Should Non-Profit Boards Get Paid?

A couple of weeks ago, the board of the Tampa General Hospital voted to take compensation for their board service, between $15,000 and $30,000 per year. Because nonprofit board positions are frequently unpaid, this raised a number of eyebrows and got a number of people talking and thinking about the issue (this article, by Monica Oss, was among my favorites). One board member resigned over the decision, and the board has since rescinded their decision.

But I think it’s still a question worth answering. There is some case to be made for compensation: as Ms. Oss points out, for-profit board members are compensated, often quite handsomely. And there’s certainly a time commitment involved with being a board member–in the Tampa General Hospital example, 6 meetings per year, plus committee meetings and retreats with hospital staff. Further, board members are expected to give their expertise, and as you can imagine, hospitals require a lot of specialized knowledge. If that knowledge has value (it does), isn’t it worth paying for?

Even with those arguments in mind, I’d still say that generally speaking, compensating board members is probably a bad idea.

First, compensating board members is a drain on resources. Not to pick on Tampa General Hospital, but to use them as an example, there are 15 board members, and each could have taken somewhere between $15,000 and $30,000. There were some board members who planned to decline the compensation, but assuming each board member took $15,000, that’s $225,000 being paid out in board compensation each year. I don’t know the hospital’s budget (it’s probably pretty big), but that’s quite a bit of money that could go to other projects in the organization.

Second, it may damage your relationship with the public. As a 501(c)(3) organization, your financials are available to the public through your tax returns. The public is generally wary and suspicious of nonprofits–if they’re going to give, they want to know that it’s going to help somebody. It doesn’t seem to please the media either; look at the first Tampa Bay Times article I linked above–in those first few paragraphs, it’s pretty clear the reporter does not approve. When you’re paying the board, that increases overhead and that can damage your relationship with the public.

Third, because paying directors is unusual, board members generally aren’t expecting, much less demanding, to be paid. Most directors understand that board service is a volunteer arrangement–and in some organizations, even an arrangement that requires the board member to give to the organization. In the Tampa example, one board member quit over the compensation arrangement, and others declined to take any compensation. Making board service more like a part-time job rather than a volunteer service opportunity might even turn some people off from the position.

And then there’s the legal stuff. Paying your board runs the risk of creating “inurement” to the directors. As it’s said in the regulations, the net earnings of the organization may not “inure in whole or in part to the benefit of private individuals.” By the way, don’t get too hung up on “net earnings,” as the Tax Court has said, any “unjust enrichment” counts (even a really small amount), whether its from the gross earnings or net earnings or whatever. If there is inurement, the organization’s tax-exemption can be revoked. Additionally, an insider that receives such a benefit gets hit with a 25% tax, and if the organization is not made whole, the insider gets hit with another 200% tax on the transaction. Additionally, any board member that approves such a transaction gets hit with a 10% tax. To sum up, this is a big deal.

Of course, often organizations will provide private benefits to individuals, and it’s not a problem. For instance, a food pantry provides food to people. A library lets people check out its books and CDs and whatnot. That’s not an unjust benefit, that’s just serving your charitable class as part of your exempt purpose. Using Tampa General Hospital as an example, a board member could be admitted to the hospital just like anyone else.

So what’s actually a problem? When you’re dealing with insiders of the organization (and board members are definitely insiders), those insiders cannot get the better of a transaction with the organization. It’s perfectly okay for an organization to do business with its insiders, but the terms have to be fair–if anyone is to be favored, it’s the organization. Also, any transactions between the organization and an insider are best done “at arm’s length,” meaning that the insider doesn’t have any special influence over the organization. Often, nonprofits have conflict of interest policies that require board members who stand to benefit from a transaction to disclose their interest and possibly recuse themselves from the discussion and decision. By the way, conflict of interest policies are a good idea.

Would this be private inurement? It’s hard to say (this is all very case-by-case), but here are the questions we need to ask:

First, is the compensation fair and reasonable? What are the skills the board members are providing? How much time do the board members spend on their duties? I’d suggest that an organization that compensated its directors get crystal clear on the time spent and the value provided by the directors. Also, the fact that other boards are usually uncompensated is a problem, although in the Tampa case, the board suggested a growing trend of paying directors a stipend. Again, this is all going to be largely determined by the facts of a particular case.

Second, is the compensation negotiated at arm’s length? Probably not. The problem is that there’s going to be a conflict of interest–the board members are voting on their own compensation. That’s a real problem with board compensation. One way to deal with that might be a “27th Amendment” solution–the 27th Amendment to the U.S. Constitution requires that no law changing the pay for a representative or a senator can take effect until the next Congress, so all the representatives and one-third of the senators have to survive an election to experience the change in pay. Perhaps something like that–where no board compensation changes could take effect until after the next board election–would make board compensation more palatable from a conflict-of-interest perspective. To my knowledge, that theory is untested.

Because paying directors is an unusual practice, an organization that decides to do it can expect to be scrutinized thoroughly–from the IRS, the media, and the public. Between the risks of the IRS finding inurement, the potential for public relations damage, and the possible better uses for the funds, I’d generally advise against paying board members.

Form 1023-EZ: Is It Working?

Short answer: it depends on what you mean by “working.”

Not a very satisfactory answer, is it? As much as I wanted a 10-word blog post, we’ll have to go a bit longer to really answer this question.

The 1023-EZ was introduced a little under 2 years ago to help deal with the tremendous backlog of tax-exemption applications facing the IRS. The idea was that small organizations didn’t really need a full review. Those organizations could fill out a shorter form and get a decision much more quickly. This would free up the IRS’s staff to scrutinize full 1023s more closely.

For what it’s worth, I’m a big fan of the IRS doing some triage here. The IRS was getting crushed by applications in the past, and it makes sense for the IRS to focus its efforts on the biggest organizations. Also, the effort needed to complete a full Form 1023 is a burden on small organizations. The IRS estimates that it takes 15.5 hours to properly prepare the full Form 1023. Form 1023 itself is 12 (fine, 11.5) pages, plus the 8 possible schedules that may also be required. Form 1023 is difficult to prepare well, and it can be tough for a small organization.

What Form 1023-EZ is doing well

Speed of review. The IRS turnaround times for both Form 1023-EZ and Form 1023 applications have dropped considerably. The IRS used to have a webpage showing the average age of its pending applications, but it has retired that, instead asking that you follow-up within 90 days for a 1023-EZ or 180 days for a full 1023. That’s much faster than the turnaround before the 1023-EZ came along. This is great for applicants and the IRS.

Client satisfaction. The Journal of Accountancy reports that overall satisfaction regarding the process was at 87% for 1023-EZ users and 72% for 1023 users. Further, 1023-EZ users reported more significantly more satisfaction with the time and ease of completing the application, the length of the process, and the ease of understanding the application than 1023 users.

What Form 1023-EZ isn’t doing well

Compliance. Organizations currently attest to numerous key things regarding compliance:

  • That the organization has the appropriate organizing document for its type of entity (articles of incorporation for a nonprofit corporation, for instance),
  • That the organization’s purposes are limited to one or more of the exempt purposes under Section 501(c)(3),
  • That the organization is not allowed to engage–except as an insubstantial part of its activities–in activities that do not further one or more of the exempt purposes under Section 501(c)(3),
  • That the organization’s organizing document requires that the organization will give its assets to another 501(c)(3) organization or the government upon dissolution,
  • That the organization won’t support or oppose candidates for office,
  • That the organization’s net earnings won’t be given to the organization’s insiders,
  • That the organization will not engage in a trade or business outside of its exempt purposes,
  • That if the organization attempts to influence legislation, it will only do so as an insubstantial part of its activities, and
  • That the organization will not provide “commercial-type insurance.”

At present, the IRS does not require the submission of organizing documents or corporate by-laws in order to review the organization’s compliance with these requirements. Additionally, some of the language here may by tough for the leadership of a small nonprofit to understand. For instance, what is “an insubstantial part” of an organization’s activities? I have clients ask that question fairly regularly, because it’s a term of art and they aren’t familiar with it.

A “gotcha” approach to compliance. The IRS has said that it will do more audits of organizations in order to check for compliance. I’d prefer the IRS check for compliance at the beginning of the process rather than auditing an organization that filed a 1023-EZ only to find out they are non-compliant. Will such an organization have a chance to become compliant? What will that process look like? What about the organization’s donors? What about back taxes, interest, and penalties for a non-compliant organization?

Uncertainty for organizations. When I work with clients that file a 1023-EZ, one question almost always pops up: what if we go over $50,000 in annual gross receipts? For many small organizations, those initial budgets are made in good faith, but sometimes those budgets are the product of educated guesses. It isn’t clear right now what happens if an organization exceeds the limit–should an organization that grows beyond its projections stifle its growth to avoid trouble with the IRS?

Potential for misuse. The 1023-EZ process involves fairly light oversight, so I’m sure some organizations are tempted to claim 1023-EZ eligibility to take an easier path to exemption. By tightening the oversight of the 1023-EZ process a little bit, the potential for misuse could be reduced.

How could the process be better for Form 1023-EZ users?

My suggestions would probably add some complexity and some additional turnaround time to the Form 1023-EZ process. I’m not sure I’d improve IRS user satisfaction by making these changes! By making the process “better,” I’m suggesting that a process that is still easy for small organizations to manage while allowing the IRS to find compliance problems, letting the organizations correct the problems, and getting the organization started on the right track.

So, what do I have in mind?

Require submission of organizational documents. Rather than requiring attestation to the organization’s purposes and dissolution clauses, require the organization to submit them. The organization already has to create the documents, so there’s no extra time spent for the organization. It is relatively easy to get documents into a PDF format, and reviewing them shouldn’t take that much extra time for the IRS.

Require the submission of a 3-year budget. Again, organizations have to say they don’t expect annual gross receipts of over $50,000 those first 3 years. With that in mind, do their budgets make sense? For instance, an organization that plans to hire a staff member probably can’t have a year with less than $50,000 in gross revenue and hope to survive. The IRS could follow-up on an unrealistic budget and find out if a full 1023 would be more appropriate.

Issue guidance for organizations that exceed the $50,000 limit. I suspect that the IRS is watching 990-EZ filings to see if organizations that applied with Form 1023-EZ exceeded the $50,000 limit. The IRS should do that. But what if an organization exceeds the limit? It’s not clear what would happen. Would the IRS revoke the tax-exempt status of those organizations? Maybe, although I think that’s excessive. I would expect the IRS to require a full 1023 (and the full user fee), but that’s a guess. Until the IRS has guidance, we won’t know for sure.

Form 1023-EZ has unquestionably made application for tax-exempt status more convenient, even for organizations that don’t qualify for it. Still, if we’re willing to sacrifice some of the convenience, we could achieve a more effective review process.

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Form 990 Deadline Looms for Calendar-Year Organizations

For organizations that use the calendar year as its fiscal year, the deadline for filing your annual information return (on Form 990, or some variant of it) is fast approaching: May 16, 2016. Let’s look at some of the basics of annual information return reporting for 501(c)(3) organizations:

 Which version of Form 990 do I file?

There are three main variants for Form 990:

  • Form 990, for most organizations with gross receipts of $200,000 or more OR total assets of $500,000 or more;
  • Form 990-EZ, for most organizations with gross receipts of less than $200,000 AND total assets of less than $500,000;
  • Form 990-N (e-Postcard), for most organizations with gross receipts under $50,000.

Private foundations have their own 990, the 990-PF, and black lung trusts also have their own variant, the 990-BL.

Don’t forget that your filing may be more than just the form itself–you may have additional schedules to fill out as well. If you’re working on these forms, be careful; make sure you get all the schedules you need as well–and you may want to have a professional work on it anyway.

If you qualify for 990-N (e-Postcard) filing, there is no paper form; the form is submitted electronically through the IRS website. If you’ve filed a 990-N before, that’s a new thing–the IRS had accepted them through the Urban Institute, but that changed at the end of February 2016.

There are still some organizations that are exempt from filing Form 990, and the IRS has a list of those exceptions. If your organization is of a type on that list, make sure you review the list closely to ensure that you don’t have to file something else instead. For instance, the list includes stock bonus, pension, or profit-sharing trusts that qualify under section 401 of the Internal Revenue Code. However, that entry also indicates that those trusts should file Form 5500, so be careful to make sure you don’t have some other reporting requirement.

When do I have to file?

Form 990 is due by the 15th day of the 5th month following the close of your fiscal year. If your organization’s fiscal year is the calendar year, that usually means May 15 of the following year. This year, May 15, 2016 happens to fall on a Sunday, so the deadline falls on the following Monday, May 16. If you have a different fiscal year, you’ll need to calculate it from the end of your fiscal year.

What if I miss required filings?

If you don’t file for 3 consecutive years, the IRS will automatically revoke your organization’s tax-exempt status. If that happens, the organization will no longer be tax-exempt starting from the due date of the third missed return. If the organization was a 501(c)(3) organization prior to revocation, any contributions you receive after revocation will no longer be tax-deductible for your donors, which can be a very big mess.

If your organization is automatically revoked, it is significant work to have the tax-exempt status reinstated. If this happens, you have to file an application to have your organization’s tax-exempt status reinstated. Depending on the circumstances, this can be a lot of work–in one case, I had an organization that had to file a new 1023, 990-EZs for each of the missing years, and a statement explaining why the failures occurred and how the failures would be prevented in the future. Short version: make sure the return gets filed each year!

If your organization needs an extension, it can apply for one using Form 8868.

Remember, Form 990 is a public document, and it tells the public a lot about your finances. It should be completed carefully and accurately. However, it also gives you some opportunity to brag about the projects you’ve completed, so you really can use it as an opportunity to show off your organization’s work.

Note: a version of this post originally appeared on my firm’s website, attorneykevinkelly.com, and has been updated for publication here.

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Questions to Ask Prospective Board Members

Last time, we talked about what you should be asking an organization if you’re thinking of serving on their board. Today, we’re going to do the same thing for the other side. As this Forbes article says, you’re looking for 1) the ability to handle the job, 2) their interest in doing the job, and 3) whether they’ll fit in. So, with that in mind, what should you be asking prospective board members?

1. Are you excited about our mission?

An excited, engaged board is a valuable thing to have. I don’t mean to dismiss the value of skill and experience, but an enthusiastic board member can gain skills and experience, but a skilled, experienced board member that isn’t energized may not be contributing what they do have. Ideally, you can have all of those things, but if someone isn’t really that excited about the mission of the organization, you’re probably doing both prospective board members and the organization a favor by not putting him or her on the board.

2. What skills do you bring to the organization?

Ideally, you’ll want to have a variety of skills on the board: fundraising, planning, management, and governance, for instance. It’s probably too much to expect one person–or even a few people–to contribute all the skills you need. If you know you’re missing a particular skill, obviously you’ll want to bring someone on with the skills you need, if possible.

3. What have your previous board experiences been like?

You want to get a sense of not just the technical abilities of the candidate, but also a sense of how he or she works as part of a board. Do they generally work together with other board members? Do they handle conflict well? How’s their communication style? Are they willing to present a dissenting opinion, even if that opinion is theirs alone? Can they handle being on the “losing end” of an argument? You’ll want to consider whether the personality fit is right.

If you have prospective board members who have never served on a board before (which is fine–every board member who ever served had a first time), how do they work in other teams, maybe in their work or in some other organization?

4. Can you make the commitment we ask of our board members?

When I’ve worked with organizations, occasionally I have needed to find out what the expected time commitment for a board member is. I’ve found that sometimes the organization really doesn’t know! I suppose Question 3.5, then, is what sort of time commitment is necessary? Think about all the things a board member does:

  • Attending board meetings
  • Preparing for board meetings (and yes, board members should be preparing for board meetings)
  • Attending committee meetings
  • Preparing for committee meetings
  • Attending organization fundraisers and other events
  • Asking for contributions
  • In some cases, doing the work of the organization

And by all means, be upfront about the time involved! If you tell a prospective board member that it’s a 5 hour per month commitment, and it’s really 10, you haven’t done the candidate nor the organization any favors.

5. Can you handle the fundraising commitment?

Likewise, be upfront about the fundraising or contribution expectations. Some potential board members may not be as good at raising funds–are you willing to live with that in exchange for other abilities that person might have? Is it a skill that can be built?

6. What do you expect of the organization?

This is another opportunity to gauge how well the candidate will fit into your organization. There aren’t any right answers here–but what does this person expect match up with what the experience is likely to be? Also, I’d be a little leery of someone who doesn’t have any expectations. If you get that answer, I’d press a little before moving on–after all, we want to assess fit, and that’s good for the candidate and the organization both.

7. What do you think makes for an effective board member?

I start from the assumption that everyone wants to do a good job (and in my experience, this is usually, but not always, the case). Assuming that’s the case, the answer to this question can give you a look into the standards that the candidate holds himself or herself to. Additionally, it can provide you with some insight into the standards the prospective board member will hold his or her fellow board members to, which can help you assess fit.

8. Why are you interested in board service?

There are a bunch of other ways to get involved in the community: you could join a service organization, you could do other types of volunteer work, or you could simply donate to various causes. What is it about board service specifically that’s interesting to them? This can help you determine what motivates them and how they see their skills.

9. Is it important to you to interact socially with your fellow board members?

This is not a question that had occurred to me; however, I noticed it in some other possible lists of questions (see here and here for examples, as well as some suggested questions I didn’t cover). For some people, joining a board is a social experience, and they expect to interact socially with their fellow board members. At the other end of the spectrum are people who don’t see board service as a social outlet (this is where I’m at, not that I mind social interaction). Again, this is an issue of fit: someone who wants social interaction might not enjoy a “do the work and go home” kind of board–and the opposite is probably true as well.

10. What questions do you have for the organization?

A potential board member ought to have some questions (maybe even some of the ones we talked about last time) for the organization. If prospective board members have no questions, and they haven’t already been doing something in the organization, I’d suspect that they weren’t interested or weren’t taking the commitment very seriously.

Ultimately, you want to figure out if prospective board members can bring the skills or connections you need, the enthusiasm for doing the board’s work, and a personality that will fit into your board. If someone isn’t a good fit, there’s no need to force it; trying to make someone fit will probably be bad for that person and your organization.

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Questions to Ask Before Joining a Board

If you’re active in the community–or you’d like to be–one of the things you might have considered is the possibility of joining the board of a nonprofit organization. Joining a board can be a tremendous opportunity: you can develop leadership and management skills, serve a cause you care about, and build your professional network.

That said, board service is not for everyone. Even if board service is for you, not every organization and every potential board member are going to be a good fit. And if it isn’t a good fit, it’s a lot better not to join that board in the first place.

What do you need to know? Let’s start here:

1. Why do you want to join this board?

Board service has a lot of personal benefits. Board members can meet people and expand their professional and social networks, add valuable experience to their resumes, and develop skills. But if you’re primarily joining for personal benefit, you probably aren’t going to be that great a board member–you’ve got to care about the cause or about helping whomever the organization is helping, or you probably won’t be effective.

2. Are you interested in this cause?

There are a ton of great causes out there, but not everyone cares about everything equally. You might agree that literacy and protecting animals and sheltering homeless people are all worthy things to be doing, but you probably care more about some things than others. That’s okay! Different people will have different priorities. If you’re not particularly interested in the cause of a particular organization, do them and yourself a favor and don’t join. Instead, wait for an opportunity with a organization that does something you are really interested in.

3. Have you read the organization’s key documents?

I know that an organization’s bylaws and financial reports are not usually very exciting reading. However, before you commit to the organization, you should make sure that you understand what’s going on in that organization. At a minimum, you should read the organization’s articles and bylaws (would you play a game without learning the rules first?) and the organization’s latest financial statement; you can find a good list of materials (and some other good questions) here.

4. What is expected of you?

Different organizations require different commitments from their board members. Can you make most (if not all) of the meetings? Are the board members expected to do additional fundraising activities or other work beyond the board meetings? Are there committees that you’ll be serving on as well? If you don’t have the time, it’s better to know that before you join.

5. Is the organization ethical and compliant?

This may be harder to determine from the outside, but does the organization follow the rules? Those rules include federal and state law as well as the organization’s own by-laws (yet another reason you should read them). If an organization isn’t compliant with federal and state law, or if they can’t seem to follow their own rules as set forth in the by-laws, run. Now.

6. How are the relationships in the organization?

You certainly don’t need everyone in the organization to be the best of friends, but the board, volunteers, and staff should be treating each other respectfully and professionally. If the board and the staff are stepping on each other’s toes or are unable to deal with each other appropriately, this may not be the organization for you. I’d also suggest looking out for a lot of turnover in board and staff, difficulty keeping volunteers, and donor attrition as well.

7. Does the organization carry directors and officers (“D&O”) insurance?

It is possible that directors and officers of an organization may make mistakes running the organization. In some cases, this might lead to lawsuits. Organizations can take out D&O insurance in order to indemnify their directors and officers against defending those lawsuits and paying judgments. Generally, these insurance policies will cover errors, but not intentional wrongdoing. If an organization is leaving its directors and officers uncovered, I’d probably stay away.

8. Are the organization’s finances in good shape?

Remember the financial statement you looked at up in Question 3? Well, how does the organization’s financial health look? Here are some of the issues I’d look for:

  • Is the organization following appropriate accounting procedures, and does the organization get independent audits?
  • Does the organization carry adequate cash reserves?
  • How well does the organization meet its budget? If there are major differences, what happened?
  • Is the organization susceptible to cash flow troubles? Is there a way to resolve those problems?
  • Is the organization carrying debt? If so, is the debt load manageable?
  • Does the organization depend heavily on a few donors or major grants, or does it receive broad-based support?

If an organization’s finances aren’t perfect, that might not be a deal breaker. However, the organization should be aware of any problems and committed to resolving those issues.

9. What’s expected of you?

You’ve probably already considered the time commitment needed for board meetings, but the organization may have additional expectations. In addition to board meetings, an organization may have additional committees that you may be assigned to, and in some cases, board members also do some of the work of the organization (often known as a “working board”).

Also, board members are often expected to make some sort of financial impact on the organization. Sometimes, this is a direct donation. Other times, it might be a commitment to raise a particular amount of money from others. Can you afford the amount involved, or do you have the skills and drive to raise it?

10. What is the organization’s strategic plan?

Nonprofit organizations often engage in strategic planning, which is how the organization identifies its strengths, weaknesses, opportunities, and threats (the “SWOT analysis”), it’s mission, and all of the parts needed to achieve that mission. Strategic planning is more of a process than a task; organizations often make the mistake of doing the strategic plan–and then sticking it in a file cabinet somewhere. Not only should the organization be involved in strategic planning, but that planning should be regularly reviewed, and should actually be used to guide the organization.

If you’re interested in joining a board, don’t go in blind; make sure you know what you’re getting into and what you can expect from the experience. And beware the organization that isn’t interested in answering your questions–board membership is a serious commitment, and an organization should be happy to make sure that you understand that commitment.

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