Tuesday April 23, 2024

7.3.3 Avoiding Financial Conflicts of Interest

Avoiding Financial Conflicts of Interest

Public Purpose:  Charities are granted tax-exempt status after they demonstrate that they were formed to serve the public interest.

Private Inurement:  Because charities enjoy tax-exempt status, their operations are subject to certain restrictions.

Private Benefit Leads to Loss of Tax Exemption  A charitable organization must pass both an organizational and an operational test.

Avoiding Conflicts of Interest:  Best practices require each charity put in place appropriate safeguards to ensure that the charity can continue to meet both the organizational test and the operational test.

Conflict of Interest Policy:  Below are three documents related to the adoption of a Conflict of Interest Policy. The first is a sample Conflict of Interest Policy.

Public Purpose


Charities are granted tax-exempt status after they demonstrate that they were formed to serve the public interest. This is why gifts to charities, including charities that provide education, medical services for the needy, social services or are religious, are typically deductible for income, gift or estate tax purposes.

Several types of gifts, however, do not result in a deduction for the donor. The reason for this is that they often involve a "personal benefit" transfer rather than support the public interest. For example, payment of tuition to an organization for your child or grandchild produces no deduction because there is no charitable gift; the educational benefit to the child equals the amount paid for tuition. See Sklar v. Commissioner.

Private Inurement


Because charities enjoy tax-exempt status, their operations are subject to certain restrictions. Charities are not allowed to provide direct or indirect benefits to officers, directors and other people that are closely related to the charity. This rule is called the ban on "private inurement."

The reason for this is that a charity must operate for charitable purposes, and benefiting people closely related to the charity is viewed as inconsistent with those charitable purposes. Whether a person has a close relationship with a charity depends on the specific facts of any situation, but generally the founder, an officer or director or any other person in a position to exercise influence over the charity does have such a close relationship.

Private Benefit Leads to Loss of Tax Exemption


A charitable organization must pass both an organizational and an operational test. See Chapter 7.1.1 of GiftLaw Pro. The organizational test requires that it be organized for exempt purposes. If non-exempt purposes are more than an insubstantial part of activities, it does not qualify for exempt status. Reg. 1.501(c)(3)-1(b)(1)(i). The operational test requires that the organization "operate exclusively for exempt purposes" under Sec. 501(c)(3).

Charities must be able to demonstrate that they operate for exempt purposes. Organizations do not meet this requirement if net earnings are distributed, or otherwise inure, to the benefit of private individuals, or if the organization's activities involve proscribed political activities.

In Rameses School of San Antonio, Texas v. Commissioner; the tax-exempt status of a charter school was revoked after the Tax Court determined that the school did not meet the operational test. The school did not have a functioning board that held regular meetings, did not have a budget and there were numerous examples where the school distributed funds to Patricia Fennell, the school's executive director, president and CEO, for her personal purposes. The Tax Court determined that Ms. Fennell clearly received public charity benefits that were redirected to her for private purposes. Because the school failed the private benefit test, its tax-exempt status was revoked.

Avoiding Conflicts of Interest


Best practices require each charity put in place appropriate safeguards to ensure that the charity can continue to meet both the organizational test and the operational test. These best practices would include, but are not limited to, appointing a board of directors that operates independently of any founder, benefactor, officer, director or employee; adopting a budget; holding regular board meetings; maintaining regular minutes of meetings; putting in place proper financial checks and balances such as regular financial audits and a gift acceptance policy; and adopting a conflict of interest policy.

Conflict of Interest Policy


Below are three documents related to the adoption of a Conflict of Interest Policy. The first is a sample Conflict of Interest Policy. Your organization may wish to adopt this or a similar policy. The second is a sample Conflict of Interest Policy Statement and the third document is a Conflict of Interest Questionnaire. The second and third documents include statements that will cause persons with potential conflicts of interest, such as officers, directors and committee members, to think through and disclose any potential conflict of interest. Persons with the potential for a conflict of interest typically complete the Policy Statement and Questionnaire once per year.

EXAMPLE 7.3.3A - CONFLICT OF INTEREST POLICY


Conflict of Interest Policy


Article I - Purpose

[Insert Name of Charity] ("Organization") is a tax-exempt organization. Organization has adopted this Conflict of Interest Policy ("policy") for the purpose of protecting its interests when contemplating any transaction or arrangement that might: (1) benefit the private interest of an officer or director of the Organization; or (2) result in a possible excess benefit transaction. This policy is intended to supplement, but not replace, any applicable state or federal law governing conflicts of interest applicable to tax-exempt and charitable organizations.

Article II - Definitions

  1. Interested Person. Any director, principal officer, or member of a committee with governing board delegated powers, who has a direct or indirect financial interest, as defined below, is an interested person.
  2. Financial Interest. A person has a financial interest if the person has, directly or indirectly, through business, investment, or family: (a) an ownership or investment interest in any entity with which the Organization has a transaction or arrangement; (b) a compensation arrangement with the Organization or with any entity or individual with which the Organization has a transaction or arrangement; or (c) a potential ownership or investment interest in, or compensation arrangement with, any entity or individual with which the Organization is negotiating a transaction or arrangement.

Article III - Procedures

  1. Duty to Disclose. In connection with any actual or possible conflict of interest, an interested person must disclose the existence of the financial interest and be given the opportunity to disclose all material facts to the directors and members of committees with governing board delegated powers considering the proposed transaction or arrangement.
  2. Determining Whether Conflict Exists. After disclosure of the financial interest and all material facts, and after any discussion with the interested person, the interested person shall leave the governing board or committee meeting while the determination of a conflict of interest is discussed and voted upon. The remaining board or committee members shall decide if a conflict of interest exists.
  3. Procedures for Addressing the Conflict of Interest. The following procedures shall be used to address any conflict of interest.
    1. An interested person may make a presentation at the governing board or committee meeting, but after the presentation, he/she shall leave the meeting during the discussion of, and the vote on, the transaction or arrangement involving the possible conflict of interest.
    2. The chairperson of the governing board or committee shall, if appropriate, appoint a disinterested person or committee to investigate alternatives to the proposed transaction or arrangement.
    3. After exercising due diligence, the governing board or committee shall determine whether the Organization can obtain with reasonable efforts a more advantageous transaction or arrangement from a person or entity that would not give rise to a conflict of interest.
    4. If a more advantageous transaction or arrangement is not reasonably possible under circumstances not producing a conflict of interest, the governing board or committee shall determine, by a majority vote of the disinterested directors, whether the transaction or arrangement is in the Organization's best interest, for its own benefit, and whether it is fair and reasonable. In conformity with the above determination it shall make its decision as to whether to enter into the transaction or arrangement.
  4. Violations of the Conflicts of Interest Policy. If the governing board or committee has reasonable cause to believe a member has failed to disclose actual or possible conflicts of interest, it shall inform the member of the basis for such belief and afford the member an opportunity to explain the alleged failure to disclose. If, after hearing the member's response and after making further investigation as warranted by the circumstances, the governing board or committee determines the member has failed to disclose an actual or possible conflict of interest, it shall take appropriate disciplinary and corrective action.

Article IV - Records of Proceedings

The minutes of the governing board and all committees with board delegated powers shall contain:

  1. The names of the persons who disclosed or otherwise were found to have a financial interest in connection with an actual or possible conflict of interest, the nature of the financial interest, any action taken to determine whether a conflict of interest was present, and the governing board's or committee's decision as to whether a conflict of interest in fact existed.
  2. The names of the persons who were present for discussions and votes relating to the transaction or arrangement, the content of the discussion, including any alternatives to the proposed transaction or arrangement, and a record of any votes taken in connection with the proceedings.

Article V - Voting & Information Sharing

  1. Board Votes. A voting member of the governing board who receives compensation, directly or indirectly, from the Organization for services is precluded from voting on matters pertaining to that member's compensation.
  2. Committee Votes. A voting member of any committee whose jurisdiction includes compensation matters and who receives compensation, directly or indirectly, from the Organization for services is precluded from voting on matters pertaining to that member's compensation.
  3. Information Sharing. No voting member of the governing board or any committee whose jurisdiction includes compensation matters and who receives compensation, directly or indirectly, from the Organization, either individually or collectively, is prohibited from providing information to any committee regarding compensation.

Article VI - Annual Statements

Each director, officer and member of any committee exercising powers granted by the governing board shall annually sign a statement which affirms that such individual: (1) has received a copy of the conflicts of interest policy; (2) has read and understands the policy; (3) has agreed to comply with the policy; and (4) understands the Organization is charitable and in order to maintain its federal tax exemption it must engage primarily in activities which accomplish one or more of its tax-exempt purposes.

Article VII - Periodic Reviews

To ensure the Organization operates in a manner consistent with its charitable purposes and does not engage in activities that could jeopardize its tax-exempt status, periodic reviews shall be conducted. The periodic reviews shall, at a minimum, include the following subjects, whether: (1) compensation arrangements and benefits are reasonable, based on competent survey information, and the result of arm's length bargaining; and (2) partnerships, joint ventures, and arrangements with management organizations conform to the Organization's written policies, are properly recorded, reflect reasonable investment or payments for goods and services, further charitable purposes and do not result in inurement, impermissible private benefit or in an excess benefit transaction.

Article VIII - Use of Outside Experts

When conducting the periodic reviews as provided for in Article VII, the Organization may, but shall not be required to, use outside advisors. If outside experts are used, their use shall not relieve the governing board of its responsibility for ensuring periodic reviews are conducted.

Article IX - Amendments

This Policy shall remain in full force and effect unless and until the Board of Directors adopts any amendments to or replaces this Policy, however, any such amendment or replacement of this Policy shall occur only by a recorded vote of the Board of Directors.

The undersigned does hereby certify that Organization named above has adopted this Conflict or Interest Policy as of the _____ day of _______, 20____.


Signature: ____________________________

Printed Name/Title: ____________________________


EXAMPLE 7.3.3B - CONFLICT OF INTEREST POLICY STATEMENT


Annual Conflict of Interest Policy Statement

[INSERT NAME OF CHARITY] ("Charity")

The undersigned does here certify the following:

  1. I am a director, officer or committee member of Charity. I do hereby state that I:
    1. Have received a copy of Charity's Conflicts of Interest Policy ("Policy");
    2. Have read and understand the Policy;
    3. Hereby agree to comply with the Policy;
    4. Understand that Charity is a tax-exempt, charitable organization and in order for Charity to maintain its federal tax-exempt status, Charity must engage primarily in activities which accomplish one or more of its tax-exempt purposes; and
    5. To the best of my knowledge, believe that I am in full compliance with the Policy.
  2. I further state that: ______ I have no involvement, association, financial interest, gift or loan to disclose as required by the Policy; - OR - ______ I do have one or more involvement, association, financial interest, gift or loan to disclose, in which case, I have fully disclosed the same and complied with all procedures and duties to disclosure as required by the Policy. Paperwork disclosing the actual or possible conflict of interest has been submitted to the Board of Directors.
  3. If there is any material change in my personal or financial circumstance, or that of any of my family members, that would cause a change in any of the above statements, that I will promptly notify the Board of Directors of such change in circumstances.

I have signed this Annual Conflict of Interest Policy Statement as of the ____ day of ____________, 20___.

SIGNATURE: _____________________________

PRINT NAME: ____________________________



EXAMPLE 7.3.3C - Conflict of Interest Annual Questionnaire


Conflict of Interest Annual Questionnaire

The following questionnaire is required to be completed so that [INSERT NAME OF CHARITY] ("CHARITY") can update its records of related parties and review relationships within its conflicts of interest policies. All Directors, Members, and Key Employees of Charity must complete this questionnaire annually. Answers to this questionnaire should relate to relationships that occurred during the past twelve (12) month period ending on [INSERT LAST DAY OF CHARITY'S MOST RECENT FISCAL YEAR]. Attach additional sheets if explanations require additional space. Once you have completed the questionnaire, please sign and date in the space provided and return with original signature to:

Mail To: _________________________________ (Name of Charity)

_________________________________ (Compliance Officer)

_________________________________ (Address)

_________________________________ (City, State & Zip)


  1. Are you an officer of an organization that conducts business with CHARITY? Yes___ No ___. If yes, please disclose organization(s) _____________________________________ __________________________________________
  2. Are you a current or past Board member of a business in which CHARITY invests? Yes___ No___. If yes, please disclose organization(s)_____________________________________ __________________________________________
  3. Do you have a family relationship with anyone who has, or had in the past a noted relationship with CHARITY (family includes your spouse, parents, children, grandchildren, great-grandchildren, siblings and spouses of any family relationships)? Yes___ No___. If Yes, please disclose family member(s) and nature of relationship(s): _____________________________________ __________________________________________
  4. Have you participated, directly or indirectly, in any employment agreement, compensation relationship, or any other arrangement opportunity with a third party vendor who does business with CHARITY that has resulted or could result in personal benefit to you? Yes___ No___. If Yes, please disclose_____________________________________ __________________________________________.
  5. Have you received, directly or indirectly, any salary payments, loans, or gifts of any kind or any free service, discounts, or other fees from any person/organization engaged in any transaction with CHARITY? Yes___ No___. If Yes, please disclose. _______________ _______________________________________________________________________.
  6. Do you share ownership of a business that does business with CHARITY? Ownership means voting power of a corporation, profits interest in a partnership, or beneficial interest in a trust. Yes____ No____. If Yes, please disclose. _______________________ _______________________________________________________________________.
  7. If you have attached an addendum, please note here how many additional pages ____.


Signature _______________________________ Date _______________

Print Name _______________________________________________



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