Nonprofit Executive Compensation: What You Need to Know

2017 Compensation Trends

Overland Park, KS (November 10, 2017) – Like religion, politics, and sports, nonprofit executive compensation often evokes strong emotion.

Donors, the public, and state and federal officials have at times expressed outrage at the compensation that nonprofit CEOs receive, especially if these organizations are public charities or foundations and rely on donations from the public.

Nonprofit compensation can also draw fire from the IRS.

The Internal Revenue Service (IRS) is charged with enforcing the Federal Private Inurement Prohibition.

According to GuideStar, the information service specializing in reporting on U.S. nonprofit organizations. And, the most common type of private inurement is excessive compensation paid to insiders. This Federal Private Inurement Prohibition strictly forbids a tax-exempt organization’s decision makers – board members, trustees, officers, or key employees – from receiving unreasonable benefits from the nonprofit’s income or assets. Further, excessive compensation paid to nonprofit executives is the most common violation of this prohibition, and the IRS can levy hefty fines on the persons and organizations involved.

What’s allowed

The IRS permits tax-exempt organizations to pay executives “fair and reasonable” compensation.  However, there’s no universal standard for determining fair and reasonable. So, as is often is the case, organizations must make interpretations and decisions in what can be a very grey area.

Every tax-exempt organization that compensates its leaders must determine what is appropriate pay and benefits based on the following considerations:

  • Charities can pay their executives market rate.
  • Market rate is determined by researching what someone in a similar position would earn at an organization of like size and has a similar mission or field of activity.
  • Charities can look at for-profit compensation when determining market rate, if the job, organization size, and organization mission/purpose are comparable.
  • The IRS has no standard formula for determining compensation, nor are there tables that define fair and reasonable compensation for an organization.

Consequences for not following the rules

IRS penalties for excess compensation can range from fines to a revocation of an organization’s tax-exempt status. Fines tend to be the more likely consequence, and are often known as excess benefit transaction excise taxes or intermediate sanctions. Further, fines can be levied on both the executive who received the overpayment and the board members who approved it or knew about the excess but did nothing about it.

Protecting Your Organization and its Leaders

A nonprofit organization’s Board can shield its members and its executives by doing the following:

  • Approving compensation in advance and ensuring that no one in the approval process has a conflict of interest concerning the decision.
  • Basing its decision on comparability data obtained before the compensation is approved.
  • Documenting the approval process at the time it approves the compensation. The documentation should include the following:
    • Terms of the transaction and the date of its approval.
    • Members of the authorized body present during the debate and vote on the determination and transaction.
    • Comparability data obtained and relied upon for the transaction.
    • Actions taken by any members of the authorized body having a conflict of interest.
    • Documentation of the basis for the determination.

Recommended Next Steps

To fully protect the organization, its leaders, and its Board members, and to reach the best decisions regarding executive compensation for the organization, nonprofit organizations should clearly define a process for determining executive compensation and carefully follow that process for all executive compensation decisions. That process should define the comparable market to be used for the analysis and decisions, and should determine the authorized body to recommend and approve the compensation.

In addition, the timing and process steps should be defined, as well as who should gather the comparable data. The process should also include documentation of the process and decision, and identification of any conflict of interest by anyone on the authorized body, excusing from the process and decision those with a conflict of interest. Above all, nonprofit organizations should remain consistent, but adjust the process as the organization or field of activity experiences significant changes.

As we find ourselves in the throes of budget season, and year-end nears, the time is right for nonprofit organizations to carefully prepare this standard practice and consistently execute the process for determining executive compensation to protect the organization and enable it to focus on executing the mission and strategies of the organization.

Jon Binder
Senior Consultant & Compensation Practice Leader
OMNI Human Resource Management
jbinder@omnihrm.com

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