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5 Tests to Determine If Your Directors Are Independent

October 09, 2015

Having trouble determining the number of independent directors in your organization? There are four characteristics of independence that will help.

On Form 990, Not-for-Profit organizations are required to provide the number of independent voting members and directors of the governing body. The IRS, the state attorney’s general, and prospective donors are all interested in this information because having an independent director shows that an organization practices good governance.

What characterizes “independence”?

To be independent means that a director:

  1. Has no conflict of interest- If the director has a conflicting interest with the exempt organization, he/she cannot be considered independent.
  2. Is not compensated as an officer- The director cannot be treated as “independent” if he/she is compensated as an officer or other employee of the exempt organization or of a related organization. Also, a director cannot be compensated by an unrelated individual or organization for services to the organization or a related organization (if the compensation is required to be disclosed on Form 990).
  3. Is not compensated as an independent contractor- A director cannot be independent if he/she receives more than $10,000 as an independent contractor.
  4. Is not involved in a transaction with a related organization- It is crucial that both the director and any of his/her family members are not involved in a transaction with a related organization.
    • What is a related organization? A related organization refers to any entity that:
      • Controls the exempt organization,
      • Is controlled by the exempt organization,
      • Is controlled by the same people that control the exempt organization,
      • Is classified by the IRS as a supporting organization of the exempt organization, or
      • Is a sponsoring organization or contributing employee in regard to a Section 501(c)(9) voluntary employees’ beneficiary association.
  5. Is not involved in a transaction within the organization- The director or one of his/her family members cannot be involved in a transaction with the exempt organization which would be required to be reported on the organization’s Schedule L, Transactions with Interested Parties.

Any exceptions to these rules?

A director can still be classified as independent under certain transactions that conflict with the above four qualifications. The director can:

  • Make donations of any denomination to the exempt organization
  • Be part of the governing body of another charity that receives funds from the exempt organization during its tax year
  • Receive financial benefits from the exempt organization because he/she is a member of the class served by the organization in practicing its exempt purpose (financial benefits must agree with the terms of membership of the organization).

Many organizations distribute questionnaires among their directors as a way of determining independence.

Questions? Contact any member of our Not-for-Profit Services Team.

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