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A nonprofit organization has a purpose other than turning a profit—but that doesn’t mean nonprofits aren’t profitable. If nonprofits weren’t viable, revenue-creating entities, they wouldn’t be able to pay their bills and wouldn’t exist.

The key difference between a nonprofit and a for-profit is that with a nonprofit, no proceeds generated by the organization benefit any individual.

Instead, all proceeds are invested into the organization to further its reach, used as donations to a charitable cause, or used in a way that benefits the public.

So how is a nonprofit able to pay its employees? The basic premise is fairly simple: all wages, like in any other business, are considered an expense. If a nonprofit requires employees, the employees’ wages are simply costs of doing business.

Determining Who Should Be Paid

Nonprofits often make use of volunteers, but it’s both common and practical to have paid staff as well. Paid employees can include both regular staff and those in leadership positions, such as CEOs and executive directors. Board members, however, are typically volunteers. Board members may be reimbursed for board-related expenses, such as travel, but they usually should not receive compensation.

Occasionally, however, a board member might also be a paid employee or might provide a contracted service, such as legal advice. Because of the potential for conflict of interest, these situations are best avoided when possible. However, this isn’t always realistic or practical, particularly for small nonprofits just starting out. In these cases, nonprofits should, of course, provide compensation for services received, but the nonprofit should take a few extra steps as well.

• Board members receiving compensation for employee or contracted services should recuse themselves from any votes or decisions related to their own contract, position, fee, or salary.
• All votes related to such contracts, positions, fees, or salaries should be documented diligently.
• The choice to contract a board member’s services instead of the services of comparable non-members should be justified and documented (such as with competing quotes or bids from non-member contractors).

Ideally though, if a board member wants to move into a paid position in the nonprofit, they would typically resign from the board before applying for the paid position.

Calculating Salary

Once you’ve determined whom to pay, it’s necessary to determine a wage or salary. The IRS guidelines for compensation (found in Schedule J for Form 990) are somewhat vague, noting that wages or salary should be “reasonable” and not “excessive.” So how do you determine what is reasonable?

There are a few key factors to consider when calculating a reasonable salary.

• Wage laws: Nonprofits are subject to the same wage laws as for-profit companies. This means you’ll need to pay the higher federal or state minimum wage, as well as any overtime, insurance, or other compensation required by state and federal laws.
•  Job description: Salary should be in line with typical salaries for the particular job. What services are provided? How many hours are worked? What do comparable businesses in the area pay employees for similar services?
• Background: Significant experience, specialized skills, or extensive education can all justify higher salaries. Note that the reverse is true as well. If someone has little or no experience, a high salary may need more justification if called into question by the IRS.
• Budget: Salaries shouldn’t be grossly out-of-line with the budget of the nonprofit. For example, a $20K annual salary may be reasonable based on the job description, but if the charity only brings in $25K a year, the IRS may consider this figure much less “reasonable.”

Using the above factors, you should be able to calculate a reasonable salary and document your rationale. It’s also a good idea for the board to approve salaries each year, even if no changes are being made so that there’s a consistent record of oversight.

Salary Practices to Avoid

In addition to following good practices for calculating salary, it’s also useful to note some potential missteps that could draw negative attention. In particular, the IRS is not fond of salary calculations based on incentives or percentages.

• Incentive-based pay: Incentives, such as bonuses and commissions, are common in the for-profit world, especially for executives. However, the IRS much prefers fixed wages or salaries for nonprofit employees. The IRS keeps a close eye on any incentive-based pay to ensure it’s truly reasonable and not simply a cover for private, individual benefit.
• Percentage-based pay: Some nonprofits consider offering salaries that reflect a percentage of funds raised or investment income earned. As noted above, however, salaries should be carefully researched, calculated, and well-documented to reflect the services rendered, hours worked, the expertise offered, and comparable salaries of similar positions in the area. Matching salary to the fluctuations of money coming into the nonprofit would not meet any of these criteria. And much like incentive-based pay, fluctuating salaries invite scrutiny due to their potential for abuse.