States Target Nonprofit Executive Pay

by Linda M. Lampkin, Senior Nonprofit Compensation Specialist 24. January 2014 08:11

Should nonprofit executives “volunteer” a part of their compensation (by receiving a discounted salary) because they work for a charitable organization?  Alternatively, is a “high” salary important to attract the kind of talent needed to achieve the purpose of the nonprofit?  The IRS says that pay must be reasonable and that salary data on comparable jobs in comparable organizations must be used to document that what is paid is appropriate.  However, some states are moving to supplement that IRS scrutiny at the federal level with some limits on salaries for nonprofits at the state level.  (More discussion at http://www.cbiz.com/page.asp?pid=10098)

When nonprofits are funded by state grants and contracts, proponents of executive salary caps say that taxpayers should not pay high salaries.  As in the private sector, there is concern that executive pay is too high as a multiple of the average worker’s pay, although it seems unlikely that an executive salary cap will cause other salaries to increase.  Other advocates of salary caps contend that they will reduce the state’s costs and that additional money needed for the executives can be funded from other sources, like federal grants or private donations.  However, critics say that pay limits would make it much more difficult for nonprofits to hold onto top executives and recruit qualified new ones.  If a high salary results in higher revenue for the organization, they contend it is money well spent.

While the debate about state regulations continues, some of the organizations that pay the highest salaries, such as hospitals, may not be affected, as their revenues may come from the federal government or from private philanthropy rather than via state funds.

Currently, New York and New Jersey actually have some regulations in place, setting salary caps on nonprofits that receive state revenues.  In Massachusetts, legislation has been proposed, and the Attorney General has issued several reports on high pay which illustrate the state’s concern.  In Florida, legislation was also discussed but not enacted.

The different existing regulations and legislative proposals contain a lot of details which must be considered to fully assess the impact of a cap on nonprofit salaries, but below is a table providing an overview, developed using ERI’s Nonprofit Comparables Assessor.  The average annual pay for an Executive Director of two types of organizations (Arts and Human Services) with $25 million in annual revenues is shown in the four states, along with the salary cap under discussion or in force. 

This table illustrates several points:

  • Arts organizations pay their EDs much more than human services nonprofits.
  • Florida salaries are often lower than in the other states.
  • Salary caps, if implemented as proposed in Florida, could have a major impact; but the impact for Massachusetts would be much less because of the higher cap under discussion.
  • The caps in effect in NY and NJ might have a significant effect, but the various exemptions available have mitigated that impact for many organizations.

As the Massachusetts AG’s report suggests, “nonprofit compensation committees … should consider their charitable mission, how the executive pay compares to other workers’ salaries, and take into account the amount of public support the nonprofit receives from its tax-exempt status.”   Legislators in many states as well as the IRS regulators are watching closely as these compensation decisions are made.