Nonprofit Executive Compensation 101: What You Need to Know
There are many good reasons to start a nonprofit organization, such as developing a resource for your community. Whether the entity hires volunteers or has paid employees, it faces certain risks that call for special types of insurance. Here’s a look at what nonprofit executive compensation covers.
Risk Nonprofit Executives Face
Executives at a nonprofit organization are expected to maintain public trust, and they can be sued or investigated if allegations are raised about improper fundraising or other questionable schemes. While nonprofit organizations are exempt from paying taxes, the IRS might launch an inquiry if it suspects an organization is overpaying employees or if the firm fails to comply with federal regulations.
Nonprofit organizations should be able to explain to the IRS and the public why executives get paid a high salary and generous benefits. Meanwhile, board members should be aware of regulations surrounding nonprofit executive compensation.
What the IRS Allows for Nonprofit Compensation?
Tax-exempt organizations are allowed by the IRS to pay executives a “reasonable” salary. The IRS, however, does not give specific details or set standards on what it considers “reasonable.” Here are factors your nonprofit organization should consider when determining “reasonable” payment to executives:
- Executives should be paid the market rate
- You can determine the market rate by studying the pay rates at similar nonprofit organizations
Penalties for Non-compliance
The consequences of failing to comply with federal regulations related to overpaying executives at a nonprofit organization can range from fines to investigations. A 501(c)(3) or 501(c)(4) organization is expected to focus on public service rather than make a few people rich.
The IRS may levy fines on board members and other executives if it suspects overpayment. Some executives may pay as much as $100,000 to the IRS if they are paid $250,000 in salary, and the IRS learns the more appropriate compensation should have been $150,000. The IRS treats each case individually and does not have a blanket guide for all nonprofits. The IRS may demand that an executive pay a 25 percent excise tax on an overpayment.
Learning from Compensation Surveys
It’s helpful to study entities similar to your nonprofit organization via market studies and organizational profiles. The IRS looks at studies of nonprofits relating to executive compensation to determine the appropriate pay. Some studies that meet IRS requirements have been published by the National Center for Charitable Statistics (NCCS), Charity Navigator, ERI Economic Research Institute, and the Urban Institute.
Nearly all tax-exempt organizations must file an annual information return with the IRS, which reveals executive salaries. This information helps the organization maintain a transparent image with the public.
For assistance with crafting an executive compensation strategy for your nonprofit organization, contact the experts at McKnight Associates, Inc. We are ready to offer you hands-on human resources consulting for colleges, universities, medical centers, and organizations of all sizes.