It's important to distinguish between a nonprofit and a family-owned business. A nonprofit conducts business without shareholders or a motive to make a profit. It is a sole entity that may have been started by a family or various family members.
While family members can be involved in a nonprofit, there is a caveat. The IRS will flag and question any nonprofits that are led and controlled by multiple family members. The IRS defines relationships among board members in relation to blood, marriage, or outside business connections.
If you have family members on a nonprofit board, you also need to have non-family members. To receive 501(c)(3) approval, a nonprofit board must consist of over half non-family members. More specifically, family involvement in a nonprofit is legal as long as at least 51% of your board of directors are unrelated.
What are the 501(c)(3) Board of directors requirements?
A 501(c)(3) nonprofit organization is exempt from paying federal income tax. Donations to these public charities are also tax deductible. This is why the IRS implemented strict requirements for a company to receive this status.
When it comes to the board of directors, keep in mind that…
- The specific amount of directors required for a nonprofit corporation is variable, depending on the state where the nonprofit is incorporated. For example, New York requires at least three directors, while it is enough in Delaware to only have one. Check our full overview of all states.
- A 501(c)(3) board of directors is required that all members attend at least one yearly meeting. There are no limits on meeting term lengths set by the IRS.
- The board of a nonprofit may have to include officers, such as a secretary or treasurer. This advisory rule depends on the law of the state where the nonprofit is incorporated. For example, some states allow one person to hold numerous officer positions.
Generally, it is best to have a 501(c)(3) organization with at least 51% of unrelated board members. These requirements have to be taken into consideration when appointing board members.
What is considered to be a conflict of interest?
A conflict of interest is defined as an inconsistency between private interests and the official responsibilities of a person in a position of trust. A conflict of interest arises when a reasonably informed associate within a nonprofit has the appearance of personal or even professional gain. The eyes of the law judge a person involved who, on behalf of a nonprofit, promotes their personal interests most evidently.
By design, a nonprofit is a business that has been granted tax-exempt status because it benefits a social cause for the public good to some degree.
Types of Conflict of Interest
Family members & Personal Relationships
When applying for a job at a nonprofit, hiring family members can be viewed as getting special treatment. Family members involved with nonprofits have the potential to cause a conflict of interest.
Beyond family, personal relationships among nonprofit board members also create a conflict of interest. If board members have a personal relationship, they may receive preferential treatment, which may lead to special favors like salary increases.
An example in hiring is when you give special treatment in a nonprofit or any workplace to a family member. This is a classic example of family preference in addition to extra money or perks for relatives.
For-profit interests
Nonprofit board member should not bring their outside financial interests into their nonprofit organization. Using the nonprofit to benefit their personal investments would create a conflict of interest.
One example is if you use the nonprofit's resources to benefit your personal business or investments. Another instance of a personal conflict of interest is using a nonprofit without disclosing the relationship you have with an outside company that has a competing or similar mission to the nonprofit. This could be the case if a board member also serves as the CEO of a company within a similar industry.
Disadvantages of having family members on your board
Having family members in your nonprofit — especially on your board — can be problematic. As the governing body of a nonprofit, the board of directors makes all the major decisions.
For example, if a nonprofit only has three or four people on the board, all decisions may be greatly affected if the majority of the board members are related. When family members are involved, they may be more concerned with their benefit instead of the public good. Nonprofits and charities are created for the benefit of the public, not for the gain of family members and close friends.
In the past, the IRS has deemed any nonprofit with more than 49% of their board as setting off red flags and conflicts of interest. If this is the case with your nonprofit, the IRS may ask that you provide proof of your legal status as a nonprofit. You’ll need to show them that at least 51% of your board members are unrelated. The IRS is extremely concerned and attentive to your nonprofit board background.
Conclusion
It’s wise to be careful about conflict of interest within a nonprofit. While it’s okay to have family members involved in your nonprofit and on a nonprofit board, you should be open about the relationships of all employees and board members.All nonprofits should establish family participation clauses to protect against conflict of interest and prevent members from resigning because of family or relationship preferences and ties.
Overall, nonprofits need clear guidelines to avoid conflicts of interest. A family that starts a nonprofit has to be open and transparent. Legally, at least 51% of board members should not be related. Nonprofit board members should meet periodically, at least once a year, to discuss and vote on the affairs of the organization and ensure there are no conflicts of interest.