Setting Nonprofit Executive Compensation

by Jim Rebenar, CPA, Audit Partner

Posted on December 11, 2024

Executive compensation is an often-scrutinized piece of information reported on a nonprofit organization’s Form 990. From grantors to potential donors, the IRS, and even the media, the level of interest in what nonprofit executives are paid has never been greater. What should you do to ensure your top executives receive competitive compensation while avoiding excess benefit transaction penalties from the IRS or harm to your public image?

According to the IRS, compensation for nonprofit executives must be considered “reasonable and not excessive”, but what does that mean? Instead of providing concrete guidelines or a specific pay range, the IRS has chosen to put it on the organizations to perform their due diligence and arrive at a compensation package that is reasonable when compared to similar organizations.

As the ultimate responsibility in setting compensation for an organization’s top executive lies with the board of directors, it is recommended that the board adopt a written policy for conducting a study of comparable salary and benefits data. Such a review should be performed by an independent compensation committee, free from influence by management. Many nonprofits choose to create the compensation committee from a subgroup of its board members or assign the task to an existing group, such as the executive committee.

Compensation data can be obtained from a wide variety of sources, which include salary surveys, state-specific compensation reports, or a search of publicly available tax returns. The most important part is the data must be comparable, meaning it should be from similar organizations with people working in equivalent positions. The comparability criteria can include factors such as the size and location of the organization, the nature of operations, and the duties of the executive position.

Other items to consider when developing your policy are how often the review will be performed and what will be used to assess the executive’s performance. If not done annually, it is recommended the review be conducted at least every few years. The compensation policy can include any tools or information the board may find useful in their evaluation, such as a written report from the executive detailing achievements and progress against goals.

Finally, it is essential to document the result of the review and get the full board’s approval on the recommended compensation. Be sure to include who was involved, what comparability data was used, and how it was obtained, as well as the terms of the compensation package and when it was approved. Properly conducting and documenting the comparison study creates a rebuttable presumption that the executive compensation is reasonable and not excessive and, therefore, protects your organization.