While the Internal Revenue Service is seen as the primary watchdog to the nonprofit world, attorneys general also can investigate nonprofits, and AG investigations into nonprofits and churches are on the rise.
This may be surprising, but in most states, attorneys general not only have the power to investigate nonprofits and churches, but they also have the power to render civil and criminal penalties and prosecute and remove board members.
In one non-church nonprofit matter in Minnesota, the attorney general even petitioned to dissolve a nonprofit.
There is certainly an overlap between an attorney general and the IRS’s involvement in investigating churches and nonprofits for financial concerns, but it seems that the attorney general’s offices are picking up in areas where the IRS is not.
Under IRS regulations, the IRS must have a “reasonable belief”—with evidence—that wrongdoing is occurring.
However, “reasonable belief” is not a requirement for attorneys general.
In our law practice—exclusively devoted to representing churches and nonprofits—this has been the fastest-growing trend in years.
From 2010 through 2022, we only saw a handful of these investigations. They predominantly focused on non-church nonprofit organizations.
Since fall 2022, though, we have represented churches and nonprofits in more than a dozen attorney general investigations.
What triggers an attorney general investigation?
Just as Scripture refers to money as the root of all evil, in the nonprofit compliance world, money is indeed the root of all state attorney general investigations.
Due to the potential for fraud, state attorneys general are very interested in how church boards handle money provided by the citizens of their states.
The online complaint process is simple, and can trigger an investigation for reasons that include, but are not limited to, the following:
- Loans to directors and officers: In many states—such as Florida, Tennessee, New York, and California—it is illegal for a church to loan any money to individual board members. This may even include using church credit cards for personal purchases and reimbursing the church later, which amounts to short-term loans. There are serious legal consequences here for what essentially amounts to the comingling of church and personal funds.
- Misuse of ministry-owned housing: Problems occur in this area when a board member—most often a pastoral staff member—lives in ministry-owned property but does not have a housing allowance set up or in place, and the church does not report the value of the ministry-provided housing on individual tax returns.
- Questionable expenditures potentially in violation of tax laws: When an attorney general receives a complaint that a board member is personally benefitting, the law treats this as “inurement” (improper personal financial gain from the nonprofit).
- Personal clothing purchases
- Excessive travel expenses that appear to be personal
- Personal expenses (food, medical treatment, and other similar items)
Impropriety Related to Unrelated Business Income (UBI): Revenue generated by your church that appears to be substantial and not closely related to its exempt purposes may trigger unrelated business income taxes. Correct legal and accounting counsel on how to properly set up and facilitate your ministry’sUBI is critical. Improperly structuring multi-entity ministries—especially if UBI is involved and board members are involved in the process—can have dire consequences and present the appearance that the church is funneling money to the personal business endeavors of the church’s directors.
What does an attorney general investigation look like?
With an increase in these investigations, church leaders may wonder what to expect if one arises.
At the preliminary stage, there is a unique and limited opportunity to directly refute charges and provide the necessary evidence to do so.
But suppose the investigator sees that the organizational and legal health of the church is in disarray. In that case, it is a sure bet that the attorney general’s office will begin to investigate. At this juncture, this could be a criminal investigation into individual board members. It could also be a civil matter against board members and/or the entity, or a combination of both.
In all matters, hiring competent legal counsel to represent your organization throughout the investigation is critical.
If the matter is potentially criminal, the attorney general will have the option to investigate and present the findings to a grand jury for indictment. In lieu of indictment, some states may allow the church the opportunity to hire its own forensic auditor (holding certified fraud examiner (CFE) and/or certified financial fiduciary (CFF) certifications) to provide an independent report as to whether financial malfeasance occurred.
These audits often require $50,000 to $100,000 to complete. It’s expensive, but it’s better than a criminal indictment. And the state may still choose to indict depending on the findings.
Train your staff on how to avoid—and spot—financial misconduct with the help of Church Law & Tax’s “Safeguarding Your Church’s Finances”— an online course led by CPA Vonna Laue geared for church board members, pastors, church administrators and financial leaders, and even volunteers.
How can my church be prepared for an attorney general investigation?
Our firm has yet to encounter a board involved in an attorney general investigation that had been properly trained on:
Focus on the following areas to reduce the risk of a lengthy investigation:
Board member training covering fiduciary duties, oversight responsibilities, and understanding your church’s governing documents and board policies. Every new board member should also receive this training. Proper board disciplines should include—but not be limited to—keeping accurate minutes and board member recusal of voting as it relates to conflicts of interest.
Written board policies and procedures that promote legal and financial integrity such as:
- Conflict of interest policy
- Independent compensation policy
- Confidentiality policy
- Restricted funds policy
- Policy prohibiting cash structuring
Simply ensuring your board members have this information and understand their roles will virtually eliminate this risk.
Dustin Gaines is a pastor and a lawyer who is a partner with My Church Law Firm in Texas. Dustin specializes in litigation related to churches, schools, and religious non-profits.