The District of Columbia City Council is now considering legislation that could greatly affect DC nonprofits. In fact, if taken literally and enacted as currently written, the bill might cause a host of unintended consequences, including prohibiting nonprofits from engaging in unrelated trade or business activities even if tax is paid on the revenues earned.

Further, as written, a nonprofit may be banned from acting as the general partner of a low-income tax credit project and might similarly be prohibited from investing in a for-profit subsidiary. In fact, this bill might even impede routine investment activities of a nonprofit.

If enacted, this legislation would allow the District’s attorney general to:

• Seek a court-ordered receivership or charter revocation as to any DC nonprofit that: 1) conducts more than an insubstantial amount of activities that are “inconsistent” with its nonprofit purposes; 2) uses or transfers “substantial” assets in a manner that does not serve or that is “inconsistent” with its exempt purposes; 3) pays “unreasonable compensation” to an officer or director; or 4) engages in any private benefit activity
• Seek a court order seizing “unreasonable compensation” paid to a director or officer

While building confidence in the nonprofit sector is a laudable goal, this bill does not follow the model that the Internal Revenue Service (IRS) adopted after the United Way scandals of imposing intermediate sanctions in the form of a punitive tax on excess benefits transactions; instead, it authorizes the District to pursue the ultimate sanction of charter revocation.

While DC nonprofits of course may circumvent this law, if it is adopted, by reincorporating in another jurisdiction, this time-consuming and disruptive step could be avoided if the District were to adopt a regulatory regime similar to the federal tax laws. Such an approach could empower the attorney general to impose intermediate sanctions patterned on the federal tax rules and to enforce the private inurement and private benefit rules that are already well-developed in federal tax law through local injunctive action. By adding an enforcement mechanism but not new substantive rules, the District could avoid disruption and still enhance donor confidence.

If you have any questions about this update, or if you would like additional information, please contact:

Richard Newman
202.857.6170
newman.richard@arentfox.com

Deanne M. Ottaviano
202.775.5781
ottaviano.deanne@arentfox.com

Marc L. Fleischaker
202.857.6053
fleischaker.marc@arentfox.com