There are few questions we deal with more than this one. That is, how do you deal with related members on your nonprofit’s board of directors. Let’s start by defining what is technically meant by “related”.
For IRS purposes, relationship among board members is narrowly defined, typically confined to blood, marriage, or outside business connection. Each of these has limitations also. Blood relations are family members extending to mother, father, brother, sister, son, daughter, and grandmother or grandfather. Once it gets to aunts, uncles, and/or cousins, you’re probably beyond the strict definition of blood related. Marriage relations can include spouse, son or daughter-in-law, and mother or father-in-law. With regard to business, two or more business partners serving on the board, while collectively owning 35% or more of a for-profit company, are considered related, as are co-workers that have a superior/subordinate relationship at the company they work for.
Former spouses are NOT considered to be related.
Why It Matters
The IRS considers related board members to not be completely independent. Even if the people in question believe they are not subject to influence by virtue of that relationship, the IRS doesn’t buy it. They consider it to be a conflict-of-interest that impacts the charity. As such, there are strict rules with regard to nonprofit governance where related board members are involved. These rules vary greatly, depending upon whether the nonprofit is a public charity or a private foundation.
Public charities are the most common 501(c)(3) organizations. These are also the nonprofits that the IRS is most concerned about board composition. The IRS requires that public charities have at least 51% of the voting members of the board of directors be unrelated. Beyond a simple majority, it is also important that the organization is able to form a quorum of majority-unrelated directors in order to conduct an official board meeting. To put that in perspective, if a nonprofit has 7 board members, two of whom are married, the overall balance is OK. But, if only 4 directors can attend a board meeting, and 2 of the 4 are the related directors, a quorum hasn’t been reached.
A question we often get involves, for example, two married couples being a board, but neither couple is connected to the other by relationship. Both individuals in each marriage are related (obviously!), but the relationships are considered separately, not collectively. For example, if a board meeting is held with 7 directors, including both couples, you still have an acceptable balance, because there is no relationship connection between the 4 people.
We are often asked for the specific Internal Revenue Code rule that directly and specifically prohibits majority-related public charity boards. Often to the frustration of the asker, we cannot. This principle is one of many IRS regulations that are extrapolated from another rule. Being classified as a public charity is a preferential status level of 501(c)(3) that brings with it the highest level of donor tax-deductibility allowed. In exchange, the IRS requires that the board of the organization be free of private benefit (inurement) and governed at arms-length from the personal interest of those doing the governing. While it may not be chapter-and-verse quotable, the IRS consistently interprets public charity boards with more than half of its members related to one another as being in violation of the inurement prohibition. This is demonstrated in Revenue Rulings, Revenue Procedures, court cases, and everyday regulatory administration.
The rules are quite different for foundations, though no less restrictive. Because private foundations are not considered publicly supported, there are no limits on board composition, even allowing for an entire board to be members of one family. You often see this with family foundations. But, there are trade-offs. The IRS makes it much more difficult for board members of a foundation to be compensated as employees, compared to a public charity. It can be done, but the rules are strict and penalties for getting outside those rules are steep.