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The IRS View of Nonprofit Governance

With recent substantial changes to Form 990, the Internal Revenue Service has taken the position that good governance is of paramount importance to nonprofit organizations. Its Tax Exempt and Government Entities Division (TE/GE) has identified what constitutes good governance—an engaged, informed, and independent board; defined policies and practices; and transparency—and is focusing agency resources on enforcement of compliance with these standards.

Be forewarned that future IRS examinations will begin to emphasize good governance, with field auditors trained to collect information and complete a checklist regarding an organization's governance practices and internal controls. Auditors will seek to identify instances of noncompliance as well as any internal controls shortfalls. A recent article, "The Door Has Opened: New Form 990 Creates Strategic Opportunities and Risks for Nonprofit Organizations," notes that organizations prepared for this increased transparency can benefit, but unprepared organizations may potentially be subjected to damaging external risks. Thus, implementing best practices to meet good governance standards has never been so important.

Why, you may ask, is the IRS engaging in this focus? Simply stated, the exempt organization arena is significant and growing at a staggering pace—with more than 1.9 million exempt organizations (not including organizations qualifying for the religious exemption) and nearly 200 applications approved per day!

The size of the sector, the magnitude of its assets, and impact on the economy make good governance essential.

Sarah Hall Ingram, the IRS commissioner for Tax Exempt and Government Entities, has stated (see her comments at Georgetown University) that principles of good governance include the following:

  • The organization should clearly understand and publicly express its mission. (An organization can jeopardize its exempt status by changing its mission.)
  • The organization's board should be engaged, informed, and independent.
  • The board should have real responsibility and authority, including implementing the rules against inurement and self-dealing.
  • The organization should ensure proper use and safeguarding of assets.
  • The organization should implement policies and practices that address executive compensation, protect against conflicts of interest, and support independent financial reviews.
  • Relationships and decision making should be transparent—board decisions should be reflected in minutes, and whistleblowers should be protected.
  • The organization's Form 990 should be complete, accurate, and prepared in good faith.
  • The organization should develop a system of internal controls that is appropriate to the organization itself.

Beware: The IRS will be using Form 990, Part  VI, Governance, Policies, and Disclosure, to identify noncompliant organizations. Examiners will be looking for disclosures or the lack thereof that indicate the existence of: excessive compensation, political intervention, inurement, private benefit, and material diversion of assets. Note that such instances of non-compliance are subject to tax. There is a tax on political expenditures, an excess benefits tax on excessive compensation, and a tax on prohibited tax shelter transactions.

When an organization has adopted good governance practices, the IRS expects that there is less risk of misuse of tax-exempt status and charitable assets, assisting the IRS with managing the agency's enforcement funds and reducing the risk of non-compliance.

Good governance is at the forefront of the TE/GE. If your organization needs advice, consult a legal or tax advisor.

Sarah Avery, CPA, Friedman LLP
© 2009, Friedman LLP

Sarah Avery is a senior manager in the Not-for-Profit Services Group of Friedman LLP. Friedman LLP provides accounting, tax, and consulting services to public and privately held companies.

Best Practices in Nonprofit Governance

The seven governance and management polices identified by the IRS are:

  1. Executive compensation—determining and substantiation
  2. Conflict of interest policy
  3. Investment policy
  4. Fundraising policy
  5. Documentation of board meeting minutes
  6. Document retention and destruction policy
  7. Whistle blower policy
Topics: Policy