• IRS Releases Draft of "Best Practices" for Charity Boards
  • February 23, 2007 | Authors: J. Leigh Griffith; Donald B. Stuart
  • Law Firms: Waller Lansden Dortch & Davis, LLP - Nashville Office ; Waller Lansden Dortch & Davis, LLP - Los Angeles Office
  • Governance, particularly in the nonprofit sector, has been a theme of the Senate Finance Committee for the past few years. Many on the Senate Finance Committee Staff seemed to believe that the governing boards of charities were all too often not properly functioning, not paying adequate attention to how operations were furthering the organization's charitable purposes, not exercising proper supervision over the compensation of senior staff, not promoting transparency and embedded with conflicts of interest.

    It is clear that many of these concerns have now taken root in the IRS and that the IRS intends to be more active in the nonprofit sector. Further evidence of this fact can be seen with the IRS' preliminary draft of guidelines for charitable governing boards entitled "Good Governance Practices for 501(c)(3) Organizations."

    Waller Lansden attended a recent IRS Tax Exempt/Government Entities Council meeting where the guidelines were informally released by Marvin Friedlander, Chief of the IRS Exempt Organizations Technical Branch. While stating that "adopting a particular practice is not a requirement for exemption..." (emphasis added), nine possible practices are suggested by the IRS, including: Mission Statement, Code of Ethics, Due Diligence, Duty of Loyalty, Transparency, Fundraising Policy, Financial Audits, Compensation Practices and Document Retention Policy.

    The IRS has characterized the draft as preliminary staff discussion, not yet approved at an official level and will continue to solicit views of "stakeholders" on what the guidelines should include. The IRS has noted that good governance practices may promote compliance with tax law and that it will also continue to review recent self-regulation proposals advanced by others.

    At a minimum the guidelines underscore the IRS' continued interest in strong corporate governance as a foundation of charitable organizations and a formalization of its interest. While many of the guidelines do not cover new ground or indicate new IRS "areas of interest," there are some that do - or at least show a greater IRS interest in certain areas, including:

    In addition to the adoption of a code of ethics (see the revised instructions for IRS Form 1023) and a clear mission statement, the guidelines call for governing boards to issue formal whistleblower policies for handling employee complaints and procedures for confidential reporting of suspected financial impropriety or misuse of charity resources.

    The guidelines call for governing boards to adopt and monitor procedures for making publicly available full and accurate information of the charity's mission, activities and finances and for the charity's Form 990, annual reports and financial statements to be posted on the organization's public website. The guidelines call for staff and Board members to annually disclose in writing all known financial interests that the individual or her family members has in any business entity that transacts business with the charity. (This disclosure is not required to be posted on a web site.)

    This section involving financial audits is the only guideline that differentiates between charities based on size. This guideline calls for all but the smallest charities to have independent CPA annual audit (note, an accountant on the board probably makes the firm not independent) and for larger charities to have an audit committee and change audit firms periodically (e.g., every five years). The guidelines permit the smallest charities to have volunteers that are "traded" with similarly situated organizations to review financial information and practices.

    The guidelines generally call for no compensation of board members but permit reimbursement of direct expenses. If there is to be board compensation it should be reasonable and determined by a committee of persons who are not compensated by the charity and have no financial interest in the determination. It is suggested that the board rely on the rebuttable presumption test under the excess benefit transaction rules.

    Document Retention
    The guidelines call for a formal document (including electronic media) integrity, retention, and destruction policy with archival backup procedures and regular check-ups of the reliability of such system.

    While many of the guidelines reflect common sense, best practices for any organization, it is clear that the IRS is anticipating and "encouraging" an increase in due diligence and oversight by nonprofit governing boards. It is possible that the adoption and good faith implementation of many of the guidelines would be considered by the IRS or courts with respect to mitigation or abatement of penalties.

    A copy of the IRS draft of "best practices" guidelines for charity boards is available online.

    The IRS has indicated that a consensus of good governance practices may emerge from the various proposals. Waller Lansden is soliciting proposals and comments on the draft from nonprofits, and we will provide these comments to the IRS. A revised draft of the good governance guidelines may be expected later this year.