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Exempt Organizations

Exempt Organizations
October 2001

On September 24, 2001, the Attorney General of the State of Minnesota posted to its website a Memorandum of Understanding (“Agreement”) with two nonprofit healthcare organizations, Allina Health Systems (“Allina”) and Medica Health Plans (“Medica”), summarizing the results of its Compliance Review. Allina is a multi-entity healthcare system exempt under IRC §501(c)(3); Medica is an HMO exempt under IRC §501(c)(4). The Compliance Review was conducted for the purpose of determining the organizations’ compliance with state and federal nonprofit statutes.

The Agreement was accompanied by six volumes of findings. Findings were issued in the following areas: conflicts of interest, executive compensation, consulting expenses, travel and entertainment and administrative expenses. The Agreement outlines a number of areas in which the parties agree to restrict or modify their activities.

The findings describe numerous abuses, many of which are extreme (e.g., trips to Aruba, London, Venice, Grand Cayman, Amsterdam, Athens, etc.; millions of dollars in payments to consultants). The Agreement and findings are instructive, however, as they highlight areas in which abuses often occur. The issues covered by the Agreement and findings are those that are likely to arise in any examination by the IRS or state Attorney General.

Travel and entertainment. While the organizations had a travel policy, policy requirements appear to have been generally ignored. The findings identify employee trips to exotic locations around the world, executive club memberships, payment of spousal travel, payment for sporting events, extravagant retreats, parties and gifts. Such payments raise the possibility of impermissible private inurement under both IRS §501(c)(3) and (c)(4).

Conflicts of interest. Numerous abuses were cited involving payments by and between affiliated entities for the purpose of manipulating financial results. As a result, it was difficult for the public to evaluate the extent to which the organization was fulfilling its exempt mission. The Agreement requires the organizations to adopt a conflict of interest policy.

Executive compensation. The findings cite a lack of proper review of management compensation. Although the organization had a “Personnel and Compensation Committee,” the Committee did not exercise its oversight function responsibly. Documentation and comparability data were often poor. In fact, the organizations failed to utilize comparability data in arriving at the compensation of its chief operating officer and did not follow the guidelines under the IRS’ intermediate sanctions regulations.

Consulting fees. The findings reflect that the organizations paid in excess of $56 million dollars for consulting services over a three-year period, including $35 million to Deloitte and Touche, as well as millions of dollars for “coaches” for executives, “climate-related” consulting, and leadership training. Many of the consultants were from outside Minnesota. The findings cite a failure to interview candidates, improperly allowing outside consultants to approve fees and expense of other consultants, failure to retain local consultants, failure to prepare written contracts, failure to monitor payment or demand documentation.

The Agreement requires adoption of a policy regarding third-party contracts and a quarterly review by a board member of consultants.

Ethics policy. The Agreement requires the organization to adopt an ethics policy that precludes the receipt of gifts with a value in excess of $50, and prohibits the utilization of consultants for personal purposes.

Administrative expense. The findings note that the manner in which Allina classified expenses for purposes of the Form 990 inflated the amount of program service expenses. Fundraising, billing, auditing and accounting costs were classified as program expenses. In addition, golf games, health club memberships for executives, company parties, and Timberwolves tickets were also classified as program expenses. Thus, the Form 990 presented a distorted view of the organization’s exempt function expenditures.

The Agreement is unique in that it requires the organizations to file periodic reports with the Attorney General outside the normal filing process. For example, the Agreement requires the organizations to file with the Attorney General’s office a schedule of out-of-state travel expenses, as well as a schedule of expenses segregating administrative expenses in accordance with the Attorney General’s methodology.

In addition, the Agreement provides that the organizations “shall review the findings of the Compliance Review and, where appropriate, initiate action to recover monies inappropriately or unlawfully paid by the Company to or on behalf of the employees.”

Reference is made throughout the Attorney General’s findings of the federal tax principles that are implicated by the organizations’ actions, such as private inurement and excess benefit transactions. We have been unable to determine whether the IRS has taken, or will take, any action in this matter. Assuming the findings are true, however, IRS sanctions could include revocation of exempt status, penalties for improper filing of returns, and excise tax penalties on individuals involved in excess benefit transaction. Under intermediate sanctions, individuals could also be required to return any excess benefits received.

The Agreement and findings can be accessed at http://www.ag.state.mn.us. The exhibits cannot be accessed via the website but can be separately purchased from the Attorney General. The exhibits include Travel and Expense policy (Ex A), Conflict-of-Interest policy (Ex B), Ethics policy (Ex D), Sexual Harassment policy (Ex E), Anti-Discrimination policy (Ex F), policy regarding Third Party Contracts (Ex G), policy regarding Retention of Outside Counsel (Ex H).

Should you have any questions regarding the foregoing, please contact John Kikuchi at (925) 944-7666 or by email.


The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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