Tax-Exempt Compliance
Fiduciary Oversight and IRS Governance Expectations
October 20, 2024 — Chase Sizemore
Tax-Exempt Compliance
The relationship between nonprofit governance and tax-exempt compliance has evolved significantly over the past decade. The IRS no longer views governance as a peripheral concern; it is now a central indicator of whether an organization operates legitimately for its charitable mission.
This shift reflects a broader recognition that governance quality directly impacts compliance. Poorly governed organizations are more vulnerable to self-dealing, excessive compensation, and mission drift—the very risks the tax code is designed to prevent.
When the IRS evaluates a nonprofit’s governance practices, it looks for evidence of:
The IRS expects boards to make consequential decisions through structured processes, not at the direction of a single individual. This includes compensation decisions, major expenditures, and strategic commitments. Documentation of board deliberation and independent judgment is critical.
Organizations must demonstrate systems for identifying, disclosing, and managing conflicts of interest. This includes formal conflict-of-interest policies, documented disclosures, and evidence that interested parties recused themselves from relevant decisions.
Board decisions regarding executive compensation should be made independently, informed by market data, and documented in board minutes. The IRS views this documentation as evidence of reasonable compensation practices.
Governance documentation should demonstrate that the board regularly reviews whether the organization’s activities align with its charitable mission. Boards that can articulate their mission and show how programs serve that mission are better positioned to demonstrate tax-exempt compliance.
The Form 990, an organization’s annual tax return, has become an increasingly detailed governance document. Part VII requires disclosure of executive compensation, Part VIII captures revenue and expense detail, and the Schedule O narrative allows organizations to explain governance approaches.
The IRS uses these disclosures to identify risk areas. Organizations with inadequate governance documentation, unusual compensation practices, or unclear mission alignment face heightened scrutiny.
To align governance with IRS expectations, organizations should:
Document board processes: Maintain detailed meeting minutes that reflect independent deliberation, discussion of material decisions, and consideration of alternatives.
Implement formal policies: Adopt written policies addressing conflicts of interest, compensation, related-party transactions, and executive authority limits.
Use benchmarking data: For significant compensation decisions, gather market data about comparable positions and document that compensation is reasonable in relation to those benchmarks.
Conduct regular compliance reviews: Periodically assess compliance with tax-exempt requirements, including charitable purpose, unrelated business income, and excess benefit transactions.
Maintain institutional records: Preserve documentation of governance decisions, board approvals, and policy decisions. These records demonstrate that the board was actively engaged in governance.
Organizations that prioritize governance as a compliance matter derive concrete benefits. They can demonstrate to donors, grantmakers, and regulatory bodies that they operate with integrity and accountability. They are less vulnerable to IRS challenges. And they build board confidence that decisions are being made appropriately and legally.
The IRS expectation isn’t perfection—it’s evidence that the board takes its fiduciary responsibilities seriously and has implemented systems to ensure tax-exempt compliance.