28 Aug Diving Deeper into Nonprofit Compensation Studies
Nonprofit organizations are dedicated to their missions, but they also rely on skilled executives to lead and drive their initiatives. The IRS allows tax-exempt organizations to compensate their executives reasonably, but what exactly does “reasonable” entail?
1. Understanding Reasonable Compensation
- The term “reasonable” is context-dependent, and what may be reasonable for one nonprofit might be considered excessive or inadequate for another. To determine appropriate salary and benefits packages, nonprofits must consider various factors such as experience, skill sets, organizational size, hours worked, job responsibilities, and more.
- Market Rate Comparison: Nonprofits can determine reasonable compensation by researching the pay for similar executive roles in organizations of comparable size (revenue, number employees, expenses) and with similar missions.
- For-Profit Benchmarking: Comparing compensation trends in for-profit organizations is acceptable as long as the job role, organization size, and mission align.
- Lack of Universal Formula: The IRS does not provide a fixed formula or predefined tables for determining reasonable compensation. Keep in mind that compensation is not black and white, other skills such as industry expertise, contacts, specific job skills, etc. should be factored into the decision-making process.
2. The Role of Nonprofit Compensation Studies
Nonprofit compensation studies play a crucial role in defining reasonable compensation. Here’s how they contribute:
- Market Rate Research: These studies help nonprofits establish competitive executive compensation by analyzing pay data from peer organizations.
- Comparison with Similar Entities: By examining compensation data from organizations with similar attributes, nonprofits can make informed decisions about executive pay.
3. Consequences of Non-Compliance
Failing to adhere to IRS guidelines for reasonable compensation can lead to serious repercussions for nonprofits:
- IRS Scrutiny: Excessive executive compensation can trigger closer IRS scrutiny of tax-exempt organizations.
- Penalties for Nonprofits: For 501(c)(3) public charities and 501(c)(4) civic leagues, penalties for overpayment can range from fines to the revocation of tax-exempt status.
- Fines and Excise Taxes: Individuals who receive overpayments may be required to repay the excess amount to the organization. Failure to comply can result in significant excise taxes. These are known as intermediate sanctions, and the rules surrounding these within the IRS code are somewhat complex.
Consider a scenario where an executive received a compensation package of $250,000, but the IRS determined $150,000 as appropriate. Consequences include:
- Repayment Requirement: The executive director must repay the $100,000 overpayment with interest.
- Potential Excise Taxes: If repayment is incomplete, excise taxes may be imposed on the outstanding amount.
- Board Member Liability: Board members approving the excess compensation could also be subject to excise taxes.
4. The Importance of Reliable Data
Both the IRS and the public closely monitor nonprofit executive compensation. Accurate, up-to-date data from reputable sources on compensation at peer organizations is vital:
- IRS Scrutiny Mitigation: Reliable data safeguards decision-makers from costly excise taxes and the organization from potential tax-exempt status loss.
- Preserving Public Trust: Accurate data prevents misconceptions about compensation, fostering trust among donors, the media, and officials.
Remember executive compensation information is publicly available through the annual form 990, which is annually published on Guidestar.org and the various state charities bureau.
Nonprofit compensation studies are indispensable for organizations seeking to align executive compensation with IRS regulations and public expectations. By conducting thorough studies and benchmarking against peer organizations, nonprofits can demonstrate their commitment to transparency, fairness, and effective governance.
This blog should not be construed as legal advice.
Author: Ken Cerini
Ken is the Managing Partner of Cerini & Associates, LLP, and is the executive responsible for the administration of their not-for-profit and educational provider practice groups. In addition to his extensive audit experience, Ken has been directly involved in providing consulting services for nonprofits and educational facilities of all sizes throughout New York State in such areas as cost reporting, financial analysis, Medicaid compliance, government audit representation, rate maximization, board training, budgeting and forecasting, and more.