Nonprofits and Reasonable Compensation

Every so often a front page news story will appear citing a seemingly outrageous number as the salary of a nonprofit’s CEO. The question most people ask is how could a tax-exempt organization justly pay someone so much? In rare instances, the CEO in question has manipulated their salary in his or her favor or taken benefits not owed to them. The vast majority of the time, however, the answer rests with what the Internal Revenue Service calls “reasonable compensation.”

What is Reasonable Compensation?

A nonprofit organization is not a no-profit organization. Every successful enterprise, nonprofits included, requires profit to pay expenses (including salaries). Nonprofits, however, have no stock and none of their net profits (the money used to further the organization’s purpose) can be distributed to an individual as compensation or dividends. But nonprofits certainly can and do pay their employees competitive wages.

The term reasonable compensation is intentionally vague, but the IRS does use the following factors to determine what is “reasonable”:

  • Position duties

  • Required level of education and experience

  • Compensation offered by similar organizations of similar size

  • Typical number of hours worked

  • The nonprofit’s overall budget  

One of the biggest factors you should consider when establishing reasonable compensation is what similar organizations are paying their directors and officers.And if the people at the top are making large salaries, the other employees in the company should be well compensated as well (it would be hard to justify the president taking a six-figure salary if the other employees are only making minimum wage).

How do you Determine Reasonable Compensation?

You can do several things to help protect your nonprofit from unjust compensation accusations. They are as follows:

  • Due diligence

Research what similar nonprofits in your industry and geographic region are paying their employees, executives, and directors. This should be indicative of what your salary range should look like.

  • Create a compensation committee

The compensation committee should be comprised of independent directors. This means that anyone who will have their salary debated over by the committee should not be a part of the committee or be present while the committee is discussing pay or benefit packages.

  • Adopt a compensation policy

A section in your nonprofit’s bylaws should explain policy concerning how your nonprofit determines pay. It should explain how the nonprofit links pay to performance, value, mission, and strategy.

  • Document everything   

Keep records of the data and source of your comparable data; when, where, how, and what was decided at compensation meeting; and all other meetings and policies concerning compensation.

The Bottom Line

Nonprofits employ a large sector of our economy and are allowed to pay competitive wages. The reasoning for this is simple: just because someone works for a nonprofit doesn’t mean their work isn’t valued. But, whatever you decide to pay your employees and officers should be rigorously justified, researched and documented.

To learn more about reasonable compensation and nonprofits, visit the online resources linked below:

The IRS on Reasonable Compensation

The National Council of Nonprofits

A 2013 Charity Navigator Study on CEO Compensation

Drake Forester
<div> Drake Forester writes extensively about small business issues and specializes in translating complex legalese into language everyone can understand. His writing has been featured on Fox Small Business, AllBusiness.com, Score.org, and many other websites and blogs.</div> <div> <a href="http://www.northwestregisteredagent.com/services.html" target="_blank">northwestregisteredagent.com</a>| <a href="https://plus.google.com/+drakeforester/posts" target="_blank">Google+</a>| <a href="/author/drake-forester/all-posts" target="_blank">More from Drake</a>   </div>

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