Nonprofit Variable Pay

Reasonable Compensation Safe Harbor

The regulations provide for a "safe harbor" under which the compensation is presumed to be reasonable provided certain conditions are met.

Here are the three conditions that must be met:

1. Approval by an authorized body. The compensation arrangement needs to be approved (prior to implementation) by an authorized body of the tax-exempt organization (typically the board), composed entirely of individuals without a conflict of interest.
2. Appropriate data as to comparability. An authorized body has appropriate data as to comparability if, given the knowledge and expertise of its members, it has information sufficient to determine that the compensation is reasonable. The phrase given the knowledge and expertise of its members is a very important factor. It is not enough to have good information or data; the board must be able to properly analyze and draw conclusions from that data.

3. Documentation.Adequate documentation requires that the written or electronic records of the authorized body state:

   • the terms of a transaction and the date it was approved
   • the members of the authorized body present during the debate on the transaction, and those who voted
   • the comparability data relied upon, and how the data was obtained
   • any actions taken with respect to consideration of the transaction by members of the authorized body who had a conflict of interest
   • the basis for the determination if the authorized body determines that reasonable compensation is actually higher or lower than the comparable compensation data obtained

Non-fixed payments

The rules providing for a rebuttable presumption of reasonableness are for a fixed payment compensation package. Where there is a non-fixed payment, the organization must meet the three criteria above AND show the exact amount of the payment or the formula for determining that payment.

Burden of proof

When the three conditions are met, this constitutes a rebuttable presumption of reasonableness. This means that the burden of proof shifts from the disqualified person to the IRS to prove that there is an excess benefit. It is then up to the IRS to rebut the presumption by furnishing sufficient contrary evidence to show that the compensation was not reasonable.