Are You Paying Attention to Executive Salaries at Your Nonprofit? Should You?

by Linda M. Lampkin, Senior Nonprofit Compensation Specialist 23. January 2012 09:09

Yes, you should be interested, regardless of your level of involvement. As a donor, you work hard for your money and you should give it to diligent, effective organizations that use donations wisely. If you are even more involved and serve as a nonprofit board member, you are responsible for the compensation decisions of your organization. What's more, if you work for a nonprofit, there’s easily accessible salary data to assess your compensation level. The annual report to the IRS – Form 990 – requires detailed reporting of compensation and even documentation of the process used to determine salaries. Check out an organization’s Form 990 at ERI’s Library of Forms 990.

The IRS says nonprofits must pay employees “reasonable compensation.” Penalties for paying more include taxes on the employees who receive “excess” compensation and even the organization managers who approve salaries. In extreme cases, the organization could also lose its tax-exempt status.

So, compensation must be reasonable, but the IRS gives few specific guidelines. The total compensation must be compared with salaries for like services by like enterprises under like circumstances. This analysis must be done for each nonprofit executive. See Intermediate Sanctions.

If certain steps are followed to determine executive salaries, then a “rebuttable presumption” of reasonableness can be created, meaning that the burden of proof for unreasonable compensation falls on the IRS.

These are the steps a nonprofit board should take:

  1. Approval of the compensation package in advance by board members comprised of “disinterested” parties.
  2. Use of comparability data from other organizations (nonprofit and for-profit, if relevant) to set salaries. If the organization has gross receipts of less than $1 million, there should be data from at least three other organizations.
  3. Documentation of the basis for setting the compensation levels.

ERI’s Nonprofit Comparables Assessor (CA) provides detailed information for nonprofits to research if compensation levels are at market level. The CA demonstration version calculates the expected average annual salary for a given job title (Executive Director, CFO, etc.) from a series of user-selected inputs including the types of comparable organizations (adoption services, day care, museum, etc.), the specific size of the organization based on revenue ($1 million, $50 million, $2 billion, etc.), and the data for a specific geographic region (all US or a state). The majority of nonprofits can use this free version of CA to provide the data needed for a rebuttable presumption. The upgraded versions are designed for larger organizations, watchdog groups, and regulators.

Whatever your involvement with charities, salary data and source documentation to make informed decisions regarding nonprofit compensation is available through ERI Economic Research Institute.