Nonprofit Executive Compensation – How Do You Know If Your Organization Is In Compliance?

Written by Nick D’Alessandro, CPA

Running the day-to-day business of a nonprofit (NFP) organization, takes both time and money and, with oversight from the government, an awareness of rules and regulations that impact that organization.  One aspect that is highly scrutinized is executive compensation.  So, how do you determine what compensation to provide for your executives?

First of all, it is important to understand what constitutes compensation.  It is more than just a salary.  Compensation could also include benefits such as insurance, a car, housing allowance or other fringe benefits.  Simply put, any economic benefit to an NFP executive should be documented and approved.  In a blog post by Laura Kalick with BDO, she gives an example, “if an executive takes her family on a ten-day trip to Hawaii so that she can attend a two-day educational conference and none of the personal expenses are reported as compensation, those expenses may constitute as an automatic excess benefit.”[1]

If the IRS does find any “excess benefits” in your executive’s compensation, there could be stiff penalties to pay.  The first step is a 25 percent tax on the excess benefit transaction – compensation earned by key persons in excess of fair market value.  If the excess benefit transaction is not corrected, (paying back the excess with interest), a 200 percent tax can then apply.  There is also the possibility that the organization’s exemption would be revoked.  This penalty does not apply only to the executive that received the compensation, it applies to the board members who approved it and/or anyone on the board who knew about it as well.

So, what steps can you take to ensure that your NFP organization is properly compensating its executives?  First of all, you should have a written policy in place for determining executive compensation and be sure to follow that policy.  It is important that NFP organizations follow all of their written policies.  Additionally, find solid comparability data and use that data to make compensation decisions.  The data should be based on organizations which are similar in size or type, as well as location, endowment size, revenue, net assets, etc.  This data can be obtained from annual tax returns for smaller organizations, or through the use of databases for larger organizations.

Once you have your data, make sure it is documented and kept in your files.  This may include keeping copies of all the records you used to determine your policies in case your methods are requested by the authorities.  The IRS is looking for a process when analyzing compensation packages.  The more documentation you have to back up your compensation package, the better prepared you will be if you undergo an examination.  A best practice would be for NFP organizations to review their executive compensation annually regardless of whether it is for a new hire or not.

If you have any questions regarding your executive compensation or what documentation to maintain, please contact your BMSS professional.  Our experienced accountants are here to help you stay in compliance and maintain transparency for the government and the public.  Please contact us at (205) 982-5500 or visit us at bmss.com.

[1] Kalick, Laura. “Intermediate Sanctions and the Risks of Nonprofit Executive Compensation:  What You Need to Know.”  Nonprofit Standard.  BDO USA, LLP. August 16, 2013.