Occasionally, you have to protect people from themselves. Even those with the best of intentions can mess things up so badly that it can jeopardize what they are trying to accomplish. In the nonprofit world, there are best practices, good practices and acceptable practices…and, really, really bad practices that will cause your organization, its board, donors and beneficiaries headaches galore. This week, we are going to explore the Dirty (Half) Dozen Nonprofit No-Nos, in no particular order. We will limit our discussion to 501(c)(3) nonprofits.
1. Dictatorships. If you want to be your own boss and run the show as a benevolent dictator, then by all means, go start a business. Just don’t start a nonprofit organization. What many people fail to understand before they establish a 501(c)(3) organization is that nonprofits do not have shareholders, i.e., owners…only stakeholders. Stakeholders can be defined as an organization’s board of directors, its members and its beneficiaries. No one can legally assume ultimate control. In fact, the IRS requires tax-exempt organizations to be structured such that control rests within a group of individuals. This protects everyone involved. Many times we’ve seen placeholder boards who basically rubber-stamp every decision made by a dictatorially-inclined president or executive director. That does everyone a disservice. Even worse, the IRS will hold all the leaders accountable for the governance and management of the organization, not just the dictator.
2. Inurement. Inurement is a fancy IRS word for insiders unfairly benefitting from the assets, resources or activities of the nonprofit they serve. Sometimes this is overt misappropriation by the leaders of the organization. These are the charity leaders you see fined, indicted or dragged before Congress. More often, though, inurement is a product of not understanding the limits of conflict of interest. For example, suppose a 501(c)(3) has 5 members on its board of directors…and, 3 of those board members are paid employees of the organization. Not only is there a conflict of interest, this situation rises to the level of inurement because the board cannot form a quorum of members who aren’t paid. Therefore, it is impossible to establish compensation at arm’s-length. Even if the salaries are reasonable, the situation is indefensible since each paid board member has a motive to scratch the others’ backs. Inurement can take many other forms…from using an organization’s vehicle for personal use to buying lunches on the company credit card.
3. Private benefit. Private benefit is the kid-brother of inurement. It is best understood as any activity that benefits an individual (or company) who is not a part of the organization’s charitable beneficiaries. This can be overt, such giving vendor contracts to an insider’s business. It can also be subtle, such as endorsing any for-profit company in exchange for financial support.
4. Political activity. We talked about this during the recent presidential campaign, but it’s worth mentioning again. 501(c)(3) organizations are expressly prohibited from intervening in a campaign for public office. They cannot endorse or oppose any candidates. They can, under limited and tightly-controlled circumstances, lobby for legislative purposes. If your organization’s goals require any substantial political activity, it should consider 501(c)(4) status. For more information on the IRS’s perspective, go here.
5. Improper recordkeeping. This one is a biggie. Your organization simply must keep accurate records. Whether it is the books, contributor records, or board meeting minutes, you cannot cut corners. The IRS will hold your organization, and its leaders, responsible for complete and accurate records. The last thing you want is your board members personally penalized for a lack due diligence.
6. Failure to file required reports. The IRS requires all tax-exempt organizations, including 501(c)(3)s, to file annual Form 990. For those 501(c)(3) public charities with more than $25,000 in average annual gross revenue (and all private foundations), penalties for late filing add up at a rate of $20 per day up to a maximum of $10,000 or 5% of the gross receipts (whichever is less). Failure to file for three consecutive years will result in the automatic revocation of the organization’s tax-exempt status. Most states require annual reports, as well. Whether corporate annual reports, or charitable solicitations reporting, you must stay current. It is a lot to keep up with, but it is a lot better than being fined, or worse, shut down. For more information on Form 990 requirements, see our previous blog articles or our Form 990 services page.
This list is by no means exhaustive. We could easily make it the dirty 3 dozen. Knowing what your organization is responsible for and making sure it stays compliant helps to ensure that it will be around to serve your community in the years to come.