Tax-exempt organizations are well-advised to attribute significant focus and attention to the governance questions posed on Part VI of the Form 990, and to the underlying governance concepts raised by these questions.
On May 29, 2009, the Internal Revenue Service (IRS) posted a series of "FAQs" and other "Tips" associated with the completion of Part VI to the Form 990 (Governance, Management and Disclosure). Part VI is the section of the new, redesigned Form 990 that reflects the IRS’s major focus on the corporate governance of tax-exempt organizations. Thus, the new FAQs are likely to be welcome news to these organizations as they respond to the dramatic increase in governance-related questions in the new Form 990. The FAQs can be found here .
The FAQs contain 11 separate questions focused almost exclusively on Form 990, Part VI, Governance, Management and Disclosure. In the FAQs, the IRS makes it clear that many (if not all) of the policies and procedures about which it is asking in the Form 990 are not required under the law. Nonetheless, the IRS makes equally clear that, while none of the policies and procedures are required under the law, answering questions about whether the filing organization has adopted such policies and procedures on the Form 990 is required by law. While the IRS traditionally has not imposed penalties on failure to file substantially complete Form 990s in the past, it is an open question whether the IRS would pursue such path for an organization refusing to answer the governance questions on the current Form 990.
General Comments on Form 990 Part VI and the FAQs
Governance, in general, has become a pillar of the IRS enforcement and education programs for tax-exempt organizations. Given continued congressional scrutiny on whether tax exemption is a worthy federal subsidy for any type of tax-exempt organization, proper governance and accountability to the local community are key factors that may distinguish the tax-exempt sector from the taxable sector. From the IRS perspective, whether correct as a matter of law or not, the answers to the questions contained in Form 990, Part VI, are significant with respect to continued tax-exempt status for most tax-exempt organizations.
The FAQs may be loosely grouped into two main categories: FAQs relating to the existence of written policies on conflicts of interest, whistleblowers and document retention, and FAQs relating to whether information from organizations related to the filing organization is required to be included in the Form 990. Set forth below are discussions of the more important FAQs for filing organizations.
FAQs on Policies and Procedures
Form 990, Part VI-B, asks whether the filing organization has adopted a written conflict of interest policy (Part VI-B, Question 12a), a written whistleblower policy (Part VI-B, Question 13), and a written document retention policy (Part VI-B, Question 14). FAQ #10 clarifies that, in responding to these questions, a filing organization may not rely on the fact that its parent organization may have adopted such policies even if the filing organization is acting pursuant to the parent organization’s policies. Instead, a filing organization may only indicate that it has such policies if it has expressly adopted such written policies itself. Presumably, expressly adopting the parent organization’s policies should be sufficient to allow the filing organization to check “yes” in response to the applicable questions. As in many other parts of the Form 990, the IRS notes that the filing organization has the ability to discuss any special circumstances on Schedule O.
FAQ #3 clarifies that, for purposes of reporting whether the filing organization has adopted a particular written policy or procedure (e.g., conflict of interest policy), it may only answer “yes” (i.e., that it has adopted such policy) if it adopted such policy prior to the close of the reporting year. In other words, if the filing organization adopted a policy after the close of its reporting year but before it filed the Form 990 for such year, it must still answer that it does not have such policy. Again, Schedule O may be used to explain that the organization has adopted such policies after the close of the reporting year.
In FAQ #8, the IRS notes that it will not provide sample policies for filing organizations (even though it did so with respect to the IRS Model Conflict of Interest Policy in the late 1990s).
FAQ #5 notes that there is no legal requirement for a tax-exempt organization to show the Form 990 to its board but, nonetheless, notes that the filing organization must indicate whether it has done so in the Form 990.
FAQs on Activities of Related Organizations
FAQ #7 attempts to clarify the level of effort needed by filing organizations to ascertain information regarding independent directors and family relationships among board members. However, the only guidance provided by the FAQ is that “reasonable efforts” must be made. The IRS notes that a simple questionnaire that includes the name, title of person responding, date and signature, and attaches the Form 990 Glossary definitions of “independent voting member of governing body,” “family relationship,” “business relationship” and “key employee” may be all that is needed.
Practice Note: While the IRS suggests the use of a very simplified questionnaire, it is possible that a limited questionnaire may not capture all the information required to complete Part IV, question 28, regarding business relationships among directors, officers, key employees and their family members. In addition, such a simplistic questionnaire may cause greater problems for the filing organization by requiring greater diligence in educating board members and officers as to what information is required to be provided and by placing a greater burden on the filing organization’s general counsel or compliance officer to make certain that questionnaires were completed accurately. In other words, in preparing responses to Form 990 Part VI, Questions 1 and 2, the organization should be careful in following the IRS guidance in these FAQs and should consider using a more detailed questionnaire that is designed to more fully collect the appropriate information for all parts of the Form 990. Organizations will have to balance the need for information against the administrative inconvenience.
FAQ # 6
FAQ #6 attempts to clarify the IRS's three-part definition of "independent director" by indicating that the filing organization must use the three-part definition of “independent member” contained in the Form 990 instructions even if that definition is in conflict with state law definitions of independent members or in conflict with the filing organization’s definition of independent member in its conflict of interest policy.
Practice Note: Addressing issues of “independence” may trigger some controversy at the board level given the difference between the IRS definition of “independent” director and state law definitions of the same; potential confusion between application of the “independence” and “conflict concepts;” and potential confusion between “independence,” “conflicts” and “disinterested director” (for rebuttable presumption) concepts. In addition, application of the IRS definition of “independent” director could prompt a restructuring of the board in order to ensure independent control.
FAQ #4 only applies to filing organizations that have members or that have local chapters, branches or affiliates. The purpose of this FAQ was not to provide additional instruction to filing organizations but, instead, merely to explain why the IRS included questions on members and local chapters, branches and affiliates in the first place.
FAQ #9 discusses whether the filing organization must provide governance information regarding its related organizations. The IRS indicates that, as a general rule, the answer is no.
Practice Note: While it is not generally required, there are many situations where a filing organization should provide information about the governance of related organizations. For example, many health care organizations may not have “independent” boards (as defined in the Form 990) because they are controlled by a tax-exempt organization that has a community (i.e., independent) board. This structure has been expressly approved in IRS guidance regarding community-based boards and exemption. See, “Tax-Exempt Health Care Organizations Community Board And Conflicts Of Interest Policy,” 1997 Exempt Organizations Continuing Professional Education Text at 21, which may be found here. Unfortunately, Part VI of Form 990 fails to recognize that as a possible structure. For these filing organizations, Schedule O is the only place in Form 990 where they may describe the existence of the community (and independent) board at the parent level.
Further, many exempt organizations are exempt under the so-called integral part theory of exemption, which looks to the activities of related organizations to justify their own exemption. In isolation, these integral part organizations may appear less charitable than other exempt organizations since their exempt status is derived from another entity. Schedule O presents an opportunity for these organizations to explain the full array of charitable activities provided by the tax-exempt system. Similarly, Schedule O may be used to report community benefits provided by other tax-exempt entities within the filing organization’s tax-exempt system, to more accurately portray the true scope of activities being conducted by the filing organization’s family of tax-exempt organizations.
Part VI to the Form 990 and the issuance of these FAQs underscore the importance that the IRS attributes to effective corporate governance by tax-exempt organizations. Over the last several years, IRS officials have repeatedly expressed their belief that the existence of an independent governing board, combined with well-designed governance and management policies and procedures, increases the likelihood that an organization will comply with the tax laws. To that end, the promotion of good governance, management and accountability has become a new "pillar" of the IRS's compliance program for the tax-exempt sector. Furthermore, governance accountability is an important feature distinguishing the nonprofit model from the for-profit model for purposes of hospital tax exempt status.
There is no explicit statement of IRS jurisdiction over corporate governance of tax-exempt organizations in either the Internal Revenue Code or the associated Treasury Regulations. Rather, the IRS focus on governance is based upon what it refers to as "implicit jurisdiction," i.e., the concept that the quality of governance affects all aspects of the IRS's oversight over exempt organizations—furtherance of exempt purposes, private inurement, excess private benefit, reasonable compensation, informed and fair decision making regarding investments and fundraising practices, and self dealing. Furthermore, principles of good governance by nonprofit organizations are actively enforced by state charity officials, such as the attorney general, and actively monitored by donors' rights organizations. Effective corporate governance is also favorably recognized in the credit rating analysis process.
While one can argue that the IRS is overreaching in prescribing specific governance procedures, tax-exempt organizations are well-advised to attribute significant focus and attention to the governance questions posed on Part VI of the Form 990, and to the underlying governance concepts raised by those questions. In that regard, these newly released FAQs offer helpful guidance.