Nonprofits must state on their IRS Forms 990 the number of independent voting members on their board of directors. Donors, state attorneys general and the media increasingly have been scrutinizing this reporting, believing that independent directors are a key ingredient of good governance.
Some organizations mistakenly think that independence is only about addressing conflicts of interest. But the concept of independence in the nonprofit context is broader than that.
For purposes of reporting the independence of board members on Form 990, your nonprofit must use the IRS’s four-part definition. Under it, a board member generally is independent if he or she meets these criteria:
- The member wasn’t compensated as an officer or other employee of the organization or a related organization.
- The member didn’t receive total compensation exceeding $10,000 from the organization and related organizations as an independent contractor during the tax year. This excludes reasonable compensation for services provided as a board member.
- Neither the member nor any family member was involved in a transaction with the organization that must be reported on Schedule L, “Transactions with Interested Persons.”
- Neither the member nor any family member was involved in a transaction with a taxable or tax-exempt related organization that must be reported on that organization’s Schedule L.
You also must disclose on Form 990 whether any of your current officers, directors, trustees or key employees had a family or business relationship with each other at any time during the tax year.
Nonprofits aren’t required to engage in more than a “reasonable effort” to obtain the necessary information for the disclosures about independent directors’ family and business relationships. For example, you could distribute an annual questionnaire to all of your officers, directors, trustees and key employees asking for the relevant information.
Note, too, that a board member isn’t considered to lack independence merely because he or she is a donor to the organization. In addition, a board member can be independent even if he or she receives financial benefits as a member of the group it serves (for example, a member of a chamber of commerce who also serves on its board). A religious exception may apply if the board member has taken a vow of poverty and belongs to a religious order that receives sponsorship or payments from the organization or a related organization that don’t qualify as taxable income to him or her.
And remember, you aren’t required to have only independent board members. But some charity watchdog groups suggest that a substantial majority (meaning at least two-thirds) should be independent.
Roles for your independent directors
Independent directors are a greater testament to your organization’s integrity when they take on specific roles that can benefit from their independence. For example, the audit and compensation committees should include only independent directors. This helps assure compliance with IRS guidelines for conflicts of interest and establishing executive compensation.
It’s also a good idea to include independent directors on the governance and nominating committees and in any other board decisions where relationships could be viewed as preferential — for example, decisions related to employee salaries. And consider holding all executive sessions of your board meetings with only the independent directors.
Matter of best practices
Appointing independent directors to your board isn’t just a matter of appearance — it’s a critical component of good governance. IRS requirements aside, your nonprofit should regularly assess whether any of its directors’ financial or familial relationships affect their abilities to act in your organization’s best interests.