In honor of the upcoming Independence Day holiday, let’s talk about board independence. Is your board independent? Are you sure? You’ve probably seen this question when filing for exempt status, filing Form 990 or even on grant applications… but what does it really mean and why is it important?
Nonprofit organizations (other than private foundations) are public entities. When the founders choose nonprofit status for their idea/project, they are turning over the governance and oversight role to the public, which is represented by a board of directors. These directors should be independent with respect to the organization and each other in order to ensure that decisions are being made in the best interest of the organization and the community it serves. A director is independent with respect to the organization if all of the following criteria are satisfied:
- The director is not compensated as an employee of the organization or a related organization.
- The director did not receive total compensation (not expense reimbursements) exceeding $10,000 from the organization or a related organization as an independent contractor during the organization’s tax year.
- Neither the director, nor any family member of the director, was involved in a reportable financial transaction with the organization or a related organization during the organization’s tax year. This includes loans, grants from the organization and certain employment and independent contractor arrangements.
Directors are not considered independent with respect to each other if they have any of the following relationships:
- Family – brother, sister, spouse, in-laws, ancestors and descendants
- Business – employer/employee when the employer is a more than 35% owner or an officer/director; transacting business of more than $10,000 during the organization’s tax year; own a business together in which both own more than 10%
The organization must make a reasonable effort to determine whether the board members are related in any way. Many organizations send a form to each board member on an annual basis asking if they have any of the above-mentioned relationships with another board member. If your board is large or has had recent turnover, it’s a good idea to include a list of all board members for their reference.
Board members don’t actually have to act on their impaired independence to cause a problem – even the perception of impaired independence can damage an organization’s public image in some situations. If you have a large donation to give, would you be more inclined to trust an organization in which all board members are independent more than one in which most of the board members are family members? When a majority of the board is not independent with respect to each other and/or the organization, it’s easy for them to start making decisions that benefit their own personal interests rather than what benefits the longevity of the organization and the community impact. Often it’s not even intentional.
Although not strictly prohibited, close friendships can potentially cause poor board member judgment as well. Board members may not have much nonprofit experience and are just serving as a favor to their friend, the founder and/or executive director. They may trust their friend too much and not provide the oversight their role requires. When choosing board members, be sure to consider what’s best for the organization and its mission. It’s appropriate for some board members to be related, but it’s always best for a majority of the board to be independent.
