DEFINITION:
Commission based compensation is a payment structure determined by the amount of revenue that is brought in, on a percentage basis. To do this correctly through in an exempt organization there must be a defined cap on the percentage-based compensation as the maximum amount to be paid which would be the reasonable amount paid for the efforts put in in obtaining such revenue.
BEST PRACTICE:
Compensation in a tax exempt organization needs to be based on the job duties being performed and what is reasonable compensation for those responsibilities. Let’s look at some examples and see how this applies.
Example 1.
A reasonable salary is determined for an organization’s Executive Director to fulfill day-to-day operations. However, the organization’s income does not support the salary. The board of directors decides that they will pay a certain percentage of income received up to the determined salary amount. In this way reasonable compensation has already been determined for the job to be completed and compensation will not be above the amount that was determined to be reasonable should the organization need to fulfill the compensation with a percentage of income that the organization is bringing in.
Example 2.
The organization decides that it needs to work with the grant writer to secure grants for the organization. This can be done through a flat fee for a project or could be a salaried position. Compensation needs to be determined based on the anticipated efforts of the individual in the work that they will be doing. Compensation cannot be determined based on how much money is actually raised. For example, a grant writer is researching grants which the organization may be eligible to receive. In doing so the grant writer finds two grants that seem reasonable for the organization to be applying for. The grant writer writes the proposals and gets the board’s approval to submit those. Upon receipt of the request each grantor determines that the organization is eligible for the grants and the organization receives two grants. The first grant was a gift of $5000, while the second grant was $100,000. If the grant writer had been set to receive Commission based compensation without a cap of maximum compensation, the net earnings of the nonprofit could inure to the benefit of that grant writer as the efforts for each of the grants applied for was the same.
Let’s say 10% was an amount that was going to be used for commission-based compensation. For the first grant that compensation would be $500 but for the second grant that compensation would be $10,000 while the efforts in applying for the grants were equal. This example shows best why there must be a defined fee or salary for the efforts of the individual in this case. While the board could do 10% of the grants up to the defined fee or salary amount, leaving it open-ended would be non-compliant. By having the defined cap which is the reasonable compensation for the efforts that are being put forth the organization is able to compensate the grant writer in an appropriate manner.
Example 3.
Professional fundraisers. This is an issue that the IRS heavily scrutinizes as there are many professional fundraisers who would prefer to be contracted by an organization on a Commission based compensation that has no defined cap. But as we showed in an example two above the efforts of that professional fundraiser could be the same regardless of $5000 in revenue received $100,000 or even $1 million. We have seen the IRS accept a second approach as compliant for an exempt organization and that is when there are tiered levels of compensation depending on a threshold of revenue received. So, for example, let’s say that the professional fundraiser will receive 10% of revenue up to $10,000. At that $10,000 threshold that might reduce to 8% up to $20,000. Beyond $20,000 that might be further reduced to 5% up to $30,000, and so on and so forth until there is a cap met in which all the money that is received over a certain threshold, compensation has already been met and the organization receives all the revenue beyond that threshold. It is important to note these thresholds must be reasonable. A cap shouldn’t be put on an unrealistic amount of revenue received so as to still benefit the professional fundraiser in an unreasonable manner.
The main lesson here is that compensation in an exempt organization needs to be reasonable based on the duties that are being performed. If that reasonable amount cannot be met due to income limitations, then a percentage of income could be used to provide compensation up to the predetermined reasonable amount.
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