In PLR 20113041, the IRS revoked the tax exemption of a public charity based on excess benefit and private inurement issues. This ruling highlights practices that charities should avoid in order to maintain their tax-exempt status.

The charity's primary purpose was to pursue the study of how the interaction of land use, disturbance, and climate impact the structure and biodiversity of a particular region, and publish papers relating to such study. The charity had only one staff member who also functioned as the President. The charity's governing board consisted of three immediate family members - the President, his father (Vice President), and his wife (Secretary/Treasurer).

The IRS noted that the President had no employment contract with the charity and the charity itself had no Conflict of Interest Policy in place to determine how any conflicts, potential or actual, would be addressed.

The charity's records demonstrated that the President "consistently utilized" the charity's income for private purposes. Among the most egregious examples, the charity's records established that:

1. The President routinely made "loans to officers," but never fully substantiated the purpose of these loans. Moreover, the charity's board approved these loans, which were withdrawals from the charity's checking account and payments for the President's personal expenses, "after the fact." Note that since the charity had no Conflict of Interest Policy, the President who made these loans in the first place, then approved these "loans" with his wife and father. All of these amounts went into a "Loans to Officers" account and inadequate records were kept on how this money was spent to further the charity's exempt purposes.

2. The President sold luxury vehicles to the charity, but never transferred title, and performed upgrades without being able to prove that the vehicle even existed or was owned by the charity. Similarly, the charity paid for the President's car expenses without asking for business substantiation for these expenses.

3. The charity paid the President's personal legal expenses.

Interestingly, the IRS focused on the President's withdrawals from the charity's accounts that could not be substantiated as being for the furtherance of the charity's exempt purpose and also touched on ways in which the governing board was not providing proper oversight. In fact, the IRS noted that the charity's inurement issues and excess benefit transactions "resulted from the organization being under the control of one-person with a family-based governing board."

Moreover, the IRS noted that because of the charity's structure, "sufficient safeguards ha[d] not been put in place to prevent future violations...." Charities should be aware that governing procedures and policies, including a Conflict of Interest Policy and a recordkeeping policy, can provide these types of safeguards and help an organization function more efficiently and effectively. In fact, this ruling is a staunch reminder that these policies should be used where appropriate and tailored to the needs of each organization.

This ruling should force each charity to examine its organizational and governing structures to ensure that its board constitutes an independent body so that, unlike the charity here, its governing board has no "inherent conflict of interest when placed in a position to approve financial transactions...."

The amount of compensation paid was also at issue here because the President's salary was considered excessive based on the size of the organization's budget. Accordingly, charities, particularly smaller charities, should use comparability data, to the extent possible, in determining the salaries of its various officers and other staff. Also, having a well-written employment contract with senior employees or officers may help a charity better defend the terms and scope of an employee's or officer's employment and compensation.

This ruling confirms that the IRS is paying close attention to what charities are doing in their "back" offices. Consequently, charities that are not exercising good governance practices will certainly be at risk for revocation of their tax-exempt status.