Nonprofit Conflict of Interest Policy: IRS Rules and Sample Components

A written nonprofit conflict of interest policy is not strictly required by federal law for every 501(c)(3), but the IRS requirements around it are close enough to mandatory that operating without one is a serious risk. The IRS asks on Form 990 whether your organization has adopted a written policy, publishes a sample policy in the Instructions for Form 1023 that most nonprofits use as their template, and enforces the underlying duty of loyalty through excise taxes on insiders and, in serious cases, revocation of tax-exempt status.¹²

What Form 990 Asks About Your Policy

Every year, tax-exempt organizations filing Form 990 answer three questions about conflicts of interest in Part VI. Line 12a asks whether the organization has a written conflict of interest policy. Line 12b asks whether officers, directors, trustees, and key employees are required to disclose annually any interests that could create conflicts, including those of their family members. Line 12c asks the organization to describe on Schedule O how it monitors and enforces compliance.¹

The IRS uses these answers, along with the rest of the return, to assess noncompliance risk across the exempt sector.³ A “no” on Line 12a does not automatically trigger an audit. It does signal that the organization may lack the governance infrastructure to prevent insider deals, which can tip the balance toward examination if the organization is already on the IRS’s radar for other reasons.

Is a Written Policy Actually Required?

Federal tax law does not command every 501(c)(3) to adopt a written policy, but the IRS makes clear that organizations lose tax-exempt status if they serve private interests more than insubstantially.² A written policy is how a board demonstrates it takes that obligation seriously.

Several states go further and impose their own conflict of interest obligations by statute, sometimes requiring a written policy outright and spelling out specific approval procedures for transactions involving board members or their relatives. Because these rules vary, a nonprofit operating in more than one state should have counsel confirm its policy meets each state’s requirements. The federal template is the starting point, not necessarily the finish line.

The Five Components of the IRS Sample Policy

The IRS publishes a sample conflict of interest policy in Appendix A of the Instructions for Form 1023, the application for tax-exempt status.⁴ It covers what the IRS expects to see in any policy and gives an organization a defensible baseline if it is ever audited. The sample addresses five areas:

Definitions of who counts as an interested person and what counts as a financial interest.
The duty to disclose a conflict before a transaction is considered.
Procedures for addressing the conflict, including recusal, investigation of alternatives, and voting.
How the board handles a member who fails to disclose a conflict.
Periodic reviews of operations to confirm the organization is still functioning consistently with its charitable purposes.

Nothing prevents an organization from writing something stronger. The sample is a floor.

Who Is an Interested Person and What Counts as a Financial Interest

Under the IRS sample policy, an interested person is any director, principal officer, or member of a committee with board-delegated powers who has a direct or indirect financial interest.⁴ The definition captures anyone empowered to make financial decisions on the organization’s behalf, not just the people at the board table. For Form 990 reporting, key employees meeting certain compensation and authority thresholds are also treated as interested persons.⁵

For excess benefit transaction purposes, the federal statute defines a “disqualified person” as anyone who was in a position to exercise substantial influence over the organization’s affairs at any point during the five years before the transaction, along with their family members and any entity they control with more than a 35 percent interest.⁶ Family members include spouses, siblings, children, grandchildren, great-grandchildren, and their spouses.

A person has a financial interest if they have, directly or indirectly through business, investment, or family, an ownership or investment stake in an entity the nonprofit transacts with; a compensation arrangement with the nonprofit or with any entity or individual the nonprofit transacts with; or a potential ownership, investment, or compensation arrangement with an entity the nonprofit is negotiating with.⁴ Compensation here covers not just salary but indirect remuneration and gifts or favors that are not insubstantial.

A financial interest is not automatically a conflict. It means the board must evaluate whether the interest could influence the person’s judgment, and follow the review process before proceeding.

Disclosure, Recusal, and Documentation

The sample policy requires any interested person to disclose the existence of a financial interest and all material facts to the board or committee considering a proposed transaction.⁴ The disclosure comes before the vote, not after a contract is signed. A useful disclosure statement names the outside entity, describes the nature of the relationship (ownership percentage, employment role, family connection), states the dollar amount or estimated value of the arrangement, and notes whether it is a one-time deal or ongoing. Many organizations use a standardized form kept by the board secretary or a designated compliance officer.

Once the interest is disclosed, the interested person may present information about the transaction, then must leave the meeting during the discussion and the vote. The board chair should appoint a disinterested person or committee to investigate whether the nonprofit could get a more advantageous arrangement, with reasonable effort, from a source that does not involve a conflict.⁴ If no better alternative is reasonably available, the disinterested directors vote by majority on whether the transaction is in the organization’s best interest and is fair and reasonable.

Every part of this process belongs in the meeting minutes: who was present, the substance of the discussion, the alternatives considered, and the vote. Those records are the organization’s evidence of due diligence if the transaction is later challenged.

The Form 990 instructions also expect organizations to require annual disclosure updates from all officers, directors, trustees, and key employees, covering their interests and those of their family members that could create conflicts.¹ The annual questionnaire catches new investments, side businesses, or family ventures that appeared since the last signing.

The Rebuttable Presumption of Reasonableness

Federal regulations give boards a specific protective mechanism when approving compensation or property transfers involving insiders. A transaction is presumed reasonable if three conditions are met:

The arrangement is approved in advance by an authorized body composed entirely of individuals without a conflict of interest in the transaction.
The authorized body obtained and relied on appropriate comparability data before making its decision, such as salary surveys for similar positions at comparable organizations, or independent appraisals of property.
The basis for the decision is documented contemporaneously, not reconstructed later.

⁷

When all three conditions are satisfied, the burden shifts to the IRS to prove the transaction was unreasonable, instead of the organization having to prove it was fair. Boards that treat this step as optional are the ones most exposed if the IRS later asks questions.

What Happens If the Policy Is Ignored

When a conflict crosses into an actual excess benefit transaction, meaning a disqualified person receives compensation or other economic benefits exceeding what is reasonable, the tax consequences are severe. The person who receives the excess benefit faces an initial excise tax of 25 percent of the excess amount. If that person does not return the excess benefit plus interest within the correction period, a second tax of 200 percent kicks in.⁶ On a $100,000 overpayment, that is $25,000 initially and another $200,000 if left uncorrected.

Organization managers who knowingly approve an excess benefit transaction face their own tax of 10 percent of the excess benefit, capped at $20,000 per transaction.⁶ That is personal liability for every director who voted with knowledge of the conflict. The only escape is showing the participation was not willful and was due to reasonable cause. These excise taxes are reported on Form 4720, generally due by the same date as the organization’s annual return.⁸

Beyond the excise taxes, the IRS can revoke tax-exempt status entirely if private inurement is serious enough.⁹

Handling a Member Who Fails to Disclose

A policy is only as strong as its enforcement. Under the IRS sample, if the board has reasonable cause to believe a member did not disclose an actual or possible conflict, it must tell the member the basis for that belief and give them a chance to explain.⁴ If, after hearing the response and any further investigation, the board finds a failure to disclose occurred, it takes appropriate disciplinary and corrective action. The sample does not prescribe specific penalties, leaving that to each organization. What matters is that the response is documented and proportionate. A board that finds an undisclosed conflict and does nothing has effectively abandoned its policy.

Annual Sign-Off and Periodic Review

The IRS sample policy calls for each director, officer, and key employee to sign an annual statement confirming they have received the policy, read and understood it, agreed to comply, and disclosed any current financial interests.⁴ Alongside individual sign-offs, the policy should provide for periodic reviews of the organization’s operations to confirm it is still functioning consistently with its charitable purposes and is not drifting into activities that could jeopardize its exempt status. That broader review looks at patterns: whether certain vendors are being favored without competitive bidding, whether compensation levels are creeping upward without comparability data, and whether the disclosure system is actually catching what it should.

Form 990 also asks separately about a written whistleblower policy. That is a different document from the conflict of interest policy, though the two work together, and federal law protects those who report financial misconduct to the IRS from retaliation.¹⁰

1
Internal Revenue Service. 2025 Instructions for Form 990
2
Internal Revenue Service. Form 1023 – Purpose of Conflict of Interest Policy
3
Internal Revenue Service. Form 990, Part VI – Governance, Management, and Disclosure Frequently Asked Questions
4
Internal Revenue Service. Instructions for Form 1023
5
Internal Revenue Service. Instructions for Schedule L, Form 990
6
Office of the Law Revision Counsel. 26 USC 4958 – Taxes on Excess Benefit Transactions
7
eCFR. 26 CFR 53.4958-6 – Rebuttable Presumption That a Transaction Is Not an Excess Benefit Transaction
8
Internal Revenue Service. Form 4720 – When to File
9
Internal Revenue Service. How to Lose Your 501(c)(3) Tax-Exempt Status
10
Office of the Law Revision Counsel. 18 USC 1513 – Retaliating Against a Witness, Victim, or an Informant