How Can A Nonprofit Determine Executive Director Compensation?
So you're about to hire an Executive Director for your non-profit organization. Maybe it's for the first time, or maybe you are replacing one. But did you know that when it comes to determining how much to pay an executive director or other key employee, nonprofits have additional requirements that don't apply to other businesses? But by following a stepped process, you’ll be well within the appropriate parameters.
Here’s how to approach it:
Is the compensation reasonable?
Any compensation provided must be reasonable and not excessive. However, there’s no line in the sand test to determine what constitutes reasonable compensation. Instead, the IRS looks at the facts and circumstances of each situation to make a determination. The following are important factors that support a finding that compensation is reasonable.
The compensation should be approved in advance by an authorized body of the organization (i.e. the board of directors or a committee of the board), which is composed of individuals who do not have a conflict of interest concerning the transaction. This means that the person receiving the compensation should not be part of the review process.
The authorized body should determine the compensation after reviewing and relying on comparability data regarding compensation provided by similarly situated nonprofits (based on size, budget, and location). You can usually find comparability data through your state association of non-profits that may conduct salary surveys and offer state-specific compensation reports. Other sources include outside compensation consultants and Candid, which collects executive salary data from IRS 990 filings and makes the data available for a fee.
You need to consider what nonprofit employers with similar missions, a similar budget size, and are located in the same or a similar geographic region, pay their senior leaders. For example: don’t compare the compensation of a CEO of a large hospital or university to that of a rural day care center’s CEO.The authorized body must document the basis for how it determined the amount of compensation. The documentation should show who was involved, the process that was used to conduct the review, and the documentation comparable data that was reviewed. The documentation should also show that the board considered the comparable data when it approved the compensation. This helps establish a “rebuttable presumption of reasonableness” standard under IRS rules for nonprofits.
What happens if the compensation isn't reasonable?
If the IRS considers the compensation in excess of what is deemed reasonable, they would first determine the amount of the excess. The employee would then be subject to a 25% excise tax on the excess benefit. The employee will also be required to repay the excess amount. If they fail to do so, they will be subject to an additional 200% excise tax on the excess benefit.
A more severe penalty can be the loss of the organization’s tax-exempt status. But this is usually reserved for the most serious forms of misuse of the organization's funds.
To stay compliant with IRS rules, it is important that your nonprofit organization adopt clear compensation policies. If you need help developing or revising compensation policies, give Levene Legal a call today.
