How well are you governing your nonprofit?
Compare your practices against IRS proposal

Believing that good governance promotes tax law compliance, the IRS has issued a preliminary discussion draft of possible practices to aid charitable organizations. These days, the IRS is interested in the self-regulation proposals advanced by others, so it is soliciting ideas from those within and outside the exempt sector.

Although the discussion draft addresses only the governance of Section 501(c)(3) organizations, the proposed procedures and policies would be beneficial to any exempt organization wanting to operate more efficiently and effectively — and gain public support.

Looking at the board

In its discussion draft, the IRS emphasizes the importance of a governing board that is well informed and active in its oversight responsibilities. The board should consist of knowledgeable individuals, and each member should have expertise in areas critical to nonprofit operations, such as accounting, finance, compensation and ethics.

Organizations are cautioned against having boards that are too large or too small. Ideal board size is relative to the organization and its needs, but it should be sufficient to provide the variety of expertise required to make informed decisions. If a governing board is too large, it should have an executive committee with specific responsibilities or advisory committees charged with certain duties.

9 areas of good governance

The IRS also has recommendations to help organizations pursue or continue their exempt status and gain public support. (Keep in mind that these are not requirements.) Here are nine areas it suggests nonprofit executives and board members review:

1. Mission statement. It should concisely explain your organization’s purpose, clearly articulating why you exist, your goals, your activities and whom you serve.

2. Code of ethics and whistleblower policies. Not-for-profits are encouraged to adopt a code of ethics that describes behavior they want to encourage and, conversely, behavior they want to discourage. The emphasis of the code should be legal compliance and ethical integrity.

Be sure to evaluate the code regularly and have a process in place for employees to anonymously report any suspected financial impropriety or misuse of your nonprofit’s resources. The board or a committee, such as the audit committee, should develop the whistleblower policy and determine who should receive complaints. Many organizations are hiring outside vendors to receive complaints, which are often handled through a secure Web site.

3. Due diligence. Directors should exercise the same due diligence as any prudent person would exercise under similar circumstances. They should be fully aware of the organization’s activities, mission, goals and financial status so they can make informed decisions.

4. Duty of loyalty. Directors and staff should act solely in the interests of the not-for-profit without regard for personal interests. Specifically, this can be accomplished through adopting and implementing a conflict-of-interest policy. (Instructions for IRS Form 1023 contain a sample policy.) As scrutiny of nonprofits becomes more intense, this is one of the more important governance issues. Form 990 even contains a question about whether an organization has a conflict-of-interest policy.

5. Transparency. Full and accurate information about your nonprofit’s mission, activities and finances should be made publicly available through your Form 990, annual reports and financial statements.

You can use your responses to Form 990 questions regarding your organization’s exempt purpose and program accomplishments to show how your programs and services are helping to accomplish your mission. Nonprofits tend to provide an abbreviation of their mission and list lump sums. Go beyond general information by discussing the number of people served and specific results.

6. Fundraising policy. The board of directors should adopt and monitor policies to ensure that fundraising solicitations meet federal and state requirements. Solicitation materials must be accurate, truthful and candid. Fundraising costs should be reasonable. For instance, if your nonprofit hires a fundraiser he or she should be registered with the state and provide good references.

7. Financial audits. Your board should receive up-to-date financial statements and the Form 990. Board members should be able to understand the financial statements — if needed, the nonprofit’s accountant or a financially astute board member can provide training about how to read them. Also, your organization should operate in accordance with an annual budget approved by your board.

Nonprofits with substantial assets (not defined) should have an annual audit performed by an independent auditing firm, which should be selected and overseen by an independent audit committee. The IRS recommends periodically changing the audit firm.

If the cost of an annual audit is an economic hardship, the board treasurer or a finance committee can review bank statements, invoices and other financial documents regularly to identify any irregularities. Organizations can also ask volunteers to review financial information and practices.

8. Compensation practices. Generally, board members shouldn’t be compensated except for reimbursement of direct expenses. Also, all compensation for services should be reasonable and approved in advance by the board or a board subcommittee. Approval should be based on appropriate data presenting comparable rates for equivalent positions, and your nonprofit should document the basis for compensation. Most important, there should be no conflict of interest with the individuals involved in these decisions.

9. Document retention. A written policy should be established for document integrity, retention and destruction. The policy should also address standards for handling electronic files (including back-up procedures), archiving documents and regularly checking the system’s reliability. IRS Publication 4221 provides relevant guidelines for document handling and retention.

Give your input

Over the next months, the IRS will solicit comments and responses about this discussion draft. If it meets its goal of getting a consensus on good governance practices, the IRS and not-for-profits will benefit from the defined expectations. •