The board of directors is responsible for hiring, and establishing the compensation (salary and benefits) of the executive director/CEO by identifying compensation that is "reasonable and not excessive," but that also is attractive enough to retain the best possible talent to lead the organization. The recommended process is to conduct a review of what similarly sized peer organizations, in the same geographic location, offer their senior leaders.
In order to protect your nonprofit and its board members from potential intermediate sanctions (penalties) you may want to follow the 3-step process promoted by the IRS (in instructions to the Form 990), to determine whether compensation is "reasonable and not excessive."
Note: The IRS Form 990 asks charitable nonprofits about the process used to approve the compensation of the executive director/CEO (and certain other key employees): "Did the process for determining compensation of the following persons include a review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision?" (See IRS Form 990, Section VI, Part B, line 15.) Nonprofits filing the Form 990 must describe the process on Schedule O.
FAQs about setting executive compensation (IRS)
- Ensuring that the board has approved "reasonable and not excessive" compensation for the executive director/CEO is one of the fiduciary responsibilities of every nonprofit board. ("Are the assets of this nonprofit being used prudently and to advance the mission?") Boards that engage in an annual process of reviewing and approving the compensation of the executive director/CEO and that document this process in the minutes of board meeting(s), will be protecting their nonprofit (and themselves).
- Adopting a written policy that requires the full board to approve the compensation (salary AND benefits) is a recommended practice.
- The process boards should use to review comparability data and approve the compensation and benefits of the executive director/CEO is explained in more detail in the instructions to the IRS Form 990 (see pages 23-34, specifically the explanation for Line 15).
- Having a robust conflict of interests policy is another important aspect of ensuring fair and reasonable compensation, as well as transparency in financial transactions.
"Charities should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service. ... Charities may pay reasonable compensation for services provided by officers and staff. In determining reasonable compensation, a charity may wish to rely on the rebuttable presumption test of section 4958 of the Internal Revenue Code and Treasury Regulation section of 53.4958-6."
Source: IRS publication Governance and Related Topics - 501(c)(3) Organizations (2008)
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