Board Independence: More Than Avoiding Conflicts of Interest

Are your not-for-profit’s board members independent? Your immediate response is probably, “of course!” But contrary to what many nonprofit leaders and staffers might think, director independence goes beyond avoiding conflicts of interest. In fact, the IRS has a four-part definition of independence. If a majority of your organization’s board members don’t meet all four criteria, the IRS, donors and other stakeholders could call your governance into question.

4 criteria 

The IRS stipulates a four-part definition of independence for members of 501(c)(3) boards. To be independent, your directors can’t:

1. Receive compensation as officers or employees of your organization or a related organization.
2. Receive more than $10,000 in compensation for work as independent contractors from your organization or a related organization during the tax year (excluding reasonable compensation for services provided as a board member).
3. Engage in — or have close family members engage in — transactions with your organization that provide material financial benefits and that must be reported on Form 990, Schedule L, “Transactions with Interested Persons.”
4. Engage in — or have close family members engage in — a transaction with a taxable or tax-exempt related organization that must be reported on Schedule L.

You also must disclose on Form 990 whether any of your current officers, directors, trustees or key employees had a family or business relationship with each other at any time during the tax year.

Gathering information

Your organization should make a “reasonable effort” to obtain information for Form 990 disclosures about independent directors’ family and business relationships. You might, for example, distribute an annual questionnaire to your officers, directors, trustees and key employees asking for the relevant information.

It’s important to note that board members can be independent even if they receive financial benefits as members of the group your organization serves. What’s more, 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 or a related organization — so long as the payments don’t qualify as taxable income to that person.

You can allow some non independent members

Not all of your board members must be independent. For example, you may have on your board an employee or an individual who has lent your organization money.

But watchdog groups generally advise donors to support only organizations with a majority of independent directors. And some states (for example, California) mandate that at least half of a charitable board’s members be independent. The IRS requires that at least 51% of a charitable board be people with no familial relationship.

Avoiding conflicts

To avoid improprieties (as well as the appearance of improprieties), maintain a board composed of at least two-thirds independent members. Also make sure all members of your audit and compensation committees are independent and that independent members serve on — or, better yet, make up a majority of — your governance and nominating committees. Contact us for details.

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