Nonprofit executive compensation tops the current list of IRS hot button issues. A few weeks ago we talked about the fact that the IRS is ramping up its oversight and enforcement of nonprofit executive compensation. With all the rancor surrounding executive perks and bonuses on Wall Street, expect that populist sentiment to spill over into the nonprofit sector as well. It all adds up to the equivalent of a message written in the sky: get your house in order!
So, how do you do that? Let’s take a look at a few key points that will go a long way toward ensuring that the compensation package for your nonprofit’s leader(s) is appropriate.
Reasonable compensation. It all starts here. The IRS requires compensation packages for nonprofit executives (and other nonprofit employees, for that matter) to be reasonable. Unfortunately, the IRS doesn’t really define reasonable…at least not in a way that you could look up in Websters. Reasonable compensation is best understood in light of factors the IRS examines when determining whether or not a charity is exceeding reasonableness with its compensation arrangements. These factors look something like this:
- Actual job description
- Required level of education or experience
- Compensation averages in your area
- Number of hours worked
- The overall budget of the charity
Its also important to note that each factor is weighted differently depending upon the circumstances. It is a very subjective exercise. We’re often asked, “How much is too much?” Good question, but hard to answer. Frankly, it just depends. I know, I know…“not very helpful”, you say. There are legitimate, charitable organizations whose executives make up to, and sometimes more than, $250,000. For a very select few, a lot more. But let me put it like this…if you have an employee whose compensation package exceeds $100,000, you better be prepared to defend it. Needless to say, Wall Street-style perks and bonuses are out of the question. And, depending on your organization’s budget, a $10,000 salary package could be considered unreasonable.
Due diligence. Due diligence is the brother of reasonable compensation. In order to have a compensation package considered truly reasonable, the figure must be the result of a substantive evaluation of what makes sense for the job. That is the responsibility of the board of directors or compensation committee. It is considered a best practice to document the method used to determine salary packages. There are various resources that can be used to come up with the information: The Labor Department, census data, job-oriented websites, national and local charities, etc. It’s best to use multiple sources.
Arms-length. This is often the one that hangs folks. You can do all the due diligence you want and come up with the nation’s most reasonable compensation package, but if your compensated executives effectively control the mechanisms of their own pay, then trouble awaits you. For example, let’s say the president of the board is also the salaried Executive Director. That’s OK, as long as your board structure and meeting minutes show arms-length. In other words, the president better refrain from discussions and votes about his/her own pay package…plus, a majority of those voting on the package better not have any relation to him/her, by blood, marriage or outside business. Intermediate sanctions penalties await those that mess this part up.
Nonprofit executive compensation scrutiny is not going away anytime soon. In fact, it is only likely to increase. If you know your nonprofit has problems in this area, be proactive and get it fixed immediately.
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In regards to the non-profit’s executive…is there a formula to compare the amount of money raised vs the amount given to the executive for salary?
Not really…it’s pretty subjective. One way to look at it is whether or not the executive’s salary is considered program expenses or administrative overhead. In many organizations, salaries make up a huge percentage of the budget simply because it is paid staff members who are conducting the programs. One measurement you can use is to look at the effectiveness of the salary. If you could not accomplish what you are doing without the salary, then it is probably OK. If your effectiveness is actually being hindered by the amount of money going to salary, then you really need to examine that. It takes a truly big-picture evaluation. Good luck.
Great article! I think the term “Non-Profit” is a bit of the problem with trying to figure out the appropriate compensation for the staff. My thought is, I would like to run my non-profit to accomplish its goals, but I need to keep the roof over my family’s heads as well. I guess that is the balancing act the IRS would be looking for.
I serve on a board for a 501(c)3 organization (a nonprofit community theatre). Our Vice-President of the board is also our Managing/Artistic Director. We bring in enough income now that we can pay her a salary of about $25,000 annually to retain her for her services. The president of another local board, running the county cultural alliance, has advised us to get her off the board if we are going to pay her (for managing the theatre and directing), or the IRS will pull our 501(c)3 status.
The IRS website states that “No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization.” This statement confuses me, because it seems as though, especially for small nonprofits, that there would have to be an overlap of board members and employees. Our Artistic Director wants to remain a Board Member so she has a say in what goes on (but she would not have a say in her salary). We are trying to find out what the IRS is actually saying. Can you help?
It does sound confusing, doesn’t it? Typical IRS speak. Fortunately, your friend on the other board is incorrect. It is quite normal for board member/employee overlap…especially with smaller nonprofits. The key to avoiding inurement is managing the inherent conflict of interest. Make sure less than 50% of your board is employed by the organization. Then, all hiring and compensation issues involving employed board members must be done with those persons recusing themselves completely. I hope that helps, Rachel.