Executive Compensation

Printer-friendly version

What should a nonprofit pay its chief executive?

The board of directors is responsible for hiring and establishing compensation (salary and benefits) for the executive director/CEO that is “reasonable and not excessive,” but is also attractive enough to retain the best possible talent to lead the organization.

The recommended process for determining the appropriate compensation is to adopt a written policy that the board conduct a review of the executive’s compensation that includes a comparison of compensation paid by similarly-sized peer organizations in the same geographic location. Conducting (and documenting) this comparison creates a “rebuttable presumption” that the compensation provided by the nonprofit to its executive dire tor is “reasonable and not excessive.”

Nonprofits filing IRS Form 990 must describe the process they use to approve executive compensation as part of the nonprofit’s responses on the annual return, IRS Form 990, Section VI, Part B, line 15.

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).

Practice pointers:

(1) Do it every year: When drafting the annual calendar for the nonprofit’s activities, choose the same time every year for the board of directors (or a compensation task force of the board) to review and approve the executive director’s compensation. Many nonprofits conduct the review in advance of or in conjunction with the annual budget process.

(2) Where can you find comparability data? Your state associations of nonprofits may conduct salary surveys and offer state-specific compensation reports. Other sources include outside compensation consultants and Candid, which collects data from IRS 990 filings and makes these data available for a fee.

What is "reasonable" compensation according to the IRS?

The IRS recommends that charitable nonprofits follow its three-step process to determine that compensation is reasonable and not excessive. (See also Treas. Reg. § 53.4958-6(a))

  1. The board should arrange for an "independent body" (which means that the person receiving the compensation should not be part of the review process) to conduct a "comparability review." Many nonprofits task a "compensation committee," or use their executive committee, or another sub-group/task force of board members, for this purpose.
  2. The independent body should take a look at "comparable" salary and benefits data, such as data available from salary and benefit surveys, to learn what nonprofit employers with similar missions, and of a similar budget size, that are located in the same, or a similar geographic region, pay their senior leaders. Example: it would not be comparable to compare the compensation of a CEO of a large urban hospital or university to the CEO of a rural day care center.
  3. The independent body that is conducting the review should document who was involved and the process used to conduct the review, as well as document the full board's decision to approve the executive director's compensation (minutes of a meeting are fine for this). The documentation should demonstrate that the board took the comparable data into consideration when it approved the compensation. See instructions to the IRS Form 990 (see pages 23-34, specifically the explanation for Line 15). Nonprofits filing the Form 990 must describe the process on Schedule O. 

Practice Pointers

  • Having a robust conflict of interest policy is another important aspect of ensuring fair and reasonable compensation, as well as transparency in financial transactions.
  • 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. See instructions to IRS Form 990, pages 31-32.
  • The instructions to Form 990 include a glossary of terms and a table that shows precisely how and where to report the many types of "other compensation" that should be included in total compensation.

Tools for Boards

Resources

Find Your State Association of Nonprofits

Connect with local resources and expertise

Find

Connect With Us

1. Sign up for updates

Stay up-to-date with the latest nonprofit resources and trends by subscribing to our free e-newsletters.

2. Follow us on social media