State developments impacting the nonprofit sector

As we near the end of 2019, we continue to see states stepping up to take action with respect to regulating the nonprofit sector, either in direct response to federal policies (or threatened policies) or generally in response to the perceived reduction in federal enforcement with respect to exempt organizations. California is no exception, with Gov. Gavin Newsom recently vetoing one bill regarding nonprofit accounting rules and signing into law another bill regarding worker classification that will have significant impact on California nonprofits. New York Gov. Andrew Cuomo also recently signed into law a bill codifying at the state level the current federal prohibition on 501(c)(3)s engaging in political campaign intervention activities.

Changes to Classification of Workers

In April of last year, the California Supreme Court issued a decision in Dynamex Operations West v. Superior Court that upended the longstanding test for determining whether a worker is properly classified as an employee or an independent contractor for purposes of California's wage orders. On Sept. 18 of this year, Gov. Gavin Newsom signed into law Assembly Bill 5, codifying the new test set forth in the Dynamex decision for state law purposes. The new law will go into effect on Jan. 1, 2020.

The more stringent test set forth in Assembly Bill 5, referred to as the "ABC Test," provides that all workers are by default considered to be employees, unless the employer can demonstrate that three factors are met. The three factors are that the worker: (A) is free from control and direction by the hiring entity in performing the work, both based on the terms of the contract and in reality; (B) performs work that is outside the usual course of the hiring entity's business; and (C) is customarily engaged in an independently established trade, occupation, or business of the same general nature as the work being performed for the hiring entity. A worker may only properly be classified as an independent contractor if all three of these factors are true.

Assembly Bill 5 was in response to the rampant classification of workers as independent contractors by gig economy companies. Although the Bill includes some exceptions for certain types of services, including certain professional services, and for certain business-to-business contracting relationships, it will apply broadly to most employers in California, including many nonprofits. As a result, the last quarter of the year is seeing numerous nonprofits scramble to determine whether they need to make any changes to their worker classifications before the beginning of the new year, and what the financial implications of such changes will be. It is also widely anticipated that this new law in California could be the harbinger of what is to come in other states, and it may be wise for nonprofits located outside of California to begin considering the impact of such a potential change.

Gifts-In-Kind Legislation Vetoed

In October, Gov. Newsom vetoed another bill that would have impacted the nonprofit sector. Assembly Bill 1181 was approved by the Assembly and Senate before being sent to the governor for signature. The bill was sponsored by Assemblywoman Monique Limón (D-Santa Barbara) and would have required nonprofits to account for gifts-in-kind in a different manner. The bill, which had the support of the attorney general, was in response to a growing concern from the attorney general's office about nonprofits inflating the value of donated drugs distributed in foreign countries by reporting their value based on U.S. drug prices. The bill would have required nonprofits to instead value such gifts-in-kind contributions based on their fair market value in the end recipient market where they were redistributed.

Many nonprofits and advisors had raised concerns about imposing an accounting requirement on nonprofits that would be unique to California. In explaining his veto of the bill, Gov. Newsom similarly cited concern that the bill could "pose burdensome implementation challenges for the charities impacted by its provisions." It's easy to imagine the headache that could arise for multistate nonprofits if states imposed different accounting requirements, forcing them to maintain separate sets of accounting and undermining the use of Generally Accepted Accounting Principles. Gov. Newsom did indicate that he generally agreed that the underlying issue needs to be addressed, however, stating "I agree with the attorney general that overvaluation is a problem, and my Administration is open to exploring less burdensome ways to address the issue."

NY Law Prohibiting Political Campaign Intervention

I have written several times in this column about efforts by the current presidential administration to repeal, in whole or in part, the prohibition on 501(c)(3)s engaging in any activity in support of or in opposition to candidate for elected office. While such repeal efforts of the prohibition, which is often referred to as the "Johnson Amendment," have thus far fallen short, they have stirred a significant backlash from many nonprofits and professionals who serve or advise the sector.

I have also raised the question of how states may respond if such a repeal were ever to be successful. Just recently, New York Gov. Cuomo signed legislation intended to account for just such a possibility. The legislation (S.4347/A.623) codifies the Johnson Amendment prohibition on political campaign intervention as a condition of exemption from state taxes in New York. It adds text to the New York tax law clarifying that the provisions in the relevant section relating to political campaign activities are to be interpreted in the same manner that Section 501(c)(3) of the Internal Revenue Code is currently interpreted.

Section 23701d of the California Revenue and Taxation Code, which deals with exemption from state franchise taxes for organizations described in Section 501(c)(3), currently tracks the language of that section of the Internal Revenue Code. It describes an organization "which does not participate in, or intervene in (including the publishing or distribution of statements), any political campaign on behalf of (or in opposition to) any candidate for public office." However, if the Johnson Amendment were ever to be repealed, and if California law was not amended to remain consistent with federal requirements, California would be left to develop its own set of regulations establishing what constitute campaign intervention for purposes of Section 23701d. By incorporating the current interpretation applicable to Section 501(c)(3), New York has preemptively addressed this potential issue. It will be interesting to see if other states follow suit. 