In Sun Tzu’s The Art of War, the ancient Chinese military general was quoted as saying:

“If you know your enemies and know yourself, you can win a hundred battles without a single loss.  If you only know yourself, but not your enemy, you may win or lose.  If you know neither yourself nor your enemy, you will always endanger yourself.”

How is this quote relevant to the governance of charitable organizations?  When an organization assesses its governance, the organization should know itself.  The organization should honestly assess its governance and seek to identify potential weaknesses.  Who is the “enemy” in the world of charitable organizations?  When discussing tax compliance, the “enemy” could be construed as the IRS.  However, the IRS has actually been partnering with charitable organizations by providing tools to succeed including a “Governance Check Sheet.”  The check sheet makes it simple for charitable organizations to know what the IRS reviews during an examination.  For purposes of this discussion, we will replace “enemy” in Mr. Tzu’s quote with “interested parties.”  Using a less adversarial interpretation allows us to include other interested parties, such as potential or existing supporters.  Thus, a charitable organization should know its interested parties (the IRS and its supporters) and know itself when assessing its governance.

One of the goals the IRS had in redesigning the Form 990 was to increase transparency.  Federal tax law does not require charitable organizations to have governance policies.  However, a significant portion of the core Form 990 deals with governance-related issues.  In this respect, it appears that the IRS is fulfilling its “increased transparency” objective with these questions.  If an organization indicates in Form 990 that it does not have a conflict of interest policy, no tax law has been breached.  Having poor governance will not trigger an IRS audit by itself, but it can certainly put the organization in a bad light with supporters.  The IRS believes that a well-governed charity is more likely to be tax compliant, serve charitable interests and safeguard charitable assets.

The IRS has been examining the correlations between certain governance practices and the tax compliance of charitable organizations.  If a 501(c)(3) organization experiences an IRS audit, the IRS revenue agent will complete the “Governance Check Sheet” as part of an ongoing IRS study.   The checklist addresses the following areas of an organization’s governance:

• Compensation
• Organizational control
• Conflict of interest policy
• Financial oversight
• Document retention

Although the IRS created this checklist for its revenue agents, it provides a succinct template for an organization to not only evaluate its own governance practices, but also illuminate how it is evaluated by the IRS and possible supporters of its organization.  While an organization may not know all of the criteria its potential supporters may use, the standards of governance used by the IRS serve as a good baseline.  The worst case scenario is for an organization to be completely unaware of its governance practices and have no framework for how it is viewed by interested parties.  All too often, organizations become aware of the governance-related questions of Form 990 after the fiscal year when the return is being prepared.  At that stage, it is too late to implement policies that will allow the organization to favorably answer the governance questions in Form 990.

While charitable organizations may not need to prepare for any battles, competing for charitable dollars in a struggling economy means assessing how to show promote your organization in the best light.  An organization’s Form 990 is public information and can be viewed by third parties without the organization’s knowledge.  Websites such as www.guidestar.org allow anyone to view the Form 990 filings of charitable organizations.  The IRS does not have the authority to regulate an organization’s governance.  Therefore, the most important audience for the governance-related issues may be an organization’s supporters.  Answering the governance questions less than favorably could mean the difference between winning or losing the competition for grant dollars.

For more information contact Todd Petrich at [email protected].