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Am I An Independent Director? – JRHaeck
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Am I An Independent Director?

By admin 9 years ago
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Situation:                    O. Sue Generous (O Sue) sits on the Board of Colorado Debtors Anonymous (CDA), a 501(c)(3) organization.  Just prior to CDA’s fiscal year-end, O Sue took an advance of $1,000 to help cover travel expenses for attendance at the annual convention of National Debtors Anonymous, an association of various state “Debtors Anonymous” organizations.  O Sue attended the convention on behalf of Debtors Anonymous and shortly after fiscal year-end, properly filed an expense report with CDA, settling up amounts owing between the two, in accordance with CDA’s procedures for maintaining an “accountable plan”.  At CDA’s fiscal year-end, O Sue owed CDA $1,500 as part of a previously made pledge.  In addition, O Sue’s law firm, in which O Sue shared a 35% interest with two other partners, showed an outstanding receivable balance from CDA for $2,500 in connection with an employee’s threatened suit against CDA.  Fees for legal assistance were billed to CDA on the same terms as offered to the general public and were generated in the normal course of business.  No other legal expenses were generated during the fiscal year between O Sue’s firm and CDA.

Dilemma:                    Each year, the Board of Directors of CDA surveys its members in order to determine which, if any, were not independent, for the purposes of accurately completing its annual Form 990, Return of Organization Exempt from Income Tax.  O Sue is seeking advice as to whether any of the outstanding amounts owing between her and CDA constitute transactions that would cause her to be considered an “interested person”, and therefore, not independent.  There were no other transactions between O Sue and CDA that required Schedule L reporting.

Rule:                           The IRS requires that each nonprofit organization complete and file Form 990, Return of Organization Exempt from Income Tax.  Form 990, Part VI asks for a count of the current members of the Board of Directors, distinguishing between independent and non-independent directors.  Schedule L, Part II requires a listing of interested persons from whom or to whom the filing organization maintains an outstanding loan at fiscal year-end.  If so listed, the director would not be independent.

Answer:                      Interested persons are defined differently for each part of Schedule L.  Relating to Schedule L, Part II, interested persons include current directors, including O Sue.  Nevertheless, all transactions and outstanding balances owed between CDA and O Sue were exempt from inclusion on Schedule L, Part II.  Loan balances resulting from the following do not qualify as reportable:

  • Excess benefit transactions, reported in Part I,
  • Advances under an accountable plan,
  • Pledges (charitable contributions) receivable,
  • Accrued compensation payable by the organization,
  • Loans (with normal membership terms) from a credit union made to an interested person,
  • Tax-exempt bonds purchased from the filing organization (with publicly available terms),
  • Receivables created in the normal course of business on the same terms as offered to the general public.

Each of the amounts owing between CDA and O Sue fell into one of the categories for exemption from reporting on Schedule L, and no other transactions took place between CDA and O Sue that required listing on Schedule L. Therefore, O Sue may report herself as an independent director on CDA’s Board of Directors.

Significance                Directorship independence is determined by reference to needing to be listed on Schedule L of Form 990, Return of Organization Exempt from Income Tax.  Although the IRS requires a distinguishing count of independent and non-independent directors, there currently exist no limitations placed upon one category over the other.  Therefore, the IRS requires this information for much the same reason as it requires information about other governance practices.  Federal law does not mandate particular management structures, operational policies, or administrative practices.  Nevertheless, the IRS considers good governance practices as corollary to good tax compliance.

Since the implementation of the “new” Form 990 in 2008, the IRS began a study of the correlation between good governance practices as reported on Form 990 and tax compliance. This study is likely to continue indefinitely, or for an extended number of years.  By implication, the IRS considers Boards of nonprofit organizations with relatively high percentages of independent directors to operate better than those with low percentages.  Therefore, it might be presumed the lower the percentage of non-independent directors that govern a nonprofit organization, the lower will be the probability of IRS audit or attention.  Nevertheless, there appears to be no definitive proof that this relationship exists.

One of the purported purposes of the newly redesigned Form 990 was to make governance matters more “transparent” to the public. Therefore, it might also be surmised that the IRS considered the distinction between counts of independent vs. non-independent directors as contributing to a beneficial level of transparency, consistent with this stated objective.

We Can Help!            JR Haeck CPA Firm helps nonprofit organizations, like yours, to prepare and file their annual Form 990, Return of Organization Exempt from Income Tax.  Haeck is expert in this field, and will gladly work with your auditor, if you have one, or directly with your controller to complete this very important annual responsibility.  Contact us, or check out our web site at JRHaeck.com, to find out more.

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