Managing Nonprofit Conflicts of Interest
Conflicts of interest occur any time there is a transaction with related parties on both sides, such as buyer and seller or service provider and recipient of service. There are two main types of relationships that can be problematic for nonprofit organizations. The first is familial relationships, which means anyone who is related to a board member in any way. The second is business relationships, which includes both colleagues and bosses of anyone on the nonprofit board.
When these situations occur, the concern is that one party could unfairly benefit from the transaction because of the existing relationship. That’s an issue because, according to IRS regulations, nonprofits are not allowed to operate for the benefit of private interests. If a conflict of interest arises and there is an overpayment or underpayment involved (thus someone received a benefit), those transactions are subject to taxes and penalties that can be quite costly.
Types of conflicts
There are a few key areas where conflicts of interest arise that violate IRS regulations designed to ensure nonprofits don’t operate for the benefit of private interests.
Private benefit transactions
A benefit that is part of the organization’s exempt purpose does not serve a private interest. In contrast, a benefit provided to an individual, other than anything flowing from the organization’s charitable purpose, may be serving private interests and therefore be a nonexempt purpose. Examples include excessive compensation paid to employees, payments to outsiders for goods or services, or steering business to a for-profit company.
Private inurement
A private inurement is generally understood as providing unjust enrichment from an organization’s earnings to another party. The ban on private inurement means a charitable organization cannot unfairly or unreasonably benefit, either directly or indirectly, individuals who have a close relationship with their organization and the ability to exercise control over them. The private inurement ban only applies to officers, directors, employees, or volunteers of the nonprofit organization.
Excess benefit transactions
The IRS defines an excess benefit transaction as “a transaction in which an economic benefit is provided by a tax exempt organization, directly or indirectly, to or for the use of a disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration received by the organization.” In other words, a nonprofit organization may not provide a “disqualified person” with any benefit that exceeds fair market value of what the organization received in return.
Guarding against conflicts of interest
The first step to protecting your organization from conflicts of interest is complying with IRS regulations. The IRS requires all 501(c)(3) organizations to have a conflict of interest policy and provides language for the policy on their website.
“In addition to having a written conflict of interest policy, it is important that board members know and understand the policy.”
In addition to having a written conflict of interest policy, it is important that board members know and understand the policy. Often, it is not immediately apparent that there is a conflict of interest unless the board member has been open about the relationship. For example, family members through marriage or extended family members may have different last names. The board members must know and understand the conflict of interest policy so they can alert the board to any potential conflicts.
Another way to protect yourself from conflicts of interest is to have your board fill out an annual questionnaire to disclose any potential conflicts of interest. It includes questions about their employment, any known or potential conflicts related to the nonprofit, etc. This questionnaire not only brings potential conflicts to light, but also provides a layer of protection with the IRS. When an organization takes the step of filling out these questionnaires, the IRS presumes that there are no conflicts of interest. If by any chance one did occur, the IRS recognizes that you took reasonable steps to prevent it from happening and may be less likely to assess penalties.
Curing conflicts of interest
In the course of doing business as a nonprofit, you may find a vendor you want to hire or property you want to purchase from an individual somehow related to a board member, employee, or other person connected to the organization. What should you do then?
If your organization would like to engage in a transaction involving a familial or business relation, you must ensure that the related party in the organization is not a part of the decision and no overpayment or underpayment is involved. Be sure the recognition of the conflict and the steps taken to cure it are documented in the minutes of a board meeting to protects all parties involved.
The best way to avoid any risk of overpayment or underpayment in a conflict of interest situation is to make sure you are paying fair market value or below for the good or service. If it’s a small transaction, that can be as simple as getting three quotes from competitors or talking with others in the field of service to be sure the payment is fair. If a transaction is larger, more documentation may be needed, such as an appraisal for a real estate purchase. Recording this discussion and the subsequent vote in your meeting minutes provides documentation that due diligence was done before the transaction.
In the daily workings of a nonprofit, conflicts of interest are going to occur sometimes. By having the right policies in place and following proper procedures to cure the conflict, you can help protect your organization and reduce the risk of penalties.
If you need help establishing a compliant conflict of interest policy and training your board on recognizing conflict of interest, reach out to us today to schedule a consultation.
