Nonprofit Organization Laws and Regulations – FAQs

Attorneys, accountants, and other professionals can contribute valuable expertise to a board. Due to the potential for conflict of interest, their contributions should be voluntary. At the very least, a board member who is associated with a firm competing for a contract should abstain from discussion and voting in the selection process. If a competitive bidding process results in the selection of that board member’s firm, they should disclose the affiliation and abstain from voting on future board actions connected with that firm’s contract with the organization.

An essential part of a strong conflict-of-interest policy is a disclosure form. This is a document that every board member should complete annually, listing all of their professional, financial, and personal affiliations that might affect their independent decision-making capacity during board service.

This document serves as a guide to determine conflict of interest when specific issues are handled by the board. The chair should regularly review the document. Depending on the board’s policy, a board member with a conflict will either leave the room before discussion begins or participate in deliberation but not be present during the voting. This process protects the organization from biased decision making and allows board members to keep their integrity.

In addition to defining the caveats of conflict of interest and proposing how to deal with them, the BoardSource publication, Managing Conflicts of Interest has sample conflict-of-interest policies and a sample organizational code of ethics. The BoardSource publications Better Bylaws and The Nonprofit Policy Sampler are other resources.

Some nonprofit organizations have nepotism and fraternization policies that forbid board members from having family or other close relations with staff. If you do not have a policy, each situation needs to be treated as a special case. The board should determine whether it can or wants to live with this potentially difficult situation.

Here are some issues to discuss:

• Do you have a strong conflict-of-interest policy? Do you have a confidentiality policy?
• Is a board member able to make unbiased decisions when the staff member with whom they have a personal relationship could benefit from the outcome?
• Is the board concerned about confidential board issues being passed on to staff?
• Is the chief executive aware of this situation? How do they feel about a staff member having direct contact with a board member, and possibly passing on unfiltered information to the executive’s supervisor?
• Is it possible that this staff member gains an indirect influence in the operations of the organization?

Ultimately, it is important to focus on a strong confidentiality policy and discuss ethical behavior in general rather than assume that a fraternization policy will eliminate the actual problem.

In the strictest sense, bylaws are not public documents. They are the internal rules and regulations to guide your board’s activities. As a reference document, when filing for your tax-exempt status, it is good practice to include your bylaws if they have already been drafted. When incorporating your organization, your bylaws can provide helpful information on your organization.

Even if the law does not consider your bylaws a public document, your willingness to distribute a copy to anyone requesting it increases your accountability and transparency to the public. Considering your bylaws as a public document also can force your board to pay careful attention to its contents. Keep the bylaws alive by evaluating them on a regular basis and amending them when they seem to lose validity or no longer correspond to your values.

All nonprofits and their board members are encouraged to be active advocates of their mission. However, the IRS allows 501(c)(3)s to engage in lobbying only as long as it is not a “substantial part” of their activities. As the “substantial part” definition is rather ambiguous, public charities that lobby should understand the monetary parameters for what constitutes “substantial.” 501(c)(4) social welfare organizations and 501(c)(6) trade associations may engage in lobbying activities without limits; in fact, that can be one of their main functions.

It is important to remember that political activity — campaigning in favor or against a candidate — is strictly prohibited for a charity. A violation of the IRS regulations may result in an organization losing its tax-exempt status or having to pay excise taxes on the money improperly spent.

All nonprofits can engage in lobbying to a varying degree, but political activity is completely out of bounds for public charities. “Political activity” refers to partisan campaigning for or against a candidate. However, there are some nonprofits that can fully focus on political activity: Section 527 organizations or Political Action Committees associated with nonprofits other than public charities. These are independent groups whose mission is to support and influence the election of a political candidate. They accept contributions for candidates, and, although these contributions are not tax-deductible, they are exempt from federal gift tax.

Nonpartisan voter education, activities related to get-out-the-vote efforts, and sponsoring nonpartisan candidate forums are usually allowed for charities, but it is important to be familiar with the IRS regulations to avoid putting the organization’s tax-exempt status in danger.

Public charities cannot engage in any kind of partisan political activity, directly or indirectly. PACs can be formed by 501(c)(4)s (social welfare organizations) and 501(c)(6)s (trade associations and business leagues), but 501(c)(3)s may not create their own committees.

One of the ways a board can protect its members against personal liability is to have an indemnification policy written into its bylaws. “Indemnification” means that the organization relies on its own resources to pay board members’ legal costs for claims that result from board service. However, an indemnification policy goes only as far as the organization’s resources allow. If the organization lacks resources to pay, board members will not be adequately protected. Many states permit indemnification only as provided in the organization’s bylaws.

In addition to carefully defined risk-management procedures, it is wise for an organization to complement its indemnification clause by purchasing Directors’ & Officers’ (D&O) insurance. D&O insurance generally covers costs that the organization may incur while indemnifying its board members. However, it is important to read the policy for coverage exceptions and to determine whether permission must be obtained from the insurance company prior to incurring any costs or selecting a defense attorney.

Directors’ and Officers’ insurance is a specific insurance policy to safeguard board members and the organization for causes of action not covered by a general liability policy. D&O insurance is a separate policy from the general liability policy. An important benefit of D&O insurance is broad coverage for employment-related claims.

If your nonprofit has employees, it is important to determine that your D&O policy provides broad coverage for these types of claims. Typically, a D&O insurance policy will provide both defense and indemnification for the individual directors and officers and the organization. Since each insurance company offers a different policy form with distinctions that could dramatically alter coverage, it is important to check the specific language on your policy.

The Nonprofit Risk Management Center spends each day dealing with risk management, board liability, and insurance issues. It has excellent publications and articles on the Web site. Another reference for providers of insurance for nonprofits is the Nonprofits Insurance Alliance. You also may contact your state association. To find it, go to the National Council of Nonprofits.

The articles of incorporation should remain as general as possible within the framework of your state laws. The bylaws will provide further detail on the governance structure, and additional policies and procedures secure the rest of the necessary guidelines for the effective and ethical functioning of your organization.

Sometimes, major changes in the organization’s status, activities, or structure force you to amend the articles and to file an updated copy. These include

• changing the organization’s name or address
• substantially changing the organization’s mission
• altering the provision for the disposition of assets if the organization is dissolved
• changing the organization’s membership structure

The answer is “It depends.” But when it is possible, the rewards usually outweigh most of the concerns. A few states do not allow young people to serve on boards, and many states have laws prohibiting minors to sign binding contracts. Before inviting young people to serve on your board, verify whether your state has an age limit for board members. Even if your state law prohibits minors from serving as full members of the board, there are many ways to benefit from the ideas and perspectives that young people bring. You can ask them to serve as nonvoting members of the board, to become members on an advisory council, or to chair a committee or a special event.

If you decide to invite a minor to serve as a board member, keep these points in mind:

• Provide adequate orientation or assign a board mentor.
• Avoid electing minors as officers in charge of financial matters.
• When the law prohibits it, don’t allow minors to sign binding contracts for the organization.
• Provide D&O insurance for the entire board, but be aware that some policies may exclude minors.

Often, chief executives are said to serve as ex officio members of their board, meaning that they attend board meetings “by reason of their office,” rather than through elections. Other ex officio members could be government officials who are required to represent the government as part of a major grant provision. These delegates are appointed because of the position they hold and not because they have expressed particular interest in the organization.

It is important to expect the same commitment from these delegates as from other board members. There is often a misconception that ex officio board members lack voting rights, but the term has nothing to do with voting. It is important to clarify in the bylaws whether ex officio board members may have the right to vote. BoardSource recommends that chief executives serve as nonvoting ex officio members of the board.

Your articles of incorporation should include a statement of dissolution. Its purpose is to define the fate of your organizational assets if the organization ceases to exist. The statement must make it clear that none of the remaining assets will benefit a private person but will be distributed to another tax-exempt nonprofit.

Here is a sample statement: “In the event of dissolution of the Good Organization, the board of directors shall, after paying and making provisions for the payment of all liabilities, distribute all the assets of the corporation to an organization dedicated to charitable and/or educational purposes that has been recognized as a 501(c)(3) organization by the Internal Revenue Service.”