5 Key 501c3 Rules That Your Board Must Follow
Once elected to your nonprofit board of directors, each trustee is expected to familiarize themselves with your bylaws, articles of incorporation, and other essential resources.
With this knowledge, board members will better understand the duties, obligations, and regulations that cover trustee governance, providing the opportunity for officers to understand their role within the nonprofit and avoid legal pitfalls.
To help new board members acclimate to their new position, we walk you through 5 key rules that your board must follow to remain 501c3 compliant to safeguard your tax-exempt status.
For your organization’s protection, let’s jump right in!
- Preface to Board Rules
- Rule #1: Do Not Delegate Responsibility
- Rule #2: Act with a Duty of Care
- Rule #3: Act with a Duty of Loyalty
- Rule #4: Act with a Duty of Obedience
- Rule #5: Avoid Conflicts of Interest
- Additional Concerns
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Preface to Board Rules
There is a lot of bad advice out there, as well as a lot of useless information. So we have consulted our board members and spoken to nonprofits around the US, as well as combining what we already know from resources like the Basic Duties of Directors & Charitable Trust Obligations to determine the 5 most important rules.
Pro Tip: Remember that these are not all of the rules that must be followed, but only a selection of crucial mandates that can post significant problems upon a failure to comply.
Rule #1: Do Not Delegate Responsibility
As each board member signed on to certain responsibilities to facilitate nonprofit board governance of the organization, it is important that they acknowledge full responsibility for duties that fall within their position’s job description.
This sentiment aligns directly with Section 5210 of the Law for Charitable Acts and Omissions. However, despite the importance of self-dealing with tasks, the section does grant provisions for board members to delegate tasks, such as assigning other members, staff, volunteers, or employees roles or even control over particular projects within their jurisdiction.
However, the directors are expected to hold overarching responsibility for that project and manage it in a way that ensures the people involved are performing procedures properly.
Sadie says no to delegating responsibility!
This rule is important because it establishes that each board member needs to act in a manner within the nonprofit’s best interest. It also ensures they represent themselves accordingly and that anyone working on their behalf is doing the same.
Rule #2: Act with a Duty of Care
The first of the three major fiduciary principles all nonprofit board member positions are expected to perform, the duty of care expects officers to make proper use of the organization’s facilities, human resources, and all other assets at their disposal while promoting goodwill throughout their tenure.
This duty requires directors to be intimately familiar with the mission statement, IRS tax law, basic legal obligations, bylaws, and Section 5231 of the Law.
Section 5231 essentially establishes that a director will perform their assigned duties with good faith, including when serving on board committees while behaving in a prudent manner that correlates with the best interests of the nonprofit corporation.
For example, directors need to keep current on entity projects and actions furthering the mission statement as well as attending meetings and important events. More specifically, they must prevent mismanagement of funds, adhere to whistle-blowing policies, and ensure appropriate nonprofit safeguards are in place such as workers compensation and other important insurance policies.
Rule #3: Act with a Duty of Loyalty
The duty of loyalty keeps trustees aligned with the organization’s purpose by mandating that board members make sure that all projects, events, and activities are focused on furthering the mission.
Duty of Loyalty, at its core, is meant to ensure that every decision board members make is in the best interest of the board rather than any one individual member.
As the interests of the nonprofit come first, that means each officer must acknowledge any conflict of interest situations in advance so that no negative consequences arise due to personal agendas. More on this later!
To fulfill the three principles, a board member with a personal interest should want to disengage themselves from questionable situations, especially because if they vote and the issue passes, they may be called on to provide evidence to support that the transaction is fair.
Loyalty gets two thumbs up from David!
There are strict rules about conflict of interest, so make sure all board members are briefed on proper behavior as improprieties may cause you to lose your tax-exempt status.
Rule #4: Act with a Duty of Obedience
Fiduciary obedience means following all laws, including the organization’s private bylaws while taking action to ensure that others within the organization are doing the same.
Here are some specific responsibilities that align with this duty:
Follow nonprofit’s bylaws and governing mandates
Make sure all organization mission projects observe legal compliance
Address all types of laws whether internal or external concerns
Ensure proper use of company funds
Implement procedures to maintain compliance and accuracy with documents
Take steps to protect the organization’s 501c3 status
Pro Tip: Making sure all of your board members are all on the same page in understanding current laws and regulations is the best way to ensure the board as a whole acts with a duty of obedience. Requiring new members to read this documentation during the onboarding process is just one way to handle this. In addition, follow-up discussions concerning integral documentation may help clear up any trustee questions.
Rule #5: Avoid Conflicts of Interest
501c3 requires that board members of nonprofit or charity agencies put the organization’s interests above their own. Disclosure of all potential conflicts is the first step in making sure that incidents where your nonprofit faces this issue are minimal.
Discovering any situations where a director may have a personal stake in a transaction or receive compensation from them turns them into an "interested director." An interested director is when a trustee or even a group of officers stand to gain for a transaction.
This situation muddies the water and calls into question whether the transaction is really in the best interest of the organization and its mission or the best interest of those members who have a stake in the outcome.
Recognizing these situations beforehand and having interested directors abstain from voting on those topics is a best practice. This exemption ensures that voting is performed with the mission in mind instead of a personal stake.
Board members are supposed to always act in the interest of the organization. Many organizations offer their nonprofit board of directors salary compensation, that is not all that uncommon. However, when structuring the compensation, you have to think through how this incentive may alter decision-making.
For example, when compensation or bonuses are aligned with quarterly earnings, board members may be more inclined to focus on short-term growth at the detriment of long-term stability.
Nobody likes conflicts of interest, especially Anthony.
This concept is especially when board members stand to acquire financial gain beyond the reasonable compensation provided, as in when they make decisions based on relationships or income streams that come from outside the organization. This is why conflicts of interest are important to disclose.
The 49% Rule
To reduce risk, most nonprofits take special care to enact the 49% rule. That means that the percentage of board members that are considered interested directors is limited to less than half of the total number of members. An interested director is someone who received compensation within the last year and/or any member of their family.
In California, this is not a recommendation, but a requirement in accordance with Section 5227 of the state’s Nonprofit Corporation Law.
This measure protects the nonprofit while ensuring that there are enough board members to successfully manage a vote with interest party exemptions.
A side effect of this policy is that it automatically creates limitations on how many directors from a specific family can serve on the board at any one time, as those with familial ties are viewed as possessing similar interests.
To close, this section will give you an overview of rules that goes beyond the 5 key rules previously outlined. With it, you can do more intensive research to protect your 501c3 status and help your board keep to the straight and narrow path.
Separating Private Interests
Remember that as a tax-exempt entity, your organization is not allowed to support in any way the private interests of any person internally or externally. The nonprofit itself is the only entity that should benefit.
For instance, a conflict can occur when a director provides a paid service, such as that of an attorney. It is tempting for other officers and members of the organization to want to recommend their services to others.
However, this advertisement can be seen as the attorney profiting from the status of a board member as they are receiving increased monetary gain as a result of any recommended clients.
Because of these types of situations, more organizations transcribe specific amendments to their bylaws regarding this type of conflict. The end result typically prohibits these services or requires that the board member in question relinquishes their role on the board for 501c3 protection.
Annual Audits and Reporting
Even though your corporation may be tax-exempt, you still have the legal obligation to file the IRS Form 990 or some variation depending upon your nonprofit’s status. Auditors should ensure accuracy and legal compliance. The Treasurer of the board ensures that the audit is completed, and reports the results of the audit to rest of the board. They also make sure that the recommendations from the audit are implemented.
Avoid Political Entanglements
Your organization may not support or oppose any political entities and must abstain from any political activities no matter if it is local or federal. The IRS mandates that 501(c)(3) nonprofits "are prohibited from participating in any political campaign for (or against) any candidate for elective public office."
Clearly defining this regulation for your board, and how it impacts their personal political endeavors, will ensure alignment of expectations.
Limit Income to Organizational Use
As a nonprofit, the organization should not acquire income for any purpose other than fulfilling your mission and maintaining your organization.
There are ways that a nonprofit can benefit from other, taxable, income sources. However, any organization acquiring income for other purposes should reclassify and pay taxes on this type of income.
Proper policies and bylaws can ensure that these income streams are identified and properly accounted for to ensure the organization’s tax exemption status remains intact.
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💡What are the duties of a board of directors?
🔑 What is an interested director?
A director becomes an interested director in any situations where a director may have a personal stake in a transaction or receive compensation from it. i.e., when a trustee or even a group of officers stand to gain for a transaction. Find out more.
📝 Are nonprofit directors allowed to participate in political campaigns?
No. The IRS mandates that 501(c)(3) nonprofits are prohibited from participating in any political campaign for (or against) any candidate for elective public office. So stay away from any political entanglements! Find out more.