What Does the IRS Think About Board Composition?

Introduction

Noprofits often ask who should be on the board, and how big should the board be? There are some practical answers to those questions, but there are also some answers that can be gleaned from how the IRS instructs its employees to look at board composition. In particular, the IRS will consider the size and composition of a public charity's board when it is evaluating whether the governance structure is compatible with being a public charity. Here are some thoughts.

What the IRS Says

In non-binding internal instructions, the IRS talks about 501(c)(3) governing bodies as follows:

The Internal Revenue Service encourages an active and engaged board believing that it is important to the success of a charity and to its compliance with applicable tax law requirements. Governing boards should be composed of persons who are informed and active in overseeing a charity’s operations and finances. If a governing board tolerates a climate of secrecy or neglect, we are concerned that charitable assets are more likely to be diverted to benefit the private interests of insiders at the expense of public and charitable interests. Successful governing boards include individuals who not only are knowledgeable and engaged, but selected with the organization’s needs in mind (e.g. accounting, finance, compensation, and ethics).

Attention should also be paid to the size of the board ensuring that it is the appropriate size to effectively make sure that the organization obeys tax laws, safeguards its charitable assets, and furthers its charitable purposes. Very small or very large governing boards may not adequately serve the needs of the organization. Small boards run the risk of not representing a sufficiently broad public interest and of lacking the required skills and other resources required to effectively govern the organization. On the other hand, very large boards may have a more difficult time getting down to business and making decisions. If an organization's governing board is large, the organization may want to establish an executive committee with delegated responsibilities or advisory committees.

Irrespective of size, a governing board should include independent members and should not be dominated by employees or others who are not, by their very nature, independent individuals because of family or business relationships. The Internal Revenue Service reviews the board composition of charities to determine whether the board represents a broad public interest, and to identify the potential for insider transactions that could result in misuse of charitable assets. The Internal Revenue Service also reviews whether an organization has independent members, stockholders, or other persons with the authority to elect members of the board or approve or reject board decisions, and whether the organization has delegated control or key management authority to a management company or other persons. Organizations that file Form 990 will find that Part VI, Section A, Lines 1, 2 ,3, and 7 ask questions about the governing body.

What this Means from a Practical Perspective

These are not hard and fast rules, and clearly there is some level of subjectivity in applying them. "Too many," "too few," and "not independent enough" are qualities that will be left to the discretion of the IRS in deciding whether they apply in a particular situation. But take the guidance for the value that it provides: some thoughts about how to create a board that shows your organization to be one that is both designed to represent the public and capable of doing so.

Conclusion

Deciding how big a board should be and who should serve on the board is a major governance decision for a nonprofit. By keeping the board at an effective size and with adequate breadth and independence, a nonprofit can help persuade the IRS that the organization is truly independent and serving the interests of the public.