Setting Executive Compensation Correctly

Posted by Jonathan D. Moll, CPA

Having been given the opportunity to work closely with nonprofit organizations of all shapes and sizes over the years, it is obvious to me that many of the executive directors and leaders of these organizations are among the hardest working people I have met. They often contribute countless amounts of time and resources to help their organizations achieve their mission. The chief executives in the nonprofit sector aren’t always rewarded with levels of compensation that their for-profit counterparts receive, even though their responsibilities often demand similar dedications of time, skill, and experience. Despite this, The IRS is continuing to increase its scrutiny and crack down on salaries it considers to be unreasonable for nonprofit executives.

To stay off the IRS’s “naughty list”, you need to make sure that your board of directors, at the time it sets an executive salary, arrives at a “reasonable” amount based on comparables for similar positions and adequately documents that research. The IRS defines “reasonable compensation” as the amount that ordinarily would be paid for like services by like enterprises, whether taxable or tax-exempt, under like circumstances. Your board of directors ultimately is responsible for compensation, even if a compensation committee determines the amount. Maintaining an awareness of the following 2 concepts during the process should help keep your organization in the clear:

  • Board committee members should properly document their steps. (Including the data used for comparability, an analysis of qualifications and documentation of the discussions leading to the final decision.)
  • Disinterested parties should set compensation. The person who will benefit from the salary-setting decision shouldn’t be involved in the data-collecting and salary-setting process and specific procedures should be in place for times when a conflict of interest arises.

Compensation information is required for officers, directors, trustees, key employees and possibly your five highest compensated employees other than the aforementioned. The IRS defines key employees as employees other than officers, directors and trustees who:

  1. had reportable compensation above $150,000,
  2. had organization-wide authority or control and
  3. were among your nonprofit’s top 20 highest-paid employees

With a constantly increasing emphasis on transparency, it is more important than ever for nonprofits to maintain the public’s trust. Be proactive and protect your organization by designing procedures to assure compliance with these requirements.

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