UPDATE: This alert has been revised following a stay of a preliminary injunction on March 14, 2025, by a three-judge panel of the Fourth Circuit Court of Appeals regarding certain provisions of Executive Order 14173. For additional details, please consult our latest blog post Federal Appeals Court Reinstates Provisions of DEI Executive Orders.
Tax-exempt organizations, including private foundations and other types of nonprofits associated with high-net worth individuals, have been subject to increasing investigative scrutiny in recent years. Last Congress, for example, the House Judiciary Committee and several other committees issued document requests to multiple nonprofit organizations, and in this Congress the trend is likely to continue. The current administration issued executive orders that may impact the operations of nonprofit organizations, as outlined below. This environment brings significant uncertainty, and tax-exempt organizations should consider undertaking risk assessments and preparing now. Below, we outline potential steps for tax-exempt organizations to take. Our practitioners are available to discuss these issues as needed.
I. Recent Executive Orders
Several recent executive orders shed light on the types of activities that could be impacted:
A. EO 14173 (“Ending Illegal Discrimination and Restoring Merit-Based Opportunity”) (January 21, 2025). This order concerns “race- and sex-based preferences” in certain institutions of American society, including institutions of higher education, and provides that such preferences can violate civil rights. The order also directs federal agencies “to combat illegal private-sector DEI preferences, mandates, policies, programs, and activities.” As part of this effort, within 120 days of the order, the attorney general must submit a report identifying “key sectors of concern” and “the most egregious and discriminatory DEI practitioners in each sector.” For each relevant federal agency, the report must also specify “up to nine potential civil compliance investigations of publicly traded corporations, large non-profit corporations or associations, foundations with assets of 500 million dollars or more, State and local bar and medical associations, and institutions of higher education with endowments over 1 billion dollars. ”Finally, the report must recommend potential avenues to challenge and restrict private-sector DEI initiatives, including potential litigation, regulatory actions, and sub-regulatory guidance. The EO also obligates each federal agency to immediately include certain provisions in future federal contracts or grant awards, including requiring that the federal contractor or grant recipient (1) “agree” that its compliance with all applicable federal anti-discrimination laws is “material to the government’s payment decisions” for purposes of the False Claims Act (“FCA”), and (2) certify that it does not operate “any programs promoting DEI” that violate federal anti-discrimination laws.
B. EO 14168 (“Defending Women from Gender Ideology Extremism and Restoring Biological Truth to the Federal Government”) (January 20, 2025). This order provides that federal funds, including grants, may not be used to promote “gender ideology,” defined as “the idea that there is a vast spectrum of genders that are disconnected from one’s sex.” The order specifies that “each agency shall assess grant conditions and grantee preferences and ensure grant funds do not promote gender ideology.”
C. EO 14190 (“Ending Radical Indoctrination in K-12 Schooling”) (January 29, 2025). This order defines “discriminatory equity ideology” as “an ideology that treats individuals as members of preferred or disfavored groups, rather than as individuals, and minimizes agency, merit, and capability in favor of immoral generalizations.” The order directs the secretaries of Education, Defense, and Health and Human Services to collaborate with the attorney general to develop a strategy within 90 days to eliminate federal funding for discriminatory equity ideology in K-12 education.
D. EO 14149 (“Restoring Freedom of Speech and Ending Federal Censorship”) (January 20, 2025). This order ends censorship of protected speech and requires the attorney general with the heads of agencies to investigate activities of the federal government that are inconsistent with the purposes of the executive order.
E. EO 14154 (“Unleashing American Energy”) (January 20, 2025).This order mandates an immediate review of all agency actions (existing regulations, orders, guidance documents, etc.) that impose an undue burden on the use of domestic energy resources, with a particular attention to oil, natural gas, coal, and other energy sources. The order further requires the head of each agency, in conjunction with the director of the Office of Management and Budget, to develop and implement action plans to suspend, revise, or rescind those agency actions that are unduly burdensome.
II. Potential Congressional Scrutiny
In congressional investigations, the past is usually prologue, and recent investigations of tax-exempt organizations have typically arisen in connection with the following issues:
A. Receipt of Federal Funds: Recipients of federal funds provide a convenient hook for congressional investigators seeking to target “waste, fraud, and abuse.” Investigations focused on the distribution of federal funds often include document and information requests to develop evidence that funds were improperly awarded (perhaps due to alleged conflicts of interest) and/or not used for their intended purpose (or that the intended purpose was itself improper, such as in past investigations of government grants focused on combating “misinformation”).Even organizations that did not receive their own federal funds—for example, funder organizations—could be swept up in an investigation if they donated to an organization that did receive federal funds.
B. Support for Disfavored Policy: Organizations that are perceived to support policies that do not align with the administration’s policy priorities, including those mentioned above relating to “DEI,” “gender ideology,” and energy-related issues, could have a greater risk for potential scrutiny.
C. Perceived or Overt Political Activity, Including through Affiliated Entities: Under IRS rules, some tax-exempt organizations are prohibited from engaging in certain types of political activity. In recent years, tax-exempt organizations that are perceived as seeking to influence the political or policymaking process, including through affiliated organizations such as 501(c)(4) organizations, have been accused of engaging in impermissible lobbying, with foreign funding that could be seen to support any such activity drawing particular scrutiny.
III. Risks to Exempt Organizations
It’s important to isolate the more practical aspects of the administration’s orders from the onslaught of news and “catchy” headlines. There remain many unanswered questions related to the administration’s orders, though some of the immediate risks to tax-exempt organizations are highlighted below. In some cases, the government’s authority to investigate lawful conduct is somewhat unclear, but in other cases Congress and the executive branch already have a variety of investigative tools and tactics at their disposal, such as congressional and grand jury subpoenas, IRS audits, and investigations initiated by regulatory agencies.
A. Tax Risks
Tax-exempt organizations have been facing increased scrutiny from the administration, and there are a host of questions that may arise. First, it is unclear to what extent the administration can wield the IRS to further its agenda. Section 7217 of the Internal Revenue Code prohibits certain “applicable person[s]” from influencing taxpayer audits or directly or indirectly requesting the IRS to commence or terminate an audit. The definition of “applicable person” includes the president and vice president and employees of their respective offices as well as cabinet secretaries (except for the attorney general).
But, if this were a path that the administration followed, there are processes in place that the IRS would have to follow. For instance, to challenge an organization’s exemption, it must commence an audit and cannot simply revoke the exemption. And, Treas. Reg. section 601.201(n)(6)(i) prohibits the IRS from retroactively revoking exempt status unless there was a material omission or misstatement of fact in the application for exemption. Moreover, an organization would have the opportunity to appeal an unfavorable determination during the audit process.
If an organization is subject to an IRS audit, it is less clear to what extent that organization can rely on a determination of exemption based on activities that previously qualified as exempt but that are directly called out in the administration’s executive orders. Under the administration’s new policies announced in the executive orders, these activities could be reclassified as “unrelated”—i.e., as activities that do not further and are not related to the organization’s exempt purpose. Income from such activities is taxed as unrelated business taxable income. Alternatively—or in addition—an organization’s tax-exempt status may be jeopardized if the organization engages in an activity that the IRS determines to contravene common-law standards of charity, i.e., violates the public policy doctrine. And while this doctrine is rarely invoked by the IRS and only narrowly used by courts, recent court cases such as Students for Fair Admissions v. Harvard and American Alliance for Equal Rights v. Fearless Fund Mgmt. LLC, indicate a shifting view away from affirmative action policies, which may impact other organizations engaged in similar activities.
For tax-exempt organizations that want to challenge these policies by lobbying Congress or engaging in political campaign activity, current law limits such activity, depending on the tax-exempt status of the organization. For 501(c)(3) public charities, lobbying is permitted, as long as lobbying is not a substantial part of the charity’s activities. A 501(c)(3) organization may not engage in any political campaign activity. For 501(c)(4) and 501(c)(6) organizations, an unlimited amount of lobbying is permitted, but political campaign activity may not be “substantial.” See our November 2024 alert for a discussion of the term “substantial” in this context.
B. Other Risks
Beyond the tax risks described above, organizations need to be prepared for increased enforcement from other agencies, e.g. DOJ, or Congress, which means having a plan in place to work through an audit or investigation.
Moreover, if an organization receives and relies on federal funding, its planning or programming may also be affected by these changes. If necessary, organizations should work with outside counsel to explore and identify alternate funding options to protect operations. See also this alert, which summarizes the implications of EO 14173 (“Ending Illegal Discrimination and Restoring Merit-Based Opportunity”) and offers considerations for federal contractors and grant recipients.
Finally, there are reputational risks to consider, such as public scrutiny on social media, which could severely impact the organization—including by affecting potential donors.
C. Final Thoughts: Staying Informed and Next Steps
The changes in government enforcement priorities can be daunting. We recommend monitoring the news, communications, and legal developments. Legal challenges to executive orders are likely, and the outcome of these challenges can impact the applicability of these orders. For example, in response to the executive orders, a coalition of 16 attorneys general has issued guidance for the private sector, including nonprofit organizations, on the distinction between legal practices and policies and illegal discriminatory conduct. As another example, just a couple of days ago, the Supreme Court rejected the administration’s attempt to freeze $2 billion for foreign aid, and ordered payment to be made to USAID contractors.
And, there are steps these organizations can and should take—both to prepare for further developments and to respond to increased scrutiny. Outside counsel can assist with undertaking a risk assessment or a review of key issues to identify and, where possible, mitigate risk. This allows organizations to continue carrying out their core functions while, hopefully, avoiding investigations and scrutiny that can become distracting and expensive. Below are a few steps that organizations can undertake:
- Take a thorough inventory of the organization’s key policies, protocols, trainings, and programs and identify operational gaps (e.g., reviewing the organization’s document retention policy and updating as needed).
- Conduct targeted fact gathering through interviews and document review to identify potential risks.
- Engage outside counsel to undertake a risk and compliance assessment of internal and external DEI programs and practices.
- Monitor developments and keep key stakeholders, such as the board of directors, updated, as warranted.
- Augment or develop training mechanisms on important topics like attorney-client privilege and tax-exempt organization rules.
If you have any questions concerning the material discussed in this client alert, please contact the members of our Tax practice.
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