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One place you generally don’t expect to see “intermediate sanctions” appear is on the best seller list. But that now seems to be possible with Greg Mortenson and his books Three Cups of Tea and Stones into Schools. In an exposé on the CBS show 60 Minutes on April 17, 2011, reporter Steve Kroft questioned the legitimacy of Mr. Mortenson’s widely-read accounts of founding a non-profit, the Central Asia Institute, and constructing schools in Taliban-infested regions of Afghanistan and Pakistan. The following day, celebrated adventure author Jon Krakauer followed suit with his own take on Greg Mortenson and his persona in Three Cups of Deceit, and he implicitly raises the risk of intermediate sanctions.
Krakauer, the author of Into the Wild, Into Thin Air, and Where Men Win Glory, and a contributor to and former supporter of the CAI, claims that Mortenson’s tale is frequently, if not largely, a sham. Stories of charitable derring-do never happened, schools didn’t get built, and, among the most damning, that Mortenson used the CAI as his “personal ATM” and that the charity’s “books have been cooked to order.” Strong words. Stronger potential risks for both Mortenson and the CAI.
For those not immediately conversant on intermediate sanctions, they spring from the federal tax code and impose severe penalty (excise) taxes upon those who take advantage of their relationship to a public charity or social welfare organization to benefit themselves at a cost to their organization (by receiving an “excess benefit”). Intermediate sanctions serve as a sort of neutron bomb to a non-profit, i.e., they take out the human malefactor (the “disqualified person”) while leaving the charity standing. (Although the remaining taint may be crippling.) They start with return of the inappropriate gain, such as over-compensation of an executive, and ratchet up as follows:
- Payment of the excess benefit, with interest
plus
- 25% (of the excess benefit) as an excise tax
plus
[if there is delay in payment of the above]
- 200% (of the excess benefit) as a further excise tax
And if the (disqualified) person participated in the decision to award the excess benefit by, say, also voting as a member of the nonprofit’s board, he or she could also see an additional 10% tax (but here capped at $20,000).
Although he miscites Internal Revenue Code Section 4958 and refers to “excessive benefit,” it’s clear that Jon Krakauer is on the trail of intermediate sanctions. In support, Krakauer charges that the CAI improperly reports funds spent on promoting Mortenson’s books as program expenses, that Mortenson incurred lavish travel and lodging expenses, and that he “routinely [charged] personal expenses to CAI” and failed to account for his expenses. Indeed, an attorney reported to CAI’s board that for its fiscal year 2009, Greg Mortenson had received an estimated excess benefit of $2,421,152.71. Plugged into the framework above, this potentially creates a liability of:
$2,421,152 Repayment of excess benefit (not counting interest)
+605,288 25% excise tax
$3,026,440
+4,842,394 200% excise tax
$7,868,834
+20,000 Penalty by virtue of board membership
$7,888,834 Total
We’re starting to talk some real money here, as evidenced by the estimate from the same attorney that Mortenson could confront a total liability for the three fiscal years of 2007, 2008, and 2009 ranging from $7,868,746.31 to $23,606,238.62.
Assuming it takes no hit to its exempt status, can the Central Asia Institute continue its charitable objectives? It could reap the amount of any excess benefit to its founder, but would this fully offset any damage to its reputation? It’s too soon to tell.
Will the IRS take action? The agency might not have much choice, depending upon the profile this skirmish assumes. But let’s not forget that the intermediate sanctions rules allow the IRS to precisely impose its penalties upon Mr. Mortenson individual himself. There is, of course, the risk of collateral damage (up to $20,000 total per incident) upon other approving members of the CAI’s board. One can hope that the board properly reviewed Mr. Mortenson’s compensation increases to establish a rebuttable presumption of reasonableness (advance approval, applicable comparability data, and adequate documentation). And let’s not forget that state attorneys general can maintain enforcement actions against public charities, and in this case, the AG of Montana has just (as of April 19) begun an inquiry. It could get nasty out there.
Oh, yeah, there may also be issues of private inurement. More on that in a later post.