Nonprofit Tax Risk & Strategy Series (Part 5)
Many nonprofit organizations view governance as a legal requirement or a set of administrative policies.
However, from the IRS’s perspective, governance is much more than that—it is a key indicator of how an organization is managed, controlled, and overseen.
Through Form 990, the IRS evaluates not only an organization’s financial activity, but also its governance practices and internal controls.
Weak governance does not always lead to immediate penalties, but it often signals elevated compliance risk.
Why Governance Matters
Although the Internal Revenue Code does not prescribe specific governance structures for tax-exempt organizations, the IRS places significant emphasis on governance as part of its compliance framework.
Form 990, particularly Part VI, asks detailed questions about:
- Board structure and independence
- Governance policies and procedures
- Internal controls and oversight processes
- Review and approval practices
These disclosures provide insight into whether the organization has appropriate checks and balances in place.
Strong governance helps demonstrate that the organization is operating in furtherance of its tax-exempt purpose.
Key Areas the IRS Reviews
Board Independence
The IRS evaluates whether a majority of the board is independent.
Independence is generally assessed based on:
- Compensation relationships
- Family relationships
- Business relationships
A board with sufficient independence is more likely to provide objective oversight and reduce the risk of private benefit.
Governance Policies
Form 990 asks whether the organization has adopted key policies, including:
- Conflict of interest policy
- Whistleblower policy
- Document retention and destruction policy
While these policies are not strictly required by law, their presence—and consistent application—demonstrates a commitment to accountability and oversight.
Consistency Between Practice and Disclosure
One of the most common issues is a mismatch between what an organization reports on Form 990 and what it actually does.
Examples include:
- Indicating that the board reviews Form 990 when it does not
- Reporting the existence of policies that are not actively followed
- Providing inconsistent answers across the return
The IRS evaluates both accuracy and consistency.
Documentation of Decisions
Governance is not just about policies—it is about documentation.
Organizations should maintain contemporaneous records of:
- Board and committee meetings
- Key decisions and approvals
- Compensation determinations
- Significant transactions
Documentation provides evidence that appropriate oversight exists.
Oversight of Key Activities
The IRS looks at how organizations oversee critical areas, including:
- Executive compensation
- Related party transactions
- Financial reporting
- Internal controls
When decisions are not subject to independent review, or when documentation is limited, it can raise concerns about governance effectiveness.
The Most Common Issue: Form Over Substance
Many organizations have governance policies in place, but those policies are not consistently implemented.
Examples include:
- Conflict of interest disclosures that are not updated annually
- Board approvals that are not properly documented
- Governance practices that differ from Form 990 disclosures
The IRS focuses not only on whether policies exist, but whether they are actively followed and supported by documentation.
Building Strong Governance & Internal Controls
Organizations can strengthen governance and reduce compliance risk by implementing structured procedures:
- Conduct annual conflict of interest disclosures for board members and key employees
- Review and update governance policies regularly
- Maintain detailed and timely documentation of board and committee actions
- Ensure independent oversight of key decisions
- Align governance practices with Form 990 disclosures
Consistency and transparency are critical.
Why This Matters
Governance disclosures on Form 990 are publicly available and often reviewed by:
- Donors and grantors
- Regulators
- Charity watchdog organizations
Weak governance can raise concerns even when financial reporting is accurate.
Strong governance helps build credibility, transparency, and trust.
Final Thought
Governance is more than a compliance requirement—it reflects how an organization operates.
Clear, consistent, and well-documented governance practices help demonstrate accountability, reduce risk, and support long-term sustainability.
What’s Next
In Part 6, we will bring everything together and focus on:
Filing & compliance failures—and how to avoid the most common mistakes.
