Executive Compensation: Finding the Perfect Balance
It’s budget time, which means we are about to get inundated with questions about EXECUTIVE COMPENSATION
Executive compensation is a hot-topic button with our nonprofits. Here at OneOC we frequently have board members, and even chief executive officers themselves, asking “how much compensation is reasonable?” There’s that term “reasonable”… so pervasive and yet so nebulous.
Questions about salaries and reasonable salaries is not new. Boards have been juggling compensation issues for years. Nevertheless, economic woes and increasing scrutiny by state regulators and the IRS – not to mention the press and our donors and stakeholders – requires us to be more vigilant and transparent with our executive compensation policies and practices. On several occasions the IRS has suggested that they will continue to prioritize executive compensation as one of its main areas of focus. Those of us who have muddled through the redesigned Form 990 clearly recognize that the responsibility for greater transparency around nonprofit compensation has been thrust upon us.
While “reasonable” is not an especially helpful yardstick, the procedure behind this terminology is useful. In determining “reasonable compensation,” the IRS encourages a charity’s board to collect data on the compensation practices of similar nonprofits. In fact, the IRS outlines policy for setting nonprofit executive compensation in the Form 990 and instructions. The review process must include three elements:
- review by an independent body (such as a compensation committee or the executive committee);
- use of “comparability data,” and
- documentation (usually through minutes of the meeting) of the board’s consideration and approval of the compensation.
Compensation includes salary and benefits, such as insurance, a car, housing allowance, or other fringe benefits, that should be included in the calculation of total annual compensation. During the process of board approval of the compensation of the executive director/CEO it is essential to have comparable data in order to comply with the expectations for good governance reflected on the Form 990 (see Part VI, Section B, line 15). One method is to obtain compensation surveys or studies from outside compensation consultants for this purpose.
Tips and Tools
- Review a sample policy for board approval of compensation prepared as an illustration for small nonprofits by the National Council of Nonprofits.
- Compensation strategies are shared in a two-part best practice series on nonprofit compensation in the NonprofitLaw Blog.
- Musings from Blue Avocado on What to Pay the Executive Director.
- Attend a virtual seminar, hosted by Columbia Law School during which leading tax-exempt lawyers,who specialize in executive compensation, provide guidance to state charity regulators on the process a nonprofit board might use to establish that compensation is reasonable.
- IRS Form 990, and instructions to Form 990 and instructions for executive compensation: /www.irs.gov/pub/irs-pdf/i990sj.pdf
Having a robust conflict of interest policy is another important element of board governance and reasonable compensation.