An attorney’s view: Key issues for non-profit hospitals and healthcare systems, educational institutions, and other non-profits to be aware of in 2024

Executive summary:

Some hospitals and healthcare systems increased their spending rates in 2022 to offset steeper operational costs and lower market returns. Although markets have since recovered and inflation is declining, today may be a little too early for these organizations to think about adjusting spending rates. This is because most non-profits use a smoothing mechanism for market valuation purposes, which typically uses the average market valuation over a rolling 12-quarter period. This means that many organizations are probably not reaping the full benefits of the current market rally yet.
The IRS' proposed expansion of the definition of donor-advisors to include personal investment advisors would prevent a personal investment advisor from receiving compensation without significant adverse tax consequences. This rule, if passed, would shut down the role of personal investment advisors in managing a donor’s DAF, and would have significant impact on some DAF programs of community foundations.
As U.S. election season heats up, non-profits should carefully review the rules prohibiting political involvement, and be extra mindful of staying in compliance with these laws.

As 2024 hits its stride, what issues should non-profits, including hospitals and healthcare systems and educational institutions, be paying attention to? What are the latest developments on the regulatory front? What rules should they be aware of as the U.S. election season kicks into high gear?

To shed some light on the main issues these organizations may have to grapple with as the year unfolds, we sat down with Michele McKinnon, a seasoned non-profit attorney at the national law firm of McGuireWoods LLP. Michele has more than 35 years of experience advising public charities, major colleges and universities, supporting organizations, large private foundations, and charitable trusts on a variety of federal tax and governance matters. Below is a summary of our conversation, with answers edited for length and clarity.

When we spoke last in 2022, many non-profit organizations—including hospitals and health systems, educational institutions, community foundations, charitable organizations and private foundations—were facing some pretty strong headwinds, including decades-high inflation and declining equity and bond markets. Today, inflation is sharply lower and the stock market has reached new highs. Is it safe to say most non-profits are faring better these days?

Michele McKinnon: Yes. Most non-profit hospitals and healthcare systems are humming along smoother today as the chief concerns from 2022—skyrocketing inflation and souring markets—have gone away. In particular, the rise in markets has been great for endowed non-profits, as it’s increased funding from endowments (since the value of their assets is now worth more).

In addition, high-net-worth individuals are making more money in the markets, leading to plenty of giving. Organizations that typically receive large gifts—such as educational institutions and religious organizations—are continuing to receive funding. Private foundations and donor-advised funds, in particular, are continuing to receive donations and make grants to other charities.

Keep in mind, though, that today’s economy is unusual and is having different impacts on smaller non-profits—such as regional hospitals—that are dependent on annual gifts. These organizations, which don’t have a lot of investment assets, are struggling more, while organizations with plenty of assets are doing well because the market is doing well. In other words, the so-called dual economy, which took root during the COVID-19 pandemic, is still very much a thing today.

Some of the non-profit hospital and healthcare systems that are faring better today may have increased their spending rates in 2022 to offset steeper operational costs and lower market returns. Now that inflation is under control and markets have recovered, should these organizations consider adjusting their spending rates?

Michele McKinnon: With the macroeconomic backdrop improving, now could be an appropriate time for some non-profit hospital and healthcare systems to revisit their spending rates. To review, the board of a non-profit sets the spending rate by taking into account certain factors, including long-term purchasing power, market conditions and expected returns, as well as the needs of the organization. Boards have a duty to regularly evaluate these factors and change their spending policy if needed or as appropriate.

For many non-profits, including hospitals and healthcare systems, today may be a little too early to think about adjusting spending rates. This is because most non-profits use a smoothing mechanism for market valuation purposes. This mechanism typically uses the average market valuation over a rolling 12-quarter period, which smooths out the ups and downs of the market. Using a mechanism like this is supposed to enable non-profits to maintain consistent levels of spending that are less susceptible to market fluctuations.

Since markets only began rising last October, many organizations are probably not reaping the full benefits of the market rally yet—since the five-or-so months of up markets would be offset by the year-plus of down markets. This means, for instance, that a hospital that found itself in dire straits during the pandemic and increased its spending policy might want to wait longer to see how long the market rally lasts before weighing any alterations. But I would always encourage a board or investment committee to be monitoring these factors along with the needs of the organization on a regular basis.

Have there been any notable recent changes to the laws governing non-profits in the past two years?

Michele McKinnon: There haven’t been any significant changes to the tax laws since we last spoke in 2022. There have been a few changes that impact charitable giving—most notably, changes made by Congress pertaining to qualified charitable distributions from an IRA. These changes were made under the SECURE Act 2.0 and were effective Jan. 1, 2023. Under these rules, IRA owners over the age of 70½ can make a one-time contribution directly from their IRA to a charity in return for a charitable gift annuity (CGA) or to a charitable remainder trust (CRT). The CGA or CRT can only be funded with the IRA funds (no other asset contributions are permitted). The maximum amount that can be transferred is $50,000 (and the amount will be indexed for inflation each year, beginning in 2024). In addition, the use of this funding amount must be done in a single year, and the CGA or CRT must be funded exclusively with the IRA assets.

The beneficiary of the CGA or CRT can only be the IRA owner and/or their spouse and the remaining beneficiary must be a public charity other than a donor-advised fund or supporting organization. There are other rules that apply, and I would strongly recommend any donor or organization receiving this type of IRA distribution consult with a tax advisor before proceeding.

It sounds like actual regulatory changes have been few and far between, but there is one big proposed change pertaining to donor-advised funds that is causing quite a stir. Can you explain what this proposed change is, and what type of non-profit it would impact the most?

Michele McKinnon: Certainly. In November 2023, the Treasury Department released the first set of proposed donor-advised fund (DAF) regulations. Note that there are additional regulations to come on all of the DAF tax laws enacted by Congress in 2006. What was released last November is just the first set of proposed regulations, which address Internal Revenue Code section 4966. This section imposes a tax on taxable distributions from a DAF but also includes a number of definitional provisions. Defined terms include the definitions of a donor-advised fund (DAF), a donor, a donor-advisor and a distribution. And some of these definitions set forth in the proposed regulations have caused some consternation in the non-profit and DAF communities.

In a nutshell, donor-advisors are the individuals who provide advice on DAFs, and investment advisors are the individuals who manage DAFs. Under the proposed regulations, donor-advisors also would include personal investment advisors—people who manage an individual’s DAF and the individual’s personal assets. Today, many community foundations—in order to encourage larger gifts from donors—typically allow donors to designate their personal investment advisor (essentially, a broker or investment manager) to manage their DAF (and, with respect to the DAF, assets under the control of the DAF-sponsoring organization). Brokers or managers, in turn, are happy with this arrangement, as they continue to receive compensation from the DAF for their management services.

Critically, the notice of proposed rulemaking issued by the IRS in November, with the expansion of the definition of donor-advisors to include personal investment advisors, would prevent a personal investment advisor from receiving compensation without significant adverse tax consequences. Any payment of compensation to a donor-advisor (which would include a personal investment advisor under the proposed regulations) constitutes an “automatic” excess benefit transaction that would expose them to significant excise taxes under the excess benefit transaction rules that apply to public charities. For example, a personal investment advisor compensated $50,000 by a DAF would have to pay a 25% excise tax on the amount of the compensation paid and return the compensation (with interest) to the DAF’s sponsoring organization to avoid an additional and punitive excise tax of 200% of the compensation.

It's easy to see how this proposed rule, if passed, would shut down the role of personal investment advisors in managing a donor’s DAF and would have significant impact on some DAF programs of community foundations (and potentially other DAF sponsoring organizations in certain circumstances). I will note that there are rules designed to prevent classification of an investment advisor as a “personal investment advisor” when the investment advisor provides services to the DAF sponsoring organization as a whole and not individual DAFs.

What’s more, the proposed effective date of this change is also problematic, as it would apply to any tax year ending after the regulations are finalized. This would mean that investment management fees paid in the same year that the regulations are finalized would be considered automatic excess benefit transactions, even if paid before the actual effective date of the regulations. It could also mean that DAFs would have to change their investment advisors on short notice. During the comment period on this proposal, which ended in February, we saw many statements advocating for the effective date to be prospective, rather than retroactive. There is a hearing on these regulations scheduled for May 6, 2024, and I understand that it would be customary for Treasury to continue to accept comments beyond the end of the comment period.

Let’s turn to elections. 2024 is a big election year in the U.S.—and we all know that 501(c)(3) organizations are prohibited from engaging in “political campaign activity.” Can you walk us through what exactly this means? What are some do’s and don’ts for non-profits to be aware of in this election year?

Michele McKinnon: To reiterate, 501(c)(3) charitable organizations are specifically prohibited from being involved in any type of political campaign activity. It is an absolute prohibition and violations can result in loss of exempt status. The rule is codified in section 501(c)(3) and is often referred to as the Johnson Amendment, which was added to section 501(c)(3) in 1954. Specifically, the rule prohibits a 501(c)(3) organization from participating or intervening in (including the publishing or distribution of statements) any political campaign on behalf of or in opposition to any candidate for public office. The Johnson Amendment has received a great deal of attention over the last few election cycles, particularly in the context of religious organizations. But the rule continues to remain a requirement for tax exemption for any organization described in section 501(c)(3).

Let’s dig into this a bit. What if a non-profit university is asked to host a presidential candidate at an event on campus. Is that allowed?

Michele McKinnon: It is allowed—provided it’s done on an educational basis and there’s no indication the university is supporting or opposing the candidate politically. And the university would also have to allow other candidates the same opportunity upon request.

Notably, many election debates—both at the federal and state level—are held at non-profit universities. Under the law, this is totally fine, as it’s done on an educational “inform the voters” basis—versus the university supporting one candidate over another. Note that this rule applies to all non-profits—public charities, foundations and the like.

Can a non-profit accept contributions from an individual affiliated with a political campaign?

Michele McKinnon: Yes, as long as the gift is not used for political purposes. Non-profits are allowed to accept contributions from any individual they want—including, for instance, a person who is a large donor to a presidential campaign. But they cannot accept the gift if it will be used for political campaign activity; the funds must be used solely for the organization’s exempt purposes.

Are there any other issues non-profits should be aware of this election year?

Michele McKinnon: Yes. One topic that crops up every time election season rolls around deals with individuals who work at non-profits but engage in political activity in their own capacity. Under the IRS rules, this is allowed. For instance, a president of a non-profit can involve themselves in political activity as long as it’s not on behalf of their organization. The lines around this can get very blurred, however, as the official has to make it very clear that they are not acting on behalf of the organization.

Last but not least, there is one special type of non-profit organization that can engage in some political activity, right? Can you elaborate?

Michele McKinnon: Yes. 501(c)(4)s, or social welfare organizations, are permitted to engage in political activity without jeopardizing their exempt status, but there are limits. By law, political campaign activity may not constitute the primary activity of a 501(c)(4) organization. Note that although 501(c)(4) organizations are tax-exempt, donations to them are not tax-deductible for income tax purposes.

The bottom line

As inflation eases and the market rally continues, the outlook for non-profit organizations—including hospital and healthcare systems, schools and universities, community foundations and other charitable organizations—appears much brighter than a few years earlier. However, there are still plenty of bumps in the road ahead for non-profits to navigate, especially as election season heats up.

All non-profits should carefully review the rules prohibiting political involvement, and be extra mindful of staying in compliance with these laws during what will likely be another polarizing election year in the U.S. In addition, the IRS’ proposed regulations with additional guidance on definitions pertaining to DAFs could have significant implications for DAF-sponsoring organizations and donors to DAF if the regulations are finalized without further changes. Non-profit organizations would be wise to stay up to date on developments, and reach out if assistance is needed. At Russell Investments, our dedicated non-profit solutions team stands ready to help.