Beyond Conflicts of Interest: Ensuring True Independence on Your Nonprofit Board

Are your nonprofit’s board members truly independent? Your immediate response might be, “Of course!” But true independence extends beyond simply avoiding conflicts of interest. In fact, the IRS has outlined a specific four-part definition for board member independence. If the majority of your board doesn’t meet all four of these criteria, you risk having your governance questioned by the IRS, donors, and other stakeholders.

The Four IRS Criteria for Independence

To maintain independence as defined by the IRS, members of a 501(c)(3) board must meet all of the following conditions:

1. No Employee Compensation
   Board members cannot be compensated as officers or employees of your organization or any related entity.
2. Limited Contractor Compensation
   A board member cannot receive more than $10,000 in compensation as an independent contractor for services rendered to your organization or related organization (excluding reasonable compensation for board service).
3. No Material Financial Transactions
   Board members and their close family members must avoid transactions with your organization that provide material financial benefits and are reportable on Form 990, Schedule L, “Transactions with Interested Persons.”
4. No Reportable Transactions with Related Entities
   Board members and their close family members must avoid reportable transactions with any related taxable or tax-exempt organization that would need to be disclosed on Schedule L.

Additionally, you are required to disclose on Form 990 if any officers, directors, trustees, or key employees had family or business relationships with each other during the tax year.

Gathering Information for Compliance

To comply with these requirements, your organization must make a “reasonable effort” to gather information regarding board members' family and business relationships. Many nonprofits use an annual questionnaire for board members, officers, trustees, and key employees to ensure accurate Form 990 disclosures.

Importantly, a board member can still be considered independent even if they receive benefits as a member of the population your organization serves. Additionally, a religious exception may apply: if a board member has taken a vow of poverty and belongs to a religious order that receives sponsorship or payments from your organization, those payments generally won’t disqualify the individual from independence, as long as the payments are not considered taxable income.

Not All Board Members Need to Be Independent

It’s worth noting that the IRS does not require every board member to be independent. You might have an employee or an individual who has lent money to your organization on your board, for instance. However, watchdog groups generally recommend that nonprofits maintain a majority of independent directors, and some states, like California, require at least half of the board to be independent. The IRS also advises that at least 51% of board members have no familial relationships with each other.

Best Practices to Avoid Conflicts

For both compliance and reputation, it’s best to maintain a board with at least two-thirds independent members. To further avoid conflicts and safeguard governance integrity:

• Ensure that all members of your audit and compensation committees are independent.
• Where possible, aim for independent members to make up the majority of your governance and nominating committees.

Maintaining board independence helps promote sound governance and builds trust with the IRS, donors, and other key stakeholders. For further guidance on ensuring compliance and best practices in board governance, feel free to reach out to us.

How HoganTaylor Can Help

The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact Jack Murray, CPA, Nonprofit Practice Lead.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.