Where Was the Auditor?
Where Was The Auditor? Comments on the Senate Finance Committee’s
Letters to Six Televangelists
By: Donna Whiteside Smith, CPA & James E. Guinn, CPA Guinn, Smith & Co., Inc.
Reviewing the implied charges in the Senate Finance Committee’s letters to the six televangelists, a question that might come to the minds of some readers is “Where were the auditors?” It came to our minds.
Unfortunately, this question has arisen in the both the tax-exempt and for-profit world too many times in the last few years as large, respectable audit firms have failed to serve their function to fully inform the financial statement users about the activities of the organizations audited. Large publicly traded companies have failed under the shadow of accusations of audit failures. Stockholders have suffered terrible losses as a result. Accusations of misuse of contributions to tax-exempt organizations persist. Embarrassingly often, these problems are frequently discovered by others than the auditors.
Perhaps this is easy to understand. Auditors are not detectives and until recently have had no requirement to audit to discover fraud. If pointed questions are not asked by auditors, if an inexperienced auditor is assigned to a job, if collusion is present, if counterfeit documents are present, if auditors are not skeptical, experienced and tenacious, the odds are high fraud will go undetected.
One might say the auditor ought to be the audited company’s conscience in matters of full and honest reporting to the public about the stewardship of funds entrusted to it by donors. Regrettably, there have been incidents lately, some very highly publicized in the nonprofit world, where auditors have failed to detect abuse.
In some cases, relevant information is omitted from financial statements because of ignorance on the part of the organization itself about its reporting requirements and its regulatory environment. Or, sadly, transactions are undiscovered because of ignorance or cost cutting efforts on the part of auditors.
Others are watching. Church and ministry watchdog groups furnish information to news organizations, the Internal Revenue Service, and even to the Senate Finance Committee. The results of this activity have been making headlines recently.
Senator Grassley has made it frighteningly clear what is on the mind of the Senate Finance Committee when it comes to the financial affairs of televangelists. The Committee is now beginning the process to make known to the public exactly how funds donated to these organizations have been spent. The investigation may be a long and painful public process. The proceedings of these inquiries will likely be available for anyone who wishes to watch the Senate meetings on cable television.
In no uncertain terms, Senator Grassley has issued instructions to those six ministries to provide him evidence that the donated funds entrusted to them have not been used to provide lavish lifestyles for the organizations’ leaders. And the public method he used for that communication, no doubt intended, has put similar organizations on notice. Senator Grassley has ensured that donors, at least in these instances, will now know what happens to their contributions.
The government does have the authority, and responsibility, to investigate when it receives credible evidence of potential wrongdoing. It is within the power of the Senate Finance Committee to instigate the process to change the rules under which tax-exempt, religious organizations operate. The challenges to these six organizations posed by Senator Grassley’s inquiries may impair relationships with donors as more information comes out about their activities. These charities may very well defend themselves as to the use of donated funds under the existing regulations. However, as a result of this investigation, it is our opinion that the Senate investigation could result in more restrictive rules for the future. Some of those proposals may be found in the June 2005 report to Congress by the Panel on the Nonprofit Sector, “Strengthening Transparency, Governance, Accountability of Charitable Organizations.”
There are several sticky issues which present themselves in these letters to the six televangelists. No doubt Senator Grassley and his committee have given these issues consideration, possibly with the ultimate intention of making proposals for changes in the rules under which these and similar organizations operate. Consider these difficult issues:
• What is reasonable compensation for the executives of tax-exempt religious organizations? Should it be subject to limits? (The intermediate sanctions rules were put in place in an effort to address this issue.)
• Should Congress continue to provide special benefits to tax-exempt organizations such as reduced postal rates and relief from certain taxes?
• When is a “gift,” (commonly called “love gifts”) made to a leader of a tax-exempt organization taxable income, and when is it simply a gift between two people?
• Are there implications for the widespread use of public airwaves, (under the jurisdiction of the FCC) for fund-raising for these organizations?
• What “protector” does a donor have to ensure the proper use of money given to these organizations? Should it be the IRS? The Senate? The board of directors of the organization?
• What authority does the government have to intervene in the use of “public trust funds” (donated funds)?
• Should reporting obligations be imposed on churches and religious organizations similar to those already required for other tax-exempt organizations?
• Should the benefit of nontaxable housing allowances to religious leaders be reconsidered?
• How and what controls can be put in place so that exempt organizations are not abused by those in control?
• Where and how can the line be drawn to make the determination as to when an organization is operated for the good of the public versus for the benefit of one or more individuals? (This speaks to executive compensation.)
• To whom and how should the leaders of such a tax-exempt, religious be held accountable in the absence of a traditional congregation? (Currently, certain religious organizations have no reporting requirements other than for wages and contract services.)
• How will the Constitutional issues of religious freedom and separation of church and state factor into the Senates deliberations?
Perhaps the most important question of all is how did the state of affairs come about that triggered the Senate Finance Committee’s decision to conduct this investigation?
Did the auditors fail in their duty to educate and inform the leaders of these organizations about what constitutes taxable compensation, what constitutes reasonable compensation, what is an appropriate use of donated money, and what kind of records must be kept by the tax-exempt organization? The answer is, possibly, yes.
Auditors of religious, tax-exempt organizations should know there are significant and sensitive areas which should be examined as part of the audit process. These are ignored at the peril of the tax-exempt organization. We believe these audit procedures are fundamental and common sense ones: What environment does this organization operate in and what transactions and events pose the most serious risks to it?
Two risks tower above any other possible threats to tax-exempt organizations:
• Adverse publicity, which can destroy an organization’s ability to raise revenue, and
• The loss of the organization’s tax-exempt status, which ends an organization’s ability to receive tax-deductible donations and which could generate a crippling tax liability for the organization.
The question is whether the organization could continue functioning at the same level as it has in the past, or even continue at all. National television and Congressional investigations in the 1980s into scandals in television ministries leads us to believe that the answer is “No.”
An audit of a tax-exempt organization is not complete until these risks have been addressed. In designing audit procedures for most financial statement audits, auditors’ game plan is normally to audit for errors or fraud that will result in materially misstated financial statements. As a result, transactions that are not individually large in relation to the overall revenue or assets of an organization may be ignored by the auditors. This practice reduces the cost of audits because fewer transactions are audited. In short, the more detailed level an auditor looks at the organizations transactions, the more the audit will cost.
But when individuals responsible for the operations of a tax-exempt organization use the organization or its assets for personal benefit (this is called inurement of benefit) the concept of materially simply does not apply. When a disqualified person receives more than is reasonable or authorized for his services to a tax-exempt organization, it is called an excess benefit. The threshold for inurement of benefit or excess benefits is zero. Audit procedures for tax-exempt organizations should be designed to add the following to typical audit procedures.
• Examination or testing of the nature of expenditures with an eye to the exempt purpose.
• Examination for propriety of all payments to leaders of the organization, including both cash and non cash transactions.
• Review of charges on ministry or church credit cards for personal charges.
• Review for the reasonableness of compensation paid to the organization’s leaders and their relatives. In additional, the auditor should look for benefits or compensation given to those parties which were not board-authorized.
• Review of transactions with related organizations and persons (transactions should benefit the tax-exempt organization or at the very least, not harm it) they should have a tax-exempt purpose consistent with the mission of the organization and should be conducted at arm’s length.
• Inquiries should be made about the use of the organization’s assets and personnel for inappropriate or unauthorized benefit to disqualified persons
Basically, all payments, gifts and benefits to disqualified persons (officers, directors, key members of management, members of their families, their businesses or other entities they control, and significant donors) should be examined for propriety.
If these are not examined, the audit firm has failed in its responsibility to the organization, its donors and to other users of the financial statements. If these issues are not addressed as part of the audit process, jeopardy to the organization’s continued existence could go undetected. As a result the financials statement may be misstated. The users of the financial statements might be missing critical information about the future financial viability of the organization.
In dealing with similar matters before both the Congressional committees and the Internal Revenue Service we have learned that it is extremely likely that the Senate Finance Committee has evidence in hand, which it believes to be credible, or it would not have sent out such inquiries. Does this mean that the charges implied in Senator Grassley’s letters are necessarily infractions of law? No it does not. It does, however, give insight into what the Senate Finance Committee members consider inappropriate use of contributions and along what lines they are thinking in relation to possible changes in the law.
The federal government does not now set “reasonable compensation” for leaders of tax-exempt organizations (although it has recommended some procedures for them to follow in establishing it). Can that change? Yes, conceivably, it can change. This is an issue we believe will be thrashed out in a court room, possibly even before the Supreme Court. It is almost a certainty that Attorney Jay Sekulow of the American Center for Law and Justice will become involved in this battle. Mr. Sekulow is well-known for defending the religious, constitutional rights of organizations and individuals.
The exemption from federal income tax on revenues raised by tax-exempt organizations has been embraced by Congress because of the presumption that such funds are used for the good of the public. An auditor’s responsibility in the audits of churches and ministries is to assure himself that is truly the case. The executives and board members have a legal, moral and ethical responsibility to do the same.
This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is shared with the understanding that neither the author nor Tony Cooke Ministries is engaged in rendering legal, accounting, psychological, medical or other professional services. Laws and regulations are continually changing, and can vary according to location and time. No representation is made that the information herein is applicable for all locations and times. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
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