On Tuesday, investigators from the District Attorney’s Office arrested [CEO Kyra] Worthy at her home in Richmond and booked her into San Francisco County Jail. She was charged with 34 felonies related to wage theft, embezzlement and misappropriation of public funds. Worthy was released on a $100,000 bond, made her first appearance in court Wednesday, and plans to plead not guilty at her next hearing in September, according to her attorney. The charges come six months after SF SAFE’s board fired Worthy after another intervention by city auditors that scrutinized the nonprofit’s spending and flagged ineffective oversight by one of its city funders, the San Francisco Police Department. The case offers the clearest accounting yet of the group’s missing finances, which investigators said Worthy used on extravagant parties, luxury gift boxes and personal expenses like her parents’ home nurse.
San Francisco Nonprofit CEO’s Embezzlement Creates Manager Excise Tax Liability; the Service Should Collect
There have been a buncha nonprofit embezzlement cases, lately. Have you noticed that? The Service ought to start aggressively imposing the manager level excess benefit taxes on board members. That’s the editorial point of this post. Too many insiders are getting away with large scale and long term embezzlement while nonprofit board members treat the position like a part-time job. The job is usually part-time but Trustees can’t think like it is. Board members are the only people within the organization standing watch. At least they should be, even if being a Trustee is just a part-time thing. State nonprofit and tax laws rightly impose certain duties on board members but I bet they are rarely enforced. I’m not being a scrooge. Most trustees probably don’t even get paid but right now we might be way too far on the permissive side because that fact. If the Service started excise taxing some of these napping board members we might see fewer embezzlement cases.
Case in point: A San Francisco Chronicle article about a CEO’s embezzlement from nonprofit, San Francisco SAFE, presents a good opportunity to impose the manager excise tax under IRC 4958(a)(2). Apparently SF SAFE’s board was asleep at the wheel while its CEO engaged in “incorporated pocketbook private inurement.” Incorporated pocketbook private inurement is when an insider uses her nonprofit to fund private consumption, as though the nonprofit’s accounts are hers to do with as she pleases. The CEO is now facing 34 charges of theft, embezzlement and misappropriation of public funds. The story’s focus is on the prior warnings the board received. I thought the reporter missed the issue of whether managers are liable for the excise tax under IRC 4958(a)(2). That provision states:
4958(a)(2) On The Management — In any case in which a tax is imposed by paragraph (1), there is hereby imposed on the participation of any organization manager in the excess benefit transaction, knowing that it is such a transaction, a tax equal to 10 percent of the excess benefit, unless such participation is not willful and is due to reasonable cause. The tax imposed by this paragraph shall be paid by any organization manager who participated in the excess benefit transaction.
Fortunately, it is not often that an exempt organization violates the prohibition against private inurement or excess benefit when an insider embezzles money from the organization. That’s just theft from the organization and a prosecutor’s lodging criminal charges should logically insulate the organization against the excise tax. The organization has not normally “engaged” in the profit-taking transaction. It is rather just a victim.
I am not advocating a stricter rule. But in this case, according to the article, accountants and auditors warned the Board President and Treasurer, so much so that investigators think the Board might have passively acquiesced:
The accountants “repeatedly” wrote to SF SAFE’s board president and treasurer in emails that they “needed to place controls on Worthy’s spending, and they needed to review her purchases,” San Francisco investigators wrote in court documents released this week. Audits completed by a different firm in 2021 and 2022 raised similar concerns. In a letter to the board, accountants urged them to set up a system to restrict Worthy’s ability to spend charity money “without oversight,” according to court records.
. . .
In their arrest affidavit, which was released Tuesday, investigators with the District Attorney’s Office highlighted what they described as inaction by the board in the face of Worthy’s allegedly questionable spending. It would be “difficult” to prove that all of Worthy’s misspending constituted theft, investigators wrote, because “the board was aware of her spending for years and neglected to intervene.”
Well! The article quotes Santa Clara’s Joan Harrington who correctly noted that the board may have violated its duty of oversight. That, most likely, because the board was too busy being wined and dined by its CEO to care, according to the article. Nonprofit boards are easily seduced by the pomp and circumstance of well-catered receptions before or after meetings, and lavish parties put on by the CEO. Enough that they never ask “who is paying for all of this.” The article does not mention tax liability, as that is likely an afterthought in comparison to the criminal liability the CEO is facing. But this case proves that criminal liability shouldn’t insulate trustees from excess benefit tax liability, as would normally be the case when its all about embezzlement.
When I use this case in class, I hope my students ask whether the managers’ implicit acquiescence and failure of oversight constitutes “knowing participation.” Here is the applicable regulation:
53.4958-1(d)(3) Participation. — For purposes of section 4958(a)(2) and this paragraph (d), participation includes silence or inaction on the part of an organization manager where the manager is under a duty to speak or act, as well as any affirmative action by such manager. An organization manager is not considered to have participated in an excess benefit transaction, however, where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager’s responsibilities to the applicable tax-exempt organization.
As Harrington noted the Board President and Treasurer had a duty to act. So this case seems on all fours as far as participation. Treasury regulation 53.4958-1(d)(4)(i) discusses “knowing” participation:
53.4958-1(d)(4)(i) In General. — For purposes of section 4958(a)(2) and this paragraph (d), a manager
participates in a transaction knowingly only if the person–
53.4958-1(d)(4)(i)(A) — Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction;
53.4958-1(d)(4)(i)(B) — Is aware that such a transaction under these circumstances may violate the provisions of Federal tax law governing excess benefit transactions; and
53.4958-1(d)(4)(i)(C) — Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.
53.4958-1(d)(4)(ii) Amplification Of General Rule. — Knowing does not mean having reason to know. However, evidence tending to show that a manager has reason to know of a particular fact or particular rule is relevant in determining whether the manager had actual knowledge of such a fact or rule. Thus, for example, evidence tending to show that a manager has reason to know of sufficient facts so that, based solely upon such facts, a transaction would be an excess benefit transaction is relevant in determining whether the manager has actual knowledge of such facts.
The Service ought to start making examples of these sleepy board members, is all I’m saying.
darryll k. jones