co-authored by Jenny Kassan and Cecily Jackson

The IRS has been paying increasing attention to the governance of nonprofit organizations.  Here are some guidelines for a “governance tune up” for your nonprofit.

Step 1: Read your governance documents and revise if necessary

Gather together your articles of incorporation, bylaws, policies, and any meeting minutes documenting important decisions.  Make sure all board members, officers, and key employees have copies and read them.  Pay special attention to provisions about whether or not the organization has members, how directors are elected, number of directors, how officers are chosen, qualifications for officers and directors, terms and term limits for officers and directors, notice requirements for meetings, and whether the board is authorized to create committees that have some decision making authority.

Note that if the articles or bylaws state that the organization has members, the organization is subject to a large number of additional legal requirements regarding the rights of members to elect directors, receive information, participate in major decisions, etc.  Many organizations have people that they call members but who are not members according to the strict legal definition contained in the nonprofit statute under which they were formed.  It is essential to understand whether your nonprofit has members as defined in the statute because it will have major implications for governance.

Make sure that the governance documents are clear and easy to follow.  You may want to compare them to the statute the organization was formed under (e.g. the California nonprofit public benefit statute) to make sure there is nothing in your governance documents that conflicts with legal requirements.  If anything is inconsistent or unclear, it is time to amend the document(s).  Also, if your actual practice is different from the written policies, either the practice or the policy will need to be changed.

Step 2: Review practices for meetings

Meetings of the members (if any), board of directors, and committees (if they have any decision making authority) are where important decisions are made.  It is very important to ensure proper meeting notice (as required by the statute and bylaws) and to take accurate meeting minutes.

Step 3: Understand the powers of key players

There are few hard and fast rules about who is required to make a particular decision.  It is advisable for the board to determine in advance what decisions it will make versus those decisions that can be made by officers, committees, or staff.  For example, will the board review and approve the annual budget?  Will the board be required to approve expenditures greater than a certain dollar amount?  Having written policies regarding who has authority to make which decisions is advisable.

Some bylaws authorize the board to create an executive committee that has almost all of the authority of the board.  While this is allowed under most nonprofit statutes, the board should carefully consider whether it is advisable to delegate board authority to a committee.

Step 4: Understand duties of board members

Board members have the following duties (from the California Corporations Code and legislative committee comments):

• Duty of Care – A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances
• Duty of Inquiry – A director may not close his/her eyes to what is going on about him/her in the conduct of the corporate business and, if he/she is put on notice by the presence of suspicious circumstances, he/she may be required to make such reasonable inquiry as an ordinarily prudent person in his/her position would make under similar circumstances
  • Directors may rely on information, opinions, reports, or statements, including financial statements, prepared or presented by the following: (1) One or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented; (2) Counsel, independent accountants, and other persons on matters that the director believes to be within such person’s professional or expert competence; (3) A committee of the board on which the director does not serve, as to matters within the committee’s designated authority
  • In relying on the opinions or reports of others, the director must act in good faith and conduct reasonable inquiry when the situation indicates a need for such inquiry. The director must also be free of any knowledge that would cause reliance on data received from others to be unwarranted.
• Duty of Loyalty – A director must act in a manner that the director believes to be in the best interests of the corporation and all of its members, including the members of minority factions, and to administer their corporate powers for the common benefit
• Corporate Opportunity Doctrine – If a director becomes aware of an opportunity or a transaction that would be of interest or benefit to the corporation, the director must disclose the opportunity to the corporation and permit it to take advantage of the opportunity, if it so desires

Board members and key staff should be trained on their duties and responsibilities.

Step 5: Properly document changes in mission and activities

It is important to review the purposes statement in your articles, bylaws, original application for tax exempt status, and annual information returns.

If the organization’s actual mission and/or activities have changed, this should be reflected in amended documents and should be reported to the IRS on the annual information return.

Step 6: Review policies and consider adopting additional policies

The annual information return that nonprofits must file with the IRS (Form 990) was revised recently to reflect the IRS’ growing concern regarding governance.  The new form asks many questions about governance and policy issues. It is important to be aware of these new questions so that you are well-prepared to answer them before the deadline for filing the form.  In preparation, you will want to review what policies are already in place and what additional policies you may want to consider adopting.  The following are the primary policies that are asked about in the new Form 990:

• Process for determining compensation of the top management employees including review and approval by independent persons, use of comparability data (such as salary surveys), and contemporaneous substantiation of the deliberation and decision
• Process for board review of Form 990 prior to filing
• Conflict of interest policy
• Process for determining the independence of board members
• Process for determining family and business relationships among board members including annual disclosures
• Whistleblower  policy
• Document retention and destruction policy
• Process for review and audit of financial statements
• Process for making key documents available to the public
• Gift acceptance policy
• Policy regarding acceptance of conservation easements
• Policy regarding participation in joint ventures
• Policies and procedures governing the activities of chapters, branches, and/or affiliates
• Process for keeping meeting minutes

In May 2009 the IRS delivered trainings on nonprofit organizational governance to its Exempt Organizations examination agents and determination specialists.  These individuals review charitable organizations’ applications for exemption and annual Form 990 information returns.  They also determine which organizations should be subject to further review via an audit.

Although (as detailed below) the IRS has recommendations regarding tax-exempt organizations in general, the training materials emphasize that each organization may choose its own governance regime.

In the materials, the IRS defines governance as “the exercise of authority and control over an organization.”  The agency notes that tax-exempt organizations’ governance varies based on the size, type, structure and culture of organizations, and repeatedly stresses that “one size does not fit all.”

Highlights of the IRS’s recommendations include that the board should:

• Consist of active and engaged members;
• Have a substantial majority of independent members who do not have familial or business relationships with employees;
• Actually govern the organization’s affairs;
• Meet regularly and document meetings, committee meetings, and decisions;
• Implement policies relating to conflicts of interest, whistleblower claims, document retention and destruction, compensation, and investments;
• Employ term limits;
• Recruit board members with diverse subject matter expertise in the following areas: budget and financial management, investments, personnel, public relations and marketing, governance, advocacy, and leadership (with particular emphasis on financial management);
• Only receive compensation as reasonable and necessary for the functioning of the organization;
• Ensure compensation decisions are made by knowledgeable individuals with no financial interest in such decisions;
• Ensure that they understand any joint venture or investment of the organization.
• Ensure that fundraiser compensation is commensurate with the fundraiser’s knowledge, background, and activities performed, rather than based upon a percentage of the funds raised.

Click here to see the IRS’ complete training materials on governance.

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