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Legal Liability for Nonprofit Board Members (Part Two)

Legal Liability For Nonprofit Board Members (Part Two)

In our last article, we discussed legal liability of board members as it relates to corporate law. This post highlights liability in regards to IRS tax-exemption regulations.

The board of directors collectively governs the affairs of a nonprofit organization. As such, the officers and board members have the ultimate responsibility for seeing that the mission is accomplished. That just makes sense.  But the board has liability beyond just mission concerns: The IRS also holds the board accountable for operating under the regulations and limitations of Section 501(c) of the Internal Revenue Code. The board is potentially liable for actions the organization takes that are not within IRS boundaries. This includes fiduciary liability with regard to financial matters.

One of the best examples of liability as it relates to tax-exempt regulations is inurement. Inurement happens when individuals inside an organization receive an unfair benefit by virtue of their position. This typically takes place in the form of excessive compensation or improper use of the nonprofit’s assets (vehicles, facilities, etc.). The IRS can hold board members personally liable if they discover what they believe to be excessive compensation, especially if the organization isn’t operating at arms-length.

So what type of penalties could the board face in these situations? Intermediate Sanctions penalties could be assessed on individual board members. Initially, the IRS could fine each board member up to 25 percent of the benefit received. If the nonprofit doesn’t act quickly to comply with the IRS, it could increase to 200 percent, per board member. You read that correctly: Two hundred percent.  The ultimate penalty could be the IRS revoking the organization’s 501(c)(3) status, but most situations are resolved short of that action.

Board members should also be aware of other financial aspects of the organization. Typically organizations run into financial problems (such as fraud or improper bookkeeping) when board members turn a blind eye to who is in charge of the finances. All too often an organization has one person writing the checks, taking money to the bank, and keeping record of donations and other income generated by the nonprofit. This lack of oversight may lead to a number of issues, the least concern being unbalanced books, and the worst being stolen or missing money.  This lack of proper checks-and-balances reflects on the board as an abdication of responsibility. It’s not enough for a board member to say they didn’t know. It is their job to know! And while Intermediate Sanctions penalties are rarely assessed for this type of situation, nobody wants the headache and embarrassment of a situation that should have been avoidable. Of course, there are always unknowable variables which result in issues such as embezzlement or over compensation. As long as the board members can show that proper steps were taken to avoid these circumstances, their liability is minimal.

Like with corporate law, having proper due diligence when it comes to IRS regulations will minimize the legal liability of board members. Keep more than one eye on the organization’s finances. Have a financial committee on your board. Perhaps even hire a 3rd party accounting service to keep up with the records. Board members should also have an understanding of IRS regulations and limitations under Section 501(c). Abiding by these regulations, along with filing proper documents (such as the annual Form 990) will help the organization stay in compliance and maintain its IRS tax-exempt status.

Justin Williamson

Justin Williamson puts his writing talents to work for Foundation Group by bringing news and useful content to our fantastic clients and followers.

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