Nonprofit executive compensation tops the current list of IRS hot button issues. In recent years, the IRS has been ramping up its oversight and enforcement of nonprofit executive compensation. With all the rancor surrounding executive perks and bonuses on Wall Street, populist sentiment can 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.
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. There are some charitable organizations whose executives make up to, and sometimes more than, $250,000. For a very select few, a lot more. And, these highly compensated individuals have salary packages that fall within the reasonable zone.
But, if you have an employee whose compensation package exceeds $100,000, you should 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 must be exercised when coming up with 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.
This is the concept that often trips people up, especially in newer, smaller charities where a few individuals wear multiple hats. 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 decide 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 that arms-length decision making was used. In other words, the president should refrain from discussions and votes about his/her own pay package…plus, a majority of those voting on the package should not have any relation to him or her, by blood, marriage or outside business.
Failure to follow arms-length procedures regarding compensation can result in the IRS determining a pay package to be an excess benefit transaction, particularly if the pay is found to be unreasonable. This can further result in the assessment of what’s called intermediate sanctions penalties. These are fines levied directly against board members for allowing financial transactions that unfairly benefit insiders, a situation known as inurement.
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, get it fixed, and get back on track with compliant and transparent compensation practices.