IRS Changes Position On Who Must Approve Governance Policies

By Laura Kalick, JD, LLM in Tax

As you know, the form 990 requests information about whether an organization has adopted various policies, including conflict of interest, compensation review, document retention, etc.

These questions were introduced for the first time when the Form 990 was revised. At the time, the addition of the questions was very controversial and some still take the position that the IRS does not have the statutory authority to ask the questions. On the other hand, the IRS believes that it does have the authority to ask the questions because it is the IRS’s responsibility to see that the tax laws are properly administered.

Instructions to the 2008 and 2009 Forms 990 allowed an organization to state affirmatively that it had adopted the various policies if as of the last day of the organization’s tax year the policy was in place. Then the IRS changed the instructions for the 2010 Form 990 to provide that an organization could answer the question “Yes” but “only if the organization’s governing board (not a department or committee) adopted the policy by the end of its tax year.” Now the IRS has announced that full board approval will not be required, but rather, the IRS will instead allow a committee of the full board to adopt the policy if it is done by the end of its tax year. The IRS indicated that this change would be effective for tax years 2010 and beyond, and that the instructions will be revised for the 2011 Form 990.

How did we get to this point and what effect do these questions and instructions have on exempt organizations? Does the fact that an organization has policies necessarily mean that the organization is well governed or are there other factors that are more important? Why would it be necessary for the full board to approve adoption of a policy if a committee with delegated authority had approved the policy? Does the fact that an organization has a conflict of interest policy mean that all conflicts are disclosed and the policy is enforced?

The IRS takes the position that a well-governed organization is more likely to be tax compliant. In an attempt to prove their hypothesis, the IRS has trained its agents on governance issues and provided a check sheet [for 501(c)(3) entities] with questions in order to show that there is a correlation between a poorly governed organization and numerous infractions of the tax laws. The check sheet 1 contains various questions, including whether the organization has a written mission statement that articulates its current §501(c)(3) purpose(s); how often the full board met during the year under examination and whether the number of meetings met or exceeded the number of meeting requirements set forth in the organization’s bylaws, etc.

Although the basic premise that a well-governed organization is more likely to be more tax compliant may have some merit, as was pointed out by the Advisory Committee on Tax Exempt and Government Entities (ACT) 2, it is the practices of an organization, not necessarily the policies of an organization, that will show whether an organization is well governed. The executive summary of the report states:
Effective governance practices among these organizations will vary depending on numerous factors, including size, sophistication, location, available resources, and activities. Moreover, while we may all agree that governance matters, it is not at all clear that requiring specific governance practices results in greater compliance with the tax laws. In fact, superior board governance may have much more to do with the values, active engagement, and accountability of those in charge than with the adoption of procedures and policies.

Conclusion
The exception of document retention and whistleblower policies that Sarbanes-Oxley mandates for nonprofit organizations as well as taxable corporations, none of these other policies are required by the Federal law. In fact, the IRS cannot deny an organization exemption if it does not have a conflict of interest policy or a broad based independent board in the absence of a showing of private inurement. However, IRS will make it difficult to obtain the exemption and if an organization appears to be at risk for the possibility of providing insiders unreasonable compensation or other private inurement, agents are told to mark the case for future referral. 3 Likewise, although the IRS may request information regarding whether an organization has a conflict of interest policy or various other policies, the fact that the organization does not have the policies cannot be the basis for revocation of exemption. However, the presence of the policies does provide a framework for an organization in which to operate. One size does not fit all and organizations should adopt the policies that are appropriate for them and should use the policies as guidance in operating an effective, ethical organization.