Mere mention of the IRS tends to trigger certain symptoms among club board members: sweaty palms, worried looks, and the overwhelming feeling that, though you’ve tried to do everything right, you still may have done something wrong. That’s O.K. It’s a natural reaction. But, contrary to popular belief, the IRS isn’t simply there to breathe down your neck and make everyone at your club miserable. IRS standards, and in particular, those of Form 990, can actually be very useful tools for promoting strong governance practices at your club.
Private clubs that are tax-exempt must annually submit IRS Form 990, entitled the Return of Organization Exempt from Income Tax. Form 990 exists to provide the federal government with some idea of what tax-exempt organizations—like private clubs—do and how they are managed. It further ensures that clubs are complying with the necessary requirements to remain tax-exempt.
Corporate governance has been defined as “[t]he framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency….” Since characteristics like “accountability, fairness, and transparency” should be standards that all boards strive to uphold, effective corporate governance is a key to effective club management.
Form 990 requires clubs to take a detailed look into their governance practices and report those practices to the IRS. Essentially, the IRS is effectively regulating club governance operations through the use of disclosure requirements—and using the potential removal of a club’s tax-exempt status to ensure compliance. Though some clubs may believe that the federal government is unnecessarily intruding on its governance practices, Form 990 can provide some very interesting insight into what the IRS recommends as its best practices for effective corporate governance.
Form 990 asks numerous questions about a club’s governance practices, touching on everything from details regarding board-voting practices to specific document retention policies. The fact that these topics and others are included in the form shows the importance the IRS places on them. Rather than bristle at IRS requirements, club leaders should look at the task as a way to reassess their own governance practices each year and ensure that they’re following the practices that are most likely to lead their clubs to success down the road.
The form itself is divided into different parts, each focusing on a different set of provisions. The section that details governance can be found in Part VI.
PART VI
Governance, Management and Disclosure
When a club fills out Part VI of Form 990, the required information focuses on a club’s governing body, governance policies and disclosure practices. Federal tax law does not mandate particular management structures, operational policies or administrative procedures, but every tax-exempt club required to file Form 990 must respond to each question in Part VI. Though clubs need not have a particular iteration of a policy or procedure in place, every section delineated in Form 990 indicates the importance the IRS places on various governance practices.
In theory, this means that clubs should have written documents and policies detailing each aspect of the information listed on the form. The form provides a good opportunity for clubs to reexamine their written documents and ensure that their policies in the required areas are applicable, thorough and up-to-date. For example, does the club’s document retention plan include electronic files, including e-mail communications?
Unfortunately, some clubs have yet to adopt basic governance practices and policies and, therefore, may be at risk of coming under IRS review. Aside from preventing the potential loss of tax-exempt status, the adoption of good governance practices offers club members the transparency necessary for those in charge of club governance to govern effectively.
SECTION A
Management Matters
Some of the IRS questions related to management and governance can serve as direct guides for best practices in a club setting, though others are simply meant to provide the IRS with useful information. For the purposes of establishing good governance guidelines, this article will only examine the topics applicable to governance best practices.
Number of Voting Members of Governing Body
The IRS is interested in the number of members of the governing body with power to vote on all matters as of the end of the club’s tax year. The governing body is, generally speaking, the board of directors (sometimes referred to as board of trustees) of a corporation. Among other things, the IRS is concerned about board size because very small boards run the risk of lacking the required skills and other resources required to effectively govern, but, on the other hand, very large boards may have a more difficult time arriving at decisions. Clubs can take these same considerations into account when evaluating the effectiveness of their own boards. Identification of a club’s board on Form 990 reinforces the view that the board has a significant role in a club’s strategic direction and governance, and board size should be taken into account when assessing its effectiveness.
Number of Independent Voting Members of Governing Body
In simple terms, a member of the governing body is considered “independent” only if certain conditions applied through- out the club’s tax year including:
- The member was not compensated as an officer or other employee of the club;
- The member did not receive total compensation or other payments exceeding $10,000 from the club as an independent contractor; and,
- Neither the member, nor any family member of the member, was involved in a transaction with the club (whether directly or indirectly through affiliation with another organization) that is required to be reported on Form 990.
Although the federal tax law does not generally require a tax-exempt club to have independent members on its board, independent governing board members enhances good governance and decision-making by ensuring that the board members truly have the best interests of the members in mind, rather than being influenced by the prospect of personal financial gain.
Officer, Director, Trustee or Key Employee with Family or Business Relationship with an Officer, Director, Trustee or Key Employee
The IRS requires the club to disclose whether any of its current officers, directors, trustees, or key employees had a family or business relationship with another of the club’s current officers, directors, trustees, or key employees at any time during the club’s tax year. While these relationships may not be detrimental to the club, considering such relationships may help identify any potential decision-making biases. When evaluating the effectiveness of a club’s board, impartial decision-making is generally a positive factor in corporate governance and transparency.
Contemporaneous Documentation
Both for legal and practical purposes, it’s always important that your club keeps a record of important meetings and decisions. Documentation permitted by state law can include approved minutes, e-mail or similar writings that explain the action taken, when it was taken, and who made the decision. In this instance, the term “contemporaneous” means by the latter of (1) the next meeting of the governing body or committee (such as approving the minutes of the prior meeting) or (2) 60 days after the date of the meeting or written action.
Having contemporaneous documentation of board and committee activities helps to ensure transparency and provides a relatively reliable account of board actions. This documentation highlights the decision-making process and overall governance activities of the board.
SECTION B
Policies That Improve Compliance
In discussing corporate governance in the instructions to Part VI, Section B, of Form 990, the IRS advises that even though the information requested with respect to corporate governance is not specifically required under the Internal Revenue Code (“IRC”), the IRS considers such policies and procedures to generally improve tax compliance. A discussion of such policies follows.
Conflict of Interest Policy
A conflict of interest arises when a person in a position of authority within a tax-exempt club, such as an officer, director, trustee, manager, or key employee (collectively, the “Managers”) can benefit financially from a decision he or she could make in such capacity. Benefit is a relatively broad term in this instance and includes indirect benefits such as those to family members or businesses with which the Manager is closely associated.
A conflict of interest policy identifies the classes of individuals within the club covered by the policy, facilitates disclosure of information that can help identify potential conflicts of interest, and specifies procedures to be followed to avoid conflicts of interest.
A strong conflict of interest policy is meant to help a club monitor and manage potential conflicts. The policy should include an explanation of which persons are covered under the policy, the level at which determinations of whether a conflict has the potential to exist are made, and the level at which actual conflicts are reviewed. It should also contain an explanation of any restrictions imposed on persons with a conflict, such as prohibiting them from participating in the governing body’s deliberations and decisions with respect to related transactions.
The IRS is also interested in a description of the club’s practices for monitoring proposed or ongoing transactions for conflicts of interest and dealing with potential or actual conflicts, whether dis- covered before or after the transaction has occurred.
Though there is no IRC provision that specifically requires that a club adopt a conflict of interest policy, without one, it is unquestionably more challenging for a club to avoid conflicts. Furthermore, as a condition of its tax exemption, a club may not engage in private inurement (organized or operated for the benefit of private interests, such as the creator or the creator’s family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests). Although case law with respect to private inurement and private clubs is limited, the IRS would likely view the following transactions as problematic inurement:
- overt distributions of money by the club to members (dividends);
- excessive salaries paid by the club to managers; and,
- excessive payments by the club to members for insurance or other products.
A conflict of interest policy not only makes the task of monitoring potential or actual conflicts more manageable, but also assists the club with compliance with the private inurement provision of the federal tax law. Despite the importance of having a distinct, written conflict of interest policy signed by all club leaders, only 61 percent of clubs surveyed reported having one according to a recent survey by the National Club Association (NCA). (See article on page 14 for more survey information.) The policy should emphasize the club managers’ duty of loyalty to the club, requiring each executive to act in the best interest of the club rather than in their own personal interest. Not surprisingly, a club director with a vendor relationship, which may be perfectly reasonable or advantageous to the club, should be subject to scrutiny for potential inurement issues. A conflict of interest policy with annual disclosure requirements is a key tool in effective corporate governance and is an important part of protecting a club from unethical or illegal practices.
Whistleblower Policy
Having a whistleblower policy is also an important part of ensuring transparent governance within a club. According to NCA’s recent survey, only 54 percent of clubs had whistleblower policies in place for club employees. A whistleblower policy may encourage staff and volunteers to come forward with credible information on illegal practices or violations of adopted club policies. It also specifies that the club will protect the individual from retaliation, and identifies those staff or board members or outside parties to whom such information can be reported.
The federal Sarbanes-Oxley legislation imposes criminal liability on organizations for retaliation against whistleblowers that report federal offenses. Ensuring that those who come forward with information will be protected promotes transparency and encourages honesty among club volunteers and staff, all while helping to protect a club’s tax-exempt status.
Document Retention and Destruction Policy
One of the most important practices for any business is to have a clear document retention policy in order to protect itself and its leaders from liability. Though storage space is both limited and costly, and most documents can be disposed of after a period of time, document retention policies create a legal, reported and recorded mechanism for document disposal. Sarbanes-Oxley imposes criminal liability on tax-exempt clubs, as well as other organizations, for destruction of records with the intent to obstruct a federal investigation. Clearly written document retention policies help shield clubs from such an eventuality by making clear which documents are kept, stored or disposed of as a matter of course, and identifies the record retention responsibilities of staff, board members and outsiders.
Even with the risk that comes from not having a document retention policy, only 48 percent of the clubs surveyed in NCA’s recent study reported having one in place. The IRS believes that having a policy is so important that they have an entire section in Form 990 devoted to it.
Compensation Policy
When the IRS extended compensation reporting requirements to all 501(c)s, like social and recreational clubs, it stated that “[t]his additional compensation information is needed to more effectively administer the laws regarding inurement, exempt purpose, and private benefit, as applicable to these organizations.” The IRS further advised that an “[a]ccurate and complete reporting of executive compensation by exempt organizations has been a concern of the IRS and the public.”
Reporting a person’s compensation is quite an invasion of a person’s privacy. In the context of public charities, which are supported by tax-deductible contributions from the public, there is a strong public policy reason for such disclosure. Yet clubs do not receive tax-deductible charitable contributions, and the public does not support them. Why is compensation of club employees a public concern? It would be a challenge to present a persuasive argument as to why the compensation of a club manager, who is typically not an officer or director of a club, should be disclosed to the entire world.
Clubs are private entities that are substantially, if not exclusively, supported by members who do not receive a charitable deduction in connection with such support. If any group of persons has a legitimate interest in the compensation of a club manager, such group would be the club members who could secure such compensation information in a less invasive manner by simply contacting club administration. It is understandable why there may be discomfort on the part of clubs to make what is otherwise private compensation information public. So, why do it? Well, the short answer is—the IRS requires it, and the failure to accede to an IRS requirement may be costly.
The IRS may assess a penalty against a club that does not provide the requested compensation information. The IRS advises that a “penalty can … be charged if the organization files an incomplete return, such as by failing to complete a required line item or a required part of a schedule.” The penalty for an incomplete return is not insignificant; for example, clubs with annual gross receipts exceeding $1 million may be subject to a penalty of $100 for each day failure continues (with a maximum penalty for any one return of $50,000).
The IRS remains vigilant with respect to compensation practices of exempt organizations, including private clubs. A process should be utilized in setting the compensation of a club’s top management official, as well as the compensation of its key employees or compensated officers. These processes generally involve a review and approval process by independent persons, use of comparability data, and contemporaneous documentation with respect to the compensation arrangement. An independent review of compensation of management persons helps ensure fair compensation practices and prevents issues from arising over unfair compensation complaints from those who believe they may be getting less than they are due.
GOVERNANCE POLICIES:
To Adopt or Not to Adopt
Though the IRS asks about many different policies, there are no correct or incorrect answers; the primary requirement is that the answers be truthful. The IRS guidelines do, however, outline a list that can be used to ensure your club has the right policies in place to protect itself from liability, ensure transparent management and strengthen its good governance practices. In recent years, clubs have been adopting more of the aforementioned policies as a simple matter of good governance, and many of the policies discussed in this article serve a dual purpose: not only do they encourage good governance and transparency, but they also demonstrate that a club is well-governed in the event of an audit or investigation.
James J. Reilly, CPA, JD, is a partner at Condon O’Meara McGinty & Donnelly LLP. He can be reached at [email protected].