cash flow, but it could prove expensive if several employees are terminated at the same time.

VOLUNTEERS The Fair Labor Standards Act (FLSA) allows individuals to vol- unteer their services, without pay, to state or local government

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agencies and to nonprofit food banks for humanitarian purposes. U.S. Department of Labor guidance goes further, recognizing that individuals may volunteer their time, freely and without anticipa- tion of compensation, for religious, charitable, civic, or humanitar- ian purposes to nonprofit organizations. (See Chapter 5 for a more detailed discussion of volunteers and unpaid interns.)

RELIGIOUS ORGANIZATIONS The First Amendment to the Constitution provides that Congress “shall make no law respecting an establishment of religion, or pro- hibiting the free exercise thereof.” Countless federal statutes have the potential for interfering with religious practices, but either they contain express exemptions, or they have been held inapplicable or unconstitutional when applied to religious organizations.

Ministerial Exception One such federal statute is Title VII of the federal Civil Rights Act, which prohibits discrimination in employment based on race, color, religion, sex, or national origin. (Title VII is discussed in Chapter 14.) Under a literal reading of Title VII, a Catholic church, for exam- ple, could be forced to ordain female priests, contrary to Catholic doctrine. But most federal courts that have considered the question recognize a ministerial exception that prevents such a controversial result.

A case in the D.C. Circuit Court of Appeals, for example, involved a nun who held a doctorate in canon law from Catholic University and was an associate professor in that school’s canon law depart- ment. When the nun’s application for tenure was rejected, she sued claiming sex discrimination. The court characterized the case as “a collision between two interests of the highest order: the Govern- ment’s interest in eradicating discrimination and the constitutional right of a church to manage its own affairs free from governmental interference.” The court resolved these colliding interests by dis- missing the suit under the ministerial exception, saying that religious

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institutions are exempt from civil suits in connection with the selec- tion and employment of clergy.

The ministerial exception is not limited just to members of the clergy. It also covers lay employees of religious institutions whose primary duties consist of teaching, spreading the faith, church gov- ernance, supervision of a religious order, or participation in reli- gious ritual and worship.

Discrimination Based on Religion Even for employees who are not covered by the ministerial exception, religious organizations may discriminate on religious grounds. Title VII, by its express terms, does not apply to religious organizations with respect to the employment of individuals of a particular religion to perform work connected with the organization’s activities.

Federal labor law offers another good example of potential interference with First Amendment rights to religious freedom. By statute, an employee in a union shop who is a member of a bona fide religion that forbids union membership or union financial support may pay his or her dues to charity instead of to the union. And a 1979 Supreme Court decision in NLRB v. Catholic Bishop of Chicago held that teachers in parochial schools are exempt from National Labor Relations Board (NLRB) jurisdiction. (In an April 2017 decision involving Xavier University, the NLRB did assert jurisdiction over nonteaching employees of religious institutions— in that case, housekeepers—who were not involved in fulfilling the university’s religious mission.)

TENURE From the Latin tenere (to hold), the word tenure is usually asso- ciated with job security for faculty members at academic institu- tions. Basically, by granting tenure to a member of its faculty, the employer institution agrees that the faculty member is no longer an employee at will and can be discharged only for specified rea- sons and after following specified procedures. In simple terms, a

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tenure arrangement is a contract of employment. (Employment at will and employment contracts are discussed in Chapter 1.)

ALERT! Faculty members at public institutions are government employees and therefore enjoy

certain due process rights not applicable in the private sector. (See the due process

discussion in Chapter 4.)

Tenure is sometimes a controversial subject. Those in support argue that it is essential to protect teachers from arbitrary decisions, to promote institutional self-governance, and to preserve academic freedom. Critics contend that tenure encourages neglect of teaching responsibilities, removes any checks on the growth of irresponsi- ble opinions, and generally fosters laziness and lack of productivity: tenure lets professors “think (or idle) in ill-paid peace, accountable to nobody,” claimed one pundit. Regardless, in adopting a tenure policy, the employing institution retains ultimate control over how and when tenure is granted and how and when a tenured teacher can be removed.

Nearly all colleges and universities have a tenure system, according to the U.S. Department of Education. The specifics of the system are usually contained in the institution’s bylaws or other governing documents or in a faculty handbook. Typically, the system provides for tenure-track professors to be considered for tenure after a pro- bationary period lasting a specified number of years. (Nontenure tracks exist for part-timers, temporary appointees, and in some cases even regular, full-time teachers.) The system identifies the criteria to be considered in granting tenure, which normally includes an evalu- ation by faculty colleagues.

QUICK TIP Except for religious schools, academic institutions are no different from other employers

when it comes to discrimination. The granting or withholding of tenure based on race,

gender, age, or other prohibited grounds violates federal and local equal employment laws.

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Once a professor is granted tenure, the employing institution is restricted in its ability to terminate him or her. Termination usually requires cause, based on such factors as neglect of duty, incompe- tence, or professional or personal misconduct. (See Chapter 4 for a discussion of for-cause terminations.) Termination is also typical- ly permitted if the institution abolishes the professor’s program or department, or if the institution faces serious financial problems.

Since tenure policies amount to employment contracts, an insti- tution that fails to follow its policies can be sued for breach of con- tract. Courts are generally reluctant to inject themselves directly in the academic process by requiring, for example, that an institution grant tenure or rehire a professor who was wrongfully terminated. But courts will award money damages when tenure policies have not been followed.

CASE STUDY: DAMAGES AWARDED FOR VIOLATION OF TENURE POLICY George Washington University in Washington, D.C., had a tenure policy that required it to give a year’s advance notice to any tenure- track professor who would not be receiving tenure at the expiration of his or her probationary period. The policy went on to say that any faculty member who is not so notified will acquire tenure at the end of the term.

When the university violated its own policy by terminating a particular professor without giving him the requisite notice, the professor sued, asking the court to order that he be granted tenure. The court refused to order tenure, reasoning that it would not serve the university’s academic interests to have a body of professors whose tenure resulted from administrative neglect or oversight. The court did, however, require payment of money damages equal to one year’s salary.

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