We are often asked how many directors a nonprofit needs. The answer really depends on a variety of factors including where the nonprofit was incorporated, whether the nonprofit is a 501(c)(3) or other 501(c) organization, what kind of 501(c)(3) the nonprofit will be, and the identities of the directors. This blog post will answer many of the frequently asked questions about the composition of nonprofit and 501(c)(3) boards of directors.
Wait! Are nonprofits and 501(c)(3)s different things?
Yes. In the United States, “nonprofit” simply refers to an organization that has a purpose other than pursuing private profit, while 501(c)(3)s are organizations that are exempt from taxation because they are organized for charitable, religious, educational, scientific, literary (plus a few other) purposes. All 501(c)(3)s are nonprofits, but not all nonprofits are 501(c)(3)s. A nonprofit is incorporated under State law, while recognition of 501(c)(3) tax-exempt status is done at the federal level by the Internal Revenue Service (IRS).
Frequently asked questions about the number and composition of a 501(c)(3) or nonprofit board of directors:
- How many directors must a nonprofit have?
- Must we have a minimum of three directors for our nonprofit in New York?
- Does a nonprofit board include the Chairman, President, Secretary, Executive Director or CEO?
- How many directors does a 501(c)(3) board need?
- Can my sister, father, niece or other family member be a director in our nonprofit?
- Can my business partner or employee be a director in our nonprofit?
- Can our nonprofit pay its directors?
- How can a founder of a nonprofit maintain control of its board of directors?
How many directors must a nonprofit have?
The number of directors required for a nonprofit corporation depends on the corporate law of the state where the nonprofit was incorporated. For example, in New York, the minimum number is three, while in Delaware, the minimum number is one.
Must I have three directors on my board to run my nonprofit in New York?
No. It depends on whether the nonprofit is a New York not-for-profit corporation. A nonprofit incorporated in another state would be subject to the minimum director requirements of that other state, even if it was operating in New York. So if the nonprofit was incorporated as a Delaware nonstock nonprofit corporation, the minimum directors required would still be the one required by Delaware law and not the three required by New York law, even if the nonprofit has no operations in Delaware and all its operations in New York.
The above being said, if a nonprofit wants to be recognized by the IRS as a 501(c)(3) tax-exempt nonprofit, the nonprofit would need to meet IRS director requirements, regardless of where the nonprofit was incorporated.
Does a nonprofit board include the chairman, president, secretary, executive director or CEO?
A nonprofit board may, but is not required to, include officers. This is a point of confusion for many. Directors are simply directors. The official title of a member of the board is “director.” “President,” “secretary,” “chief world changer,” etc., even “executive director,” all refer to “officers.” Officers can, but need not be directors of a nonprofit. In practice, it makes sense for the officer who chairs board meetings (usually the president or chairman) and the officer taking the board meeting minutes (usually the secretary) to also wear the second hat of “director.”
Depending on the corporate law of the state where the nonprofit was incorporated, one person can hold multiple officer positions. In New York, for example, the officer responsible for chairing board meetings and the officer responsible for taking meeting minutes must be different persons, but either can hold multiple other offices like treasurer, Executive Director or CEO; and none of them legally need to also be a director.
How many directors does a 501(c)(3) board need?
There is no legally mandated number of directors needed for a 501(c)(3) board. Based on rulings made by the IRS, it seems that the IRS very strongly suggests that a 501(c)(3) board consist of at least three directors.
The core concern of the IRS is actually control by private interests. A 501(c)(3) is prohibited from providing undue benefits to private individuals, and from allowing its assets to inure to the benefit of private persons. This is IRS speak to address worries that (1) the private benefit of a nonprofit activity will outweigh public benefit; and (2) directors, officers and other “insiders” of the nonprofit receive financial benefits from the nonprofit that outweighs the benefits they provide to the nonprofit. Keeping these concerns in mind, the IRS will examine the composition of a 501(c)(3) board to see if it is controlled by one person, one family or one business. If so, the IRS could be inclined to strongly insist on board membership changes, stonewall the process by requiring the nonprofit to submit responses a multitude of inquiries, or find a rationale to outright deny 501(c)(3) recognition on grounds of substantial risk of private benefit or private inurement.
Additionally, within the IRS toolbox is Form 14114, which the IRS uses in the examination of 501(c)(3)s. Form 14114 provides a relatively clear roadmap of what the IRS considers good governance. The data suggests that board control by one person, one family or one business will lead to increased audit risks.
Can my sister, father, niece or other family member be a director in our nonprofit?
Yes, multiple relatives can serve as directors on a nonprofit board. However, if the nonprofit wishes to decrease the risk of audit, those relatives should make up only a minority of the board. This means that if two family members are directors of a nonprofit, ideally a minimum of three unrelated directors should also be on the board (a minimum of five directors in total).
The niece is a special situation. The IRS has definitions to determine who is and is not considered a “family member,” with respect to board composition. As of the time of this article, nieces, nephews and cousins, and certain others, are not considered “family members.”
Can my business partner or employee be a director in our nonprofit?
Yes, persons in a business relationship can serve as directors on a nonprofit board. However, if the nonprofit wishes to avoid IRS pushback in being recognized as a 501(c)(3), and if the nonprofit wishes to decrease the risk of audit, similar considerations apply as to directors that are in a familial relationship. Specifically, directors in a business relationship should only make up a minority of the board. Thus, if two directors are related by business, at least three should not be related (a minimum of five directors in total).
As with family relationships, the IRS has defined what is and what is not considered a business relationship, so what someone thinks is a business relationship may not be what the IRS thinks is a business relationship for board composition purposes.
Can our nonprofit pay its directors?
Yes, while most directors of a vast majority of 501(c)(3) nonprofits serve on a voluntary basis, nonprofit directors can be compensated. However, paying a director, whether for his or her services as a director, officer, employee, independent contractor, or supplier of a 501(c)(3) nonprofit can create additional complexity.
Given IRS concerns regarding private benefit and inurement, the IRS worries that compensated directors will look out for each other at the expense of the public interest. While there are several ways to assuage these worries, the most straightforward way of doing so is by ensuring that a majority of directors on the board serve uncompensated. This means that if two directors are being compensated, whether as directors or otherwise, at least three should not be compensated (a minimum of of five directors in total).
Additionally, with respect to compensation of any insider of a 501(c)(3) nonprofit, when compensating directors, it is important to make sure that “excess-benefit” and “self-dealing” rules are complied with, so as to avoid harsh punitive taxes and possible loss of 501(c)(3) status.
How can a founder of a nonprofit maintain control of its board of directors?
This is a very legitimate question, and one that is often asked by nonprofit founders. Nonprofit “hostile takeovers” have been attempted several times in the past, and it is reasonable for founders to want to prevent that from happening.
For a nonprofit that does not wish to be recognized by the IRS as a 501(c) tax-exempt entity, the answer is often simple: either have the founder as the only director on the board, or give the founder the sole right to choose and remove directors. However, for a nonprofit that seeks 501(c)(3) recognition, the answer is far more complicated. As discussed earlier regarding the composition of 501(c)(3) boards, the IRS has is concerned about nonprofits being controlled by one person, one family or one business. This equally extends to measures taken for a founder to maintain control over a nonprofit or its board of directors. Extensive control by a founder would likely cause delays in 501(c)(3) determination, add complexity to the application process through the need to submit additional documentation, or outright denial of 501(c)(3) recognition. Further, if the nonprofit bypasses these hurdles and gets its 501(c)(3) status recognized, it will face increased audit risks each year.
Nevertheless, for a nonprofit that seeks 501(c)(3) recognition, certain strategic measures can be taken to ensure that a founder’s vision endures. Reasonable controls, such as setting up something akin to a security council with veto powers, can be built into a nonprofit’s bylaws or constitution. These, of course, will need to be implemented in a careful, measured manner, to avoid the above mentioned issues.
This blog post is provided for general informational purposes only. It is not legal advice, and should not be a substitute for legal advice. If you have questions or comments about the post, or would like to learn more about something in the post, please feel free to contact me.
Additionally, you may be interested in taking a look at my New York nonprofit law services.