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Reasonable Compensation

Last modified: May 21, 2021
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The IRS requires salaries and wages paid to employees of a nonprofit to be limited to reasonable compensation. The IRS doesn’t do a great job of defining “reasonable”…it’s more of a “know it when we see it” sort of thing. That said, the best way to understand what the IRS requires is that employee compensation should 1) be comparable to other similar nonprofits, 2) be objectively tied to the job description, and 2) be within the organization’s ability to pay without hindering their ability to carry out their mission.

Form 990 lists your highest compensated employees. The IRS looks at this reasonableness question two ways: 1) Is compensation excessive? If so, they may determine that the organization is focused on individual gain, and not public benefit. And 2), Is compensation too low for the size and budget of the nonprofit? While #2 is less likely to generate an audit, it can happen. #1 is one of top audit triggers!

That said, there are things to consider when hiring staff and setting compensation for those positions beyond just defining reasonable compensation. Documentation of the decision makers when defining the positions…e.g., Do you have a job description and qualifications for a suitable candidate to fill this position?…and when setting the level of compensation, job market research for equitable posts and salaries. Also consider if this position is better filled as an employee or a vendor. You should make sure these things are documented in meeting minutes kept on file for future reference.

https://www.501c3.org/nonprofit-executive-compensation/

https://www.501c3.org/6-operating-policies-your-nonprofit-must-have/

https://www.501c3.org/top-10-form-990-audit-triggers-no-one-told-you-about/

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