Conflict of Interest Policy for Nonprofits: IRS Rules and Form 990

A conflict of interest policy for a nonprofit is a written document, adopted by the board, that identifies when someone in a position of authority could personally benefit from an organizational decision and sets out how that person must disclose the interest, step out of the decision, and let the disinterested members handle it. The IRS publishes a sample policy in Appendix A of the Form 1023 instructions and asks about your policy every year on Form 990.¹ The agency doesn’t legally require the exact template, but deviating without good reason invites questions during an audit, and the underlying federal tax rules carry real financial consequences: excise taxes on insiders who receive excessive benefits start at 25% of the amount involved and climb to 200% if the problem isn’t corrected.²

The Four Elements Every Policy Needs

The IRS sample policy covers four core areas, and any workable policy has to address all of them: who it applies to, what counts as a financial interest, how to handle a conflict once it’s identified, and how to document everything.¹

The sample defines a financial interest broadly. You have one if you hold any ownership or investment stake in an entity doing business with your organization, receive compensation from such an entity, or are even negotiating a potential arrangement. That last category catches situations most people overlook. If your organization is in early talks with a vendor where a board member might eventually have a financial stake, the conflict exists now, not when the deal closes.¹

A financial interest is not automatically a conflict of interest. Under the IRS sample, the board or committee first hears the disclosure, then decides whether a genuine conflict exists. A board member whose consulting firm is bidding on a six-figure contract clearly has one. A board member who owns a small amount of stock in a publicly traded office supply company probably doesn’t.

Who the Policy Has to Cover

The IRS sample applies to any director, principal officer, or member of a committee that exercises powers delegated by the board.¹ Federal tax law reaches further. A “disqualified person” under Section 4958 is anyone who was in a position to exercise substantial influence over the organization’s affairs at any time during the five years before a transaction.²

Job titles alone don’t decide coverage. Someone who manages a segment representing 10% or more of your organization’s activities, controls a similar share of the operating budget, or has authority over a significant portion of employee compensation can qualify. For Form 990 purposes, these individuals must be listed as key employees if their reportable compensation exceeds $150,000.³ For people who aren’t officers or directors, the IRS looks at real-world influence. Founders, major donors, people whose compensation is tied to revenue from activities they control, and key advisors to those with managerial authority all point toward substantial influence. Your policy should spell out how you identify these individuals rather than relying on titles.

Family Members

The disqualified person definition extends to family. If a board member’s brother owns a company bidding for a contract, that relationship creates the same conflict as if the board member owned the company. The relationships that count under the federal rule are:

Spouse
Brothers and sisters (including half-siblings) and their spouses
Ancestors (parents, grandparents, and further back)
Children, grandchildren, and great-grandchildren and their spouses

Aunts, uncles, cousins, nieces, and nephews don’t automatically count under the federal definition.⁴ Many organizations extend the policy beyond the federal minimum to cover those relationships anyway, because the appearance of a conflict can be as damaging as a legal one.

Annual Disclosure

Every covered individual should complete a written disclosure form at least once a year, and again whenever a new potential conflict surfaces between annual reviews. The form should capture three categories of information.

Ownership and investment interests come first: any stake in an entity that does business with your organization or is negotiating to do so. The IRS sample sets no minimum percentage threshold; any ownership interest triggers the disclosure duty.¹ Compensation arrangements come next: any paid relationship with an entity or individual that has transactions with your organization, including consulting fees, speaking fees, and board stipends from outside entities. Family connections come third: employment, ownership, or compensation arrangements held by the family members listed above that relate to entities doing business with your organization.

Some organizations set a gift threshold. A common benchmark treats gifts of $250 or more from a single source within a twelve-month period as substantial enough to require disclosure, while smaller courtesies do not. Whatever threshold you pick, put a specific dollar amount in the policy so no one has to guess. Outside employment deserves its own line on the form. Ask each covered individual to list any outside professional roles, paid or unpaid, that relate to your organization’s work.

Completed forms go to a designated compliance officer or the board chair, who reviews submissions, flags anything that needs board attention, and follows up with anyone who hasn’t filed. That person should also maintain a current list of every individual subject to the policy, updating it whenever leadership changes or new key employees are hired.

Recusal and Voting

When a disclosed interest does rise to a conflict, the IRS sample lays out a specific sequence. The interested person presents relevant information to the board or committee, then leaves the room. Not just stops talking. Physically leaves. The remaining members discuss the matter, explore whether a better arrangement is available from a source that doesn’t involve the conflict, and vote on whether to proceed.¹

If no better alternative exists, the board can still approve the transaction, but only by a majority vote of the disinterested members, and only after determining the deal is fair and in the organization’s best interest. Meeting minutes must record the disclosure, the interested person’s departure, the alternatives considered, who voted, and the rationale for the final decision. These minutes are your evidence that the process worked as designed.

Documentation That Earns the Rebuttable Presumption

Following the right process can shift the burden of proof if the IRS ever challenges a transaction. When your board approves a compensation arrangement or property transfer while meeting three specific requirements, the law presumes the transaction is reasonable, and the IRS then has to prove otherwise.

The three requirements are conflict-free approval by a board or committee composed entirely of individuals without a conflict in the transaction; reliance on comparability data showing what similar organizations pay for similar services or charge for similar property; and timely documentation recorded at the time the decision was made, not after the fact.

The regulation spells out exactly what the documentation must include: the terms approved, the date of approval, who was present during discussion and voting, what comparability data was used, and how any conflicts were handled.⁵ For smaller organizations with annual revenue under $1 million, comparability data can be as simple as compensation information from three similar organizations in your area.⁶ If the board rubber-stamps executive compensation without pulling comparability data, or approves a real estate deal with an insider without documenting why the price was fair, you lose the presumption.

What Noncompliance Costs

When an insider receives more than fair market value from a tax-exempt organization, the IRS treats the excess as an excess benefit transaction and imposes escalating penalties on the individual who benefited.

The initial tax on the insider is 25% of the excess benefit. If a disqualified person receives $100,000 more than their services were worth, they owe $25,000 in excise tax on top of returning the excess.²
If the excess benefit isn’t returned within the taxable period, an additional tax of 200% of the excess benefit applies. On the same example, that’s $200,000 on top of the original $25,000.²
Any organization manager who knowingly approves an excess benefit transaction owes a separate tax of 10% of the excess benefit, capped at $20,000 per transaction. This applies unless the manager’s participation wasn’t willful and was due to reasonable cause.²

These intermediate sanctions were designed as an alternative to revoking an organization’s tax-exempt status, but the IRS has made clear it can still pursue revocation in appropriate cases, whether or not excise taxes are also imposed.⁷

What Form 990 Asks Every Year

Tax-exempt organizations filing Form 990 must answer whether they have a written conflict of interest policy. The question appears in Part VI, Line 12a. A “yes” on Line 12a leads to Line 12b, which asks whether officers, directors, trustees, and key employees were required to disclose interests that could give rise to conflicts annually. A “yes” there triggers a follow-up: you must describe on Schedule O how the organization regularly and consistently monitored and enforced compliance with the policy.⁸

Answering “no” to Line 12a doesn’t trigger a penalty by itself, but IRS examiners use governance answers to decide which returns deserve closer scrutiny. The Form 990 is also a public document that donors, grantmakers, and journalists can see.

Adopting, Distributing, and Enforcing the Policy

The board formally adopts the policy through a resolution recorded in the meeting minutes. A simple majority vote is standard unless your bylaws set a higher threshold. Once approved, distribute the policy to every covered individual, including incoming board members during orientation and new key employees at hiring. Each person should sign a written acknowledgment confirming they’ve read the policy, understand it, and agree to comply. Keep signed acknowledgments and completed annual disclosure forms in the organization’s corporate records. When board membership or senior staff turns over, update the distribution list and collect new acknowledgments promptly.

The policy also needs an enforcement provision. The IRS sample allows the board to take “appropriate disciplinary and corrective action” against anyone found to have violated it.¹ In practice, the board or a designated committee should investigate a suspected violation, give the individual an opportunity to explain, and document the findings in meeting minutes. Corrective action can range from a formal warning to removal from the board. If the violation involved an actual financial transaction, the board needs to assess whether an excess benefit occurred and whether correction, typically repayment of the excess amount, is needed to avoid the escalating excise taxes.

The person who reports a suspected violation shouldn’t be the same person who investigates it, and no one involved in the underlying transaction should participate in the review. Small organizations with limited board capacity sometimes struggle with this, but the investigation has to be credible enough that the IRS and your stakeholders would view it as genuine.

1
Internal Revenue Service. Instructions for Form 1023
2
Office of the Law Revision Counsel. 26 U.S. Code 4958 – Taxes on Excess Benefit Transactions
3
Internal Revenue Service. Key Employee Compensation Reporting on Form 990 Part VII
4
eCFR. 26 CFR 53.4958-3 – Definition of Disqualified Person
5
eCFR. 26 CFR 53.4958-6 – Rebuttable Presumption That a Transaction Is Not an Excess Benefit Transaction
6
Internal Revenue Service. Rebuttable Presumption – Intermediate Sanctions
7
Internal Revenue Service. Intermediate Sanctions
8
Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax – Part VI Governance, Management, and Disclosure