On February 2, 2007, a senior Exempt Organizations official at the IRS circulated a preliminary draft of “Good Governance Practices for 501(c)(3) Organizations.” While the IRS does not, at present, have authority to impose governance standards on taxexempt organization boards, the IRS official that released the proposed practices noted that they are designed to help ensure that directors understand their roles and responsibilities. To that end, the IRS has recommended that all 501(c)(3) tax-exempt organizations review and consider these suggested practices. Although adopting any particular practice is not considered a requirement for exemption, the IRS has further suggested that an organization that adopts these practices is “more likely to be successful” in pursuing its exempt purposes and earning public support. As it has indicated the recommendations are still being assessed, the IRS has requested comments on the suggested governance practices, and has further noted that a final version should be available by the end of 2007.
The suggested practices emphasize the importance that the IRS places on effective corporate governance at 501(c)(3) organizations. Moreover, the suggested practices focus on governance issues that the IRS historically has not emphasized in the taxexempt area – such as ethics and whistleblower policies. In addition, the preliminary draft suggests general concern at the IRS about the compensation of board members, and that governing boards are sometimes too small to reflect the public interest or too large to allow effective oversight of a charity’s operations and finances.
The recommendations also indicate concern with the independence and transparency of financial reporting by charities and suggest that such organizations periodically rotate the auditing firms that they retain. Finally, the proposed practices suggest that successful governing boards will include persons who are informed and active in the operation of the charity and who have expertise in areas such as accounting, finance, compensation and ethics.
The IRS-developed suggestions with respect to charity governance should be of interest to all non-profit, tax-exempt organizations but particularly to 501(c )(3) charitable organizations, which are directly referenced
The nine governance practices reflected in the preliminary draft are as follows:
- Mission Statement. The board of directors should adopt a mission statement that shows why the charity exists, what it hopes to accomplish, what activities it will undertake, where these activities will be carried out, and who will benefit from these activities. The statement should explain and popularize the charity’s purpose and guide its work and leadership.
- Code of Ethics and Whistleblower Policies. The board of directors should consider adopting a code of ethics that describes behavior it wants to encourage and behavior it wants to discourage. The code of ethics should communicate to all personnel a “culture of legal compliance and ethical integrity.” The board should also establish procedures, commonly referred to as whistleblower policies, that handle employee complaints and allow employees to report in confidence suspected misuse of the charity’s resources. These policies should be evaluated regularly. In a separate but potentially relevant development, the IRS on February 2, 2006 also named its first director to the agency’s newly-formed “Whistle-Blower Office.” The Whistle-Blower Office will analyze and process informant information from individuals who spot tax problems in their workplace.
- Due Diligence. Directors should ensure that policies and procedures are in place to help directors meet their duty of care to, and act in the best interests of, the organization. These procedures should ensure that each director (i) is familiar with the charity’s activities and knows whether these activities promote the charity’s purpose, (ii) is fully informed about the charity’s financial status, and (iii) has full and accurate information to make informed decisions.
- Duty of Loyalty. The board of directors should adopt and regularly evaluate an effective conflict of interest policy that (i) requires directors and staff to act solely in the interest of the charity without regard for personal interests, (ii) includes written procedures for determining whether a relationship, financial interest, or business affiliation results in a conflict of interest, and (iii) prescribes a certain course of action in the event a conflict of interest is identified. As part of this policy, directors and staff should be required to disclose annually in writing any financial interest that the individual or a family member of the individual has in any entity that transacts business with the charity.
- Transparency. The board of directors should adopt and monitor procedures to ensure that the charity’s Form 990, annual reports, and financial statements are complete, accurate and transparent, are posted on the organization’s public website, and are available to the public upon request
- Fundraising Policy. The board of directors should adopt and monitor policies to ensure that fundraising solicitations meet federal and state law requirements and that solicitation materials are accurate, truthful, and candid. Charities should keep their fundraising costs reasonable. In selecting paid fundraisers, a charity should use those that are registered with the state and that can provide good references. Performance of professional fundraisers should be continuously monitored.
- Financial Audits. A charity should operate in accordance with an annual budget approved by the board of directors. The board should ensure that financial resources are used to further charitable purposes by regularly receiving and reading up-to-date financial statements including Form 990, auditors’ letters, and finance and audit committee reports.
If the charity has substantial assets or annual revenue, its board of directors should ensure that an independent auditor conduct an annual audit. The board can establish an independent audit committee to select and oversee the independent auditor. Where appropriate, the auditing firm should be rotated periodically (e.g., every five years) to ensure a fresh look at the financial statements and better enable the board of directors to properly steward the organization’s assets.
For a charity with lesser assets or annual revenue, the board should ensure that an independent certified public accountant (CPA) conduct an annual audit. In lieu of an auditing firm or CPA, very small organizations could utilize volunteers who would review financial information and practices. Similarly situated organizations could trade volunteers in order to minimize costs.
- Compensation Practices. Charities should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service. Director compensation should be allowed only when determined appropriate by a committee composed of persons who are not compensated by the charity and have no financial interest in the determination. Charities may pay reasonable compensation for services provided by officers and staff. In determining reasonable compensation, a charity may wish to rely on the rebuttable presumption test of section 4958 of the Internal Revenue Code and Treasury Regulation section 53.4958-6 (i.e., the so-called “intermediate sanctions” rules).
- Document Retention Policy. An effective charity will adopt a written policy establishing standards for document integrity, retention, and destruction. The document retention policy should include guidelines for handling electronic files. The policy should cover backup procedures, archiving of documents, and regular checkups of the reliability of the system. The policy should be designed to ensure the organization can produce information needed to satisfy regulators and the public.
In addition to proposing adoption of these policies, the IRS expressed general concern about governing boards that are too small to reflect a public interest or too large to allow effective oversight of a charity’s operations and finances. The IRS noted that successful governing boards include persons who are informed and active in the operation of the charity and who have expertise in accounting, finance, compensation, and ethics.