NONPROFIT BOARD OF DIRECTORS FIDUCIARY DUTIES AND CONFLICTS OF INTEREST Terry Costolo, Esq. Community Legal Services of Mid-Florida Florida Community Development Legal Project www.flcommunitydevelopment.org
Director Fiduciary Duties • A duty of care – this duty means that the Board member actively participates, attends board meetings, is educated on the industry, provides strategic direction, and oversees management. • A duty of obedience – this duty requires the board to be familiar with the corporation’s governing documents and applicable state and federal laws. • A duty of loyalty – this duty requires the Board member to operate in the interest of the nonprofit and not to use the position to further a personal agenda. In other words, make decisions in the best interest of the nonprofit corporation; not in his or her self-interest.
Failure to Exercise Duty of Loyalty; Conflicts of Interest • What can happen if the corporation pays one of its officers or a director owned business too much?? • The nuclear sanction would be the IRS terminating an organization’s 501(c)(3) status. • Recognizing that this type of penalty may be overkill or not useful for every type of situation, the IRS adopted regulations which contain what are known as “intermediate sanctions.”
Who is Affected by Intermediate Sanctions? • Intermediate Sanctions potentially apply to an organization’s “disqualified persons” and managers. • “Disqualified persons” are defined as any person who was or is in a position to implement substantial authority over the decision-making process within an organization. The time frame for the disqualified person’s authority can be any time during a five-year • period ending on the date of the transaction. Disqualified persons can include officers, directors, and executive employees of tax-exempt • organizations, or a family member of a disqualified person. • An organization’s manager is defined as “any officer, director, or trustee of an organization who has similar powers” as a disqualified person.
What are the Penalties? • The penalties can be substantial for a disqualified person that benefits from an excess benefit transaction with an applicable tax-exempt organization. • The individual is legally responsible for a tax of 25% of the excess benefit as stated in Section 4958 of IRC. • The excess benefit is characterized as the compensation provided to the disqualified person that exceeds the economic value offered by the individual to the organization in return. • Once the 25% tax is assessed, the disqualified person has a specified amount of time to correct the excess benefit. • If the individual fails to correct the excess benefit within the allotted time frame, a second tax of 200% of the excess benefit is placed on the disqualified person.
Intermediate Sanctions Safe Harbor • Because the penalties for paying excess compensation can be so severe, the Internal Revenue Code contains a “safe-harbor” for determining executive compensation. • By following this procedure, a nonprofit organization can significantly minimize the risk that the IRS will later determine that the organization has engaged in an excess benefit transaction. • Following this procedure is known as establishing the rebuttable presumption of reasonableness. If the rebuttable presumption of reasonableness is established, payments made under the compensation arrangement will be presumed to be reasonable. • Instead of the disqualified person having to show the compensation was reasonable, the burden of proof will shift to the IRS to demonstrate that the compensation paid to the disqualified person was unreasonable.
Steps to Establish Rebuttable Presumption of Reasonableness • The three steps for establishing the rebuttable presumption of reasonableness involve: • Approval by an authorized body; • Use of appropriate comparability data; and • Documentation.
Authorized Body • An authorized body of the nonprofit organization must approve the compensation arrangement in advance. • A nonprofit’s authorized body may consist of the board of directors or board of trustees, or if permitted by state law, which is the case in Florida, a committee of the board. • Members of the authorized body cannot have a conflict of interest with respect to the compensation arrangement.
Appropriate Comparability Data • Prior to making its decision, the authorized body must obtain and rely upon appropriate data that compares the compensation to be paid with compensation paid by similar organizations for similar services. Comparability data is appropriate if it provides the authorized body with sufficient information to determine if the compensation arrangement in its entirety is reasonable. • Examples of relevant information include: Compensation paid by similarly situated for-profit and nonprofit organizations for comparable • positions; Whether or not there is a ready supply of people to perform similar services in the geographic area • where the nonprofit is located; Current compensation surveys compiled by independent firms; and • Actual written offers from similar institutions competing for the services of the disqualified person. •
Appropriate Comparability Data • For a nonprofit with annual gross receipts of less than $1 million for the three prior years, the IRS will consider the organization to have appropriate comparability data if it obtains data on compensation paid by at least three comparable organizations in the same or similar communities for similar services. • Larger nonprofits must obtain information from more organizations.
Documentation • When making its determination that compensation to be paid to a nonprofit executive is reasonable, the authorized body must adequately document the basis for its determination. The documentation may be written or electronic, such as written minutes or an email summary of the meeting. • To satisfy the IRS requirements, the documentation must note: The terms of the transaction and the date it was approved; • The members of the authorized body who were present when the transaction was debated; • The comparability data obtained and relied on by the authorized body and how the data was obtained; • and Any actions taken by a regular member of the authorized body – such as a board member - who had a • conflict of interest with respect to the transaction (e.g., the director recused himself or herself from the meeting).
IRS Form Conflict of Interest Policy • http://fredla.org/wp-content/uploads/2016/01/sample- conflict_of_interest-policy.pdf
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