To avoid issues with the IRS, and the public, nonprofit organizations must be conscientious when making decisions regarding executive compensation. Finding a healthy balance of competitive, but not excessive, compensation is essential.
Overpaying executives can lead to a decline in donations, volunteer resources and, in extreme situations, an organization could lose its nonprofit status.
The public donates to support the organization’s mission, not to pay for excessive executive compensation. Here are 9 questions to ask about nonprofit executive compensation:
1. How do you determine what is a reasonable and competitive compensation for your nonprofit executive?
To appease the public, the IRS and your executive, nonprofit organizations need to decide on compensation that is both reasonable and competitive. Though they work for charitable organizations, non-profit executives are leading complex business operations and deserve compensation based on the market.
The IRS recommends that non-profits follow its three-step process to determine reasonable compensation.
Step One: Assign an independent body of board members, with no conflicts of interest, to review and approve compensation
Step Two: Use salary surveys to determine what organizations similar in location, budget size and mission type, are paying their top executives.
Step Three: Keep documentation of the review process such as who was involved, which decision was approved and which data was considered in the decision.
2. What happens if the IRS determines that a nonprofit’s leader is overpaid?
Now that you know the risks of overpaying nonprofit executives, you’re probably wondering what happens when the IRS finds that a nonprofit leader’s compensation is excessive. According to the IRS, the executive has to pay back the excess compensation. The amount the executive pays equals excess benefit plus interest. In extreme situations, a nonprofit can even lose its status as a 501(c)(3). Nonprofit organizations should conduct an annual compensation review to prevent this from happening.
3. Is information on nonprofit executive compensation available to the public?
The short answer is yes. Donors can look at an organization’s most recent audit, Form 990, or websites such as Guide Star and Charity Navigator to locate a breakdown of administrative costs, program costs, and fundraising costs. If administrative costs glaringly outweigh other costs, the public will likely notice.
4. What measures can nonprofits take to protect their executives?
The best way for nonprofits to protect their executives is to follow the three-step IRS process mentioned above. One of the most important precautions to take is to assign an independent body to review executive compensation annually. Making sure that there are no conflicting interests is vital to the validity of the committee decision. It is also necessary to ensure that the executive is not allowed to participate in any of the discussions about his or her compensation.
5. What kinds of data should nonprofit executive compensation be based on?
When determining the compensation of a nonprofit executive, you should take the following types of data into consideration:
- Job type/responsibilities
- Required level of education or experience
- Number of hours worked
- Overall budget of nonprofit
- Compensation of similar organizations
6. What does compensation include?
Compensation is defined as anything given or received as an equivalent for services. It consists of salary and benefits such as all types of insurance, a car, a housing allowance, etc. Any additional perks that an executive receives from his or her organization are considered compensation.
7. What types of precautions should be taken during the review?
It is important to have a plan in place for the review process to prevent potential issues with the IRS or the public regarding executive compensation. The review process should be thoroughly documented with meeting notes describing what was discussed and who was present. There should also be a written policy requiring the full board to approve compensation decisions.
8. Should bonuses be allowed to substitute for lower salary?
Bonuses are acceptable if they meet specific criteria. They are NOT substitutes for lower salary. Bonuses needs to be based on specific performance measures and must not be excessive relative to peer groups of similar nonprofits. They should also be developed by an independent advisor to avoid conflicting interests.
9. What steps should you take after compensation has been decided?
Nonprofit organizations require customized compensation plans because of their unique circumstances. A well-designed compensation strategy will maintain a workforce of high-level skills for longer periods of time. Contact The Overture Group, today for comprehensive compensation consulting results that show! We’ll use our deep industry knowledge to analyze your organization and generate solutions that work for you.After an independent body has made an initial decision on executive compensation, they should review the compensation package annually to ensure that an executive’s salary remains reasonable and competitive. They should continue to ask questions and analyze data, as well.