Governance: Conflict of Interest

Governance: Conflict of Interest

5th in a Series

As a follow-up to our initial tax tip in this series entitled “Governance Issues for Tax-Exempt Organizations”, which was released on April 25, 2012, WithumSmith+Brown has compiled a list of what we believe to be “best practices” with respect to each topic included in the Federal Form 14114, Governance Check Sheet. This tax tip focuses on Form 14114, Part 5, Conflict of Interest.

BACKGROUND

A tax-exempt organization’s conflict of interest policy applies to an organization’s officers directors, trustees and key employees. As the Internal Revenue Service (“IRS”) continues to place an increasing emphasis on addressing governance issues for taxexempt organizations, it is imperative for organizations to adopt and regularly evaluate a written conflict of interest policy that requires officers, directors, trustees and key employees to act solely in the interests and charitable purposes of the organization; without regard for personal interests. The charitable mission and purpose of a taxexempt organization should be the primary goal of the tax-exempt organization. The conflict of interest policy should ensure that the charitable mission and purpose of the organization is being met and that no individual interest is prioritized.

The Federal Form 990, Return of Organization Exempt From Income Tax, addresses conflicts of interest in various sections. Core Form, Part VI, Governing Body and Management, Section B, Policies, includes questions which address (1) whether or not the organization has a written conflict of interest policy, (2) whether or not the organization’s officers, directors or trustees and key employees are required to complete a conflict of interest policy questionnaire annually to disclose any relationships that could give rise to a conflict of interest and (3) to describe how the organization regularly and consistently monitors and enforces compliance with the conflict of interest policy. Additionally, Federal Form 990, Schedule L, Transactions with Interested Persons focuses on conflicts of interest between interested persons and the organization, and requires the disclosure of information with respect to certain conflicts of interest. Interested persons are generally (1) an organization’s officers, directors, trustees or key employees, (2) certain family members of an organization’s officers, directors, trustees and key employees and (3) certain businesses with which the individuals outlined in (1) and (2) are affiliated.

In addition, Core Form, Part VI, Section A, Governing Body and Management, Questions #1 and #2 also address aspects on an organization’s conflicts of interest. Question #1b requires the organization to disclose the number of voting members of its governing body that are not independent. It is recommended that at least 50% of an organization’s voting members are independent from a Form 990 reporting perspective. Anything less than 50% could potentially give rise to a tax-exemption issue. Question #2 requires an organization to disclose whether or not any of its officers, directors, trustees or key employees have a family or business relationship with each other. Please note that these business relationships include only certain relationships that are outside of the reporting organization’s umbrella.

A conflict of interest policy, as defined in the instructions to the Form 990 is:

A policy that defines conflict of interest, identifies the classes of individuals within the organization covered by the policy, facilitates disclosure of information that can help identify conflicts of interest, and specifies procedures to be followed in managing conflicts of interest. A conflict of interest arises when a person in a position of authority over an organization, such as an officer, director, or manager, can benefit financially from a decision he or she could make in such capacity, including indirect benefits such as to family members or businesses with which the person is closely associated. For this purpose, a conflict of interest does not include questions involving a person’s competing or respective duties to the organization and to another organization, such as by serving on the boards of both organizations, that do not involve a material financial interest of, or benefit to, such person.

GOVERNANCE CHECK SHEET AND FORM 990

Questions 18a through 18c of Federal Form 14114 address whether the organization has a conflict of interest policy, the policy for addressing recusals and whether or not the policy itself requires annual written disclosures of conflicts of interest. In addition, question 18d specifically addresses whether, during the year under examination, any potential conflicts of interest were disclosed and, in these instances, whether or not the organization’s conflict of interest policy was adhered to.

According to the IRS, a conflict of interest occurs when an individual’s obligation to further the organization’s charitable purpose is at odds with their own financial interest. For tax-exempt organizations, the conflict of interest policy and questionnaire can be the most critical and controversial document for the board of trustees and officers as it aims to discover whether or not conflicts or potential conflicts actually exist.

BEST PRACTICES

As a best practice, an organization should have a conflict of interest policy that is tailored specifically to the organization and addresses all potential types of conflicts of interest. Appendix A to the instructions for Federal Form 1023, Application for Recognition of Exemption Under Internal Revenue Code Section 501(c)(3), provides a conflict of interest policy template that can be used as a guide in preparing a conflict of interest policy. An organization’s conflict of interest policy and questionnaire should address all potential conflicts of interest that are required by the Form 990; including family and business relationships between an organization’s officers, trustees, directors and key employees that are outside of the organization’s umbrella.

An effective written conflict of interest policy should, at a minimum, address the following potential conflict of interest areas:

• Purpose – a written conflict of interest policy should define what a conflict of interest is and identify and provide guidance on the most important and common conflict of interest situations that the organization may face. It should include general principles that can be applied to situations not covered in the policy.
• Scope – the policy should specify which individuals are covered by the policy. It is recommended that the conflict of interest policy cover, at the very least, all directors, trustees, officers and key employees.
• Disclosure – as a safeguard against entering into actual or apparent conflict of interest transactions, board members and certain officers should complete and sign an annual disclosure and should be reminded that they are obligated to disclose potential conflicts of interests whenever they arise.
• Procedures – clear and concise instructions should be in place to assist the individuals completing the conflict of interest questionnaire determine whether or not a conflict exists and to specify how to handle potential and actual conflicts of interest.

Please note that a sound conflict of interest policy should also outline the steps to be taken with respect to disclosed conflicts of interest. Proper review and approval procedures should be implemented by the organization’s board or a committee of the board to ensure that all potential conflicts of interest are reviewed and approved and that any necessary mitigating behavior with respect to each conflict of interest is taken.

Once established, it is important that tax-exempt organizations continuously update their conflict of interest policy and ensure adherence to the policy. Effective governance of an organization depends on decision making by the board and senior management that is unbiased. The appearance of a conflict of interest can damage an organization’s credibility and reputation and compromise its ability to fulfill its charitable purposes and mission.

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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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