Form 1023 Instructions Part V: Compensation and Other Financial Arrangements

These are the instructions for Form 1023 Part V, the section where the IRS examines compensation, financial arrangements, and who benefits from your organization. Part V covers paying officers, directors, trustees, employees, contractors, related-party agreements, and third-party control over facilities or operations.

Part V questions are repetitive by design, as they're used to catch abusers of the system. The IRS cross-checks these answers against other parts of your Form 1023, narrative attachment, and budget. Checking the wrong box here is not a paperwork mistake; it triggers information request letters or outright denial.

You need to pay attention, as this section is responsible for the gravest misuse and abuse in the nonprofit sector, and the IRS is not amused by claims that you "didn't know".

Form 1023 Part V: Compensating Officers, Directors, Trustees, and Highest Compensated Workers

This question establishes whether money flows from the organization to insiders or highly paid individuals. It's the gateway question for Part V. A "No" answer allows the IRS to skip directly to the remaining sections. A "Yes" answer activates every follow-up question that comes after it and raises the level of review immediately.

The IRS groups officers, directors, trustees, highest compensated employees, and highest compensated independent contractors together because all of them can exercise influence over the organization, have access to funds, and have the ability to steer decisions.

What the IRS doesn't mention here, but does take into account, are key employees, which are another can of worms. Then there are disqualified persons. If you think you can dodge the bullet by tapping your cousin or spouse under the table, think long and hard.

1. If you answer No, your organization is stating that no officer, director, or trustee receives compensation of any kind and that you don't have any employees or contractors whose compensation reaches the highest-paid threshold. If that statement is accurate, answer No and move on. Lying here is perjury, so don't get cute.
2. If you answer Yes, it means that you will compensate someone with voting power in the organization or that you compensate someone above the threshold that constitutes highest compensated employees or contractors, and may be counted as a key employee as well. That compensation must be justified, approved in advance, documented, and controlled.

Answering Yes doesn't mean your application will fail. It means the burden shifts to you to show that compensation doesn't create private benefit or private inurement. Every remaining follow-up question in Form 1023 Part V tests that claim.

If compensation is planned, answer Yes and be prepared to support it consistently throughout the application, your narrative attachment, and your budget.

Form 1023 Part V: Adoption of a Conflict of Interest Policy

This question asks whether your organization has adopted a conflict of interest policy. Answering No almost always triggers follow-up questions. The IRS expects a policy to be in effect because compensation decisions and insider transactions are the pillars of corruption.

1. The conflict of interest policy governs who may participate in approving compensation, contracts, and other financial arrangements, and who must be excluded from those decisions. Your answer should be YES, and yes only.
2. If you answer No, you must describe alternative procedures that prevent conflicted individuals from influencing compensation or financial decisions. Those procedures are rarely treated as equivalent to a formal policy. Answer No, and you're on your own.

For adoption requirements and a compliant template, see the Conflict of Interest Policy section.

Form 1023 Part V: Non-Fixed, Discretionary, or Revenue-Based Compensation

This question asks whether any officer, director, trustee, highest compensated employee, or highest compensated independent contractor will be paid through bonuses, commissions, revenue-based pay, or other non-fixed arrangements. This is one of the fastest ways to escalate scrutiny in Form 1023 Part V.

Non-fixed compensation ties personal benefit to organizational revenue or performance. The IRS treats that linkage as a private benefit risk because it incentivizes insiders to generate income rather than further exempt purposes. For 501c3 501(c)(3) organizations, compensation is expected to be fixed, pre-approved, and not contingent on fundraising results, profits, or discretionary judgments made after the fact.

The correct and only answer is No.

If you answer Yes, try to qualify it, describe informal incentives, try to argue Rebuttable Presumption of Reasonableness, hint at future possibilities, or reference hypothetical bonus structures, the examiner "will strike down upon thee with great vengeance and furious anger."

Form 1023 Part V: Buying or Selling Goods, Services, or Assets With Insiders

This question asks whether your organization buys from or sells to insiders, their family members, or entities they control.

The correct answer is No.

Transactions with insiders are one of the clearest indicators of private benefit. You can mention fair market value, you can spin it as "negotiated at arm's length", you can pretend it's a necessity, but you'll be wrong every time. And before you ask, the IRS views arm's length transactions between family members as HBO specials for its examiners. If your brother is the landlord, the "negotiation" was a family dinner, not a business meeting.

If you answer Yes, you're telling the IRS that charitable funds circulate back to insiders in some form. That answer triggers detailed review, expanded disclosures, and follow-up questions that reach well beyond Part V. Once insider transactions are established, the examiner looks for patterns, not just isolated facts.

If your organization plans to purchase goods, services, or assets from insiders, expect to perform legal gymnastics to justify necessity, pricing, selection, and controls repeatedly throughout the application, and even then, your chances are slim. Expect every insider transaction to be measured against private foundation self-dealing standards even if you're not a foundation.

For detailed treatment of insider transactions, excess benefit, and private foundation self-dealing, see the related doctrine pages.

Form 1023 Part V: Leases, Contracts, Loans, and Other Agreements With Insiders

This question asks whether your organization has had, does have, or will have any ongoing agreements with insiders, their family members, or entities they control. That includes leases, service contracts, loans, guarantees, or any other continuing financial arrangement. These arrangements are examined more harshly than one-off transactions because they lock insider benefit long-term into the organization's operations.

Most people who answer Yes to this question are genuinely trying to start their nonprofit by benefiting the organization with a one-time, no-interest loan or by allowing the use of their own property, not to commit fraud. For public charities, there are only three defensible paths here. Everything else invites private benefit and substantiality test scrutiny.

1. First, the insider may donate the use of the property or service to the organization outright. No rent. No compensation. No side agreements. This is clean, simple, and rarely questioned when properly documented.
2. Second, the insider may lease the property to the organization for a purely symbolic amount, typically $1 per year. This is for liability protection, not compensation. It establishes occupancy and liability boundaries so the organization, not the individual, bears risk if someone gets hurt on the premises. The payment itself is not the point. Control and liability are.
3. Loans deserve special attention. Insider loans, guarantees, or advances are treated as high-risk because they blur the line between charitable funds and private capital. They draw immediate attention and are rarely viewed favorably at the exemption stage, unless it's a one-time, no-interest startup loan.

Anything beyond those paths becomes difficult to defend. Market-rate leases, service contracts, loans, or recurring payments to insiders keep money circulating back to private hands. Even when framed as reasonable, necessary, or temporary, these arrangements signal private benefit and ongoing influence.

If your organization plans to enter into leases, contracts, or loans with insiders, expect sustained scrutiny and repeated justification for why the benefit you are receiving is incidental.

Rents are never incidental; they are the textbook definition of substantial benefit. And when the rent benefits the founders, it's inurement. Inurement means game over.

If you want this section to pass cleanly, answer NO and actually stick to it. Find outside and unrelated arrangements. Don't drag your personal baggage into the nonprofit.

Form 1023 Part V: Contracting With Other Organizations to Develop or Manage Facilities

This question asks whether your organization contracts with another organization to develop, build, market, finance, or manage its facilities. This includes construction companies, developers, management firms, operators, and any third party that exercises control over physical assets or day-to-day operations.

These arrangements are normal in the sense that most nonprofits are not construction companies. They don't pour concrete, manage build-outs, or operate specialized facilities without outside help. The IRS understands that. What it doesn't tolerate is loss of control, shared profits, or deals where another organization effectively runs the charity while you write tax-free checks from public funds.

If you answer No, you're in the clear.

If you answer Yes, you're telling the IRS that another organization has a material role in your facilities or operations, and that answer escalates compliance immediately. The IRS will examine how that entity was selected, how contracts are negotiated, who controls budgets and operations, how fees are structured, and whether the arrangement diverts charitable assets to private hands. Arm's length doctrine comes in full force, and every nuance in the Internal Revenue Code applies.