Does Nonprofit “Good Governance” Lead to IRS Tax Compliance?

by Linda M. Lampkin, Senior Nonprofit Compensation Specialist 20. April 2012 09:01

The Exempt Organizations division of the IRS thinks so, and has some preliminary evidence to back up the assertion.  In a recent speech, EO Director Lois Lerner disclosed some current research results and plans for a more comprehensive look at the link between organizations that are well governed and their likeliness to be compliant with tax law.

For the past few years, all IRS compliance checks included a check sheet on governance practices for the organization.  Obviously, the roughly 1,300 organizations in this group had already been selected for a check for reasons unrelated to governance, so it is not a statistically representative sample of nonprofits.  But the analysis of some key data points shows interesting results. 

Organizations are more likely to be compliant if they:  

  • Have a written mission statement,
  • Always use comparability data when making compensation decisions,
  • Establish procedures for the proper use of charitable assets, and
  • Have the Form 990 reviewed by the entire board of directors.

This initial analysis covers only 501(c)(3) public charities that were already selected for exam based on other criteria, but, according to Lerner, does provide some possible indicators of tax compliance.  And now an IRS strategic planning group is developing a proposal to expand the data analysis to a statistically representative sample of all nonprofits.  The IRS hopes to have the data to support its premise that good governance leads to good tax compliance.

In the meantime, filling out the governance questions on Part IV of the Form 990 is important to the IRS, and “wrong” answers in this section (for example, no comparability data used for compensation decisions) could end up leading to a review.  It is hard to envision a successful organization that does not have a written mission statement and procedures to protect assets.  A review of the Form 990 by the entire board is easily implemented.  Even comparability data are easily available -- the demonstration version of ERI’s Nonprofit Assessor, available at www.erieri.com, provides executive salary comparability data at no cost, which is adequate for the vast majority of nonprofits; larger organizations may want to purchase the Professional version which provides more detailed information. This is the same software used by IRS to check compensation levels; nonprofits can view the same analysis as the IRS compliance staff.

The IRS is always looking for ways to identify efficient ways to use its limited compliance resources.  Nonprofits may not only improve their chances of success, but also lessen the probability of an IRS investigation by implementing some simple good governance practices.