Quick Tips for Setting Nonprofit Executive Compensation

To ensure its decisions will stand up to the scrutiny of the media, regulators, and donors, and protect the employee as well as the board from personal liability, nonprofits that employ executive staff should consider implementing practices and procedures that ensure its executive compensation procedures are thorough, well-documented, and conflict-free. Recommendations include the following:

1. Use the Rebuttable Presumption Procedures. Tax-exempt organizations must pay reasonable compensation. The Treasury Regulations outline a process for public charities and social welfare organizations that, if followed, shifts the burden of proof to the I.R.S. to prove that compensation is unreasonable. The I.R.S. has published a checklist that can be used for this purpose.

2. Create a Compensation Committee. A dedicated committee is often better able to devote the time and attention that executive compensation matters require. If a compensation committee is formed, it should operate pursuant to a formal delegation of authority from the board.

3. Adopt Comprehensive Conflicts of Interest Policy. A conflict of interest policy is strongly encouraged by the I.R.S. and is a legal requirement in some states. If followed, it can help protect directors and officers from liability stemming from transactions between the organizations and insiders.

4. Adopt a Compensation Policy. A compensation policy helps to create internal consistency by specifying comparable peer groups, target market position with respect to salary, long and short-term incentives that the foundation offers, total cash compensation, standard benefits, and any executive benefits and perquisites.

5.  Use Appropriate Comparability Data. Reasonable compensation is the amount that would ordinarily be paid for similar services by similar enterprises, whether taxable or tax-exempt, under similar circumstances. To qualify for the rebuttable presumption, nonprofits with annual gross receipts under $1 million must rely on at least 3 comparables. No threshold has been set for larger nonprofits; however, the higher the proposed compensation, the more data the board should generally consider.

6.  Assess All Components of Executive Compensation Relative to Comparable Organizations. It is important to ensure that total compensation is reasonable rather than comparing salary and various perquisites in isolation. All financial benefits (other than de minimus fringe benefits) must be included in the analysis and reported as compensation.

7.  Have Full Board Approve Chief Executive’s Compensation. It is prudent to have the full board of directors approve the chief executive’s compensation package. Some boards approve other key executive’s compensation. Others delegate that task to the compensation committee or to the chief executive (within pre-established limits).

8.  Have Full Board Approve Directors’ Compensation. The full board of directors should approve any compensation paid to directors or trustees. This is a requirement under some state nonprofit corporation laws. Due to the inherent conflict of interest, the board should base its decision on the certified opinion of an independent compensation consultant or recommendations from an independent ad hoc committee.

9.  Adopt a Travel and Expense Reimbursement Policy. To ensure that travel and expense reimbursements are reasonable and necessary, nonprofits should adopt a travel and expense reimbursement policy. This is a good place to memorialize the organization’s practices in areas of I.R.S. interest such as luxury travel and spousal travel.

10.  Where The Stakes Are High, Obtain a Reasoned Opinion. A reasoned opinion from a lawyer, certified public accountant, or compensation expert protects the board from incurring penalties for “knowingly” paying unreasonable compensation to a key employee or other insider. The review can also serve as a valuable mechanism to discover and correct weaknesses in the analysis or documentation of the compensation process.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, PC. To contact Ellis, call 602-456-0071 or email us at info@caritaslawgroup.com.

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