States Ramp Up Regulation Of Nonprofits - With Help From The Feds

"Dear Charity Leader, A review of our records and information from the Internal Revenue Service cause us to believe that your organization should be registered with our office. ... However, we have no record of any filing."

This is the opening paragraph of a form letter being circulated by the Ohio Attorney General's Office to certain Ohio charities. The letter is remarkable not because it directs a charity to comply with state registration requirements, but rather because the original inquiry was prompted, in part, by information received from the Internal Revenue Service. The letter reflects growing cooperation between federal and state regulators in a heightened regulatory environment, a cooperative trend that will no doubt continue and deepen.

As set forth below, states are delving ever more deeply into regulating charities, and doing so in an ever more aggressive fashion. The states are using old tools in this effort, most prominently the charitable fund-raising registration statutes that exist in 38 states and the District of Columbia. The notable difference is that states are using information provided directly by the federal government, as well as information reported on the new Form 990, Return of Organization Exempt From Income Tax, to aid in their enforcement efforts, creating a much tighter regulatory environment.

Moreover, states are also looking at new tools, such as a bill (S.B. 40) under consideration in Oregon. The Oregon bill, if passed, would require charities to devote a minimum amount of their expenditures each year to the furtherance of charitable purposes. Donors to charities that do not reach the prescribed threshold will not be entitled to an Oregon income tax deduction for their contributions. This article briefly examines the regulatory environment in which charities have operated, and the changes to that environment we currently see.

State Regulatory Framework

State governments have concurrent jurisdiction with the federal government with respect to the oversight of, and regulatory control over, charities. After all, nearly every U.S. charity is a creation of state law, formed under a specific state's trust, unincorporated association, or nonprofit corporation law. In other words, most charities would not legally exist but for state law.

Moreover, the states' attorneys general have nearly exclusive authority over enforcement of rules and regulations regarding charitable solicitation, fraud, and breach of fiduciary duty. Generally speaking, there is no private right of action allowing individuals to police the operation of charities. As a charity is generally formed to benefit the public, it follows that the attorneys general should enforce rules designed to safeguard the public and its donations to charity, ensure that charitable assets are preserved, and protect against diverting charitable assets for personal enrichment.

So, while state regulation is not a new phenomenon, state regulatory and enforcement actions have historically been reactive. That is, state action against charities was generally in reaction to consumer complaints about a particular charity. Upon receipt of complaints, state enforcement agents would investigate a charity's compliance with registration and reporting requirements and fund-raising disclosures, and identify any fraud or excess benefit arising from a charity's operation. Rarely did a state investigation begin in the absence of a complaint.

Federal Regulatory Framework

In addition to state government...