Nonprofit Compensation: What is too much? …and who decides?

Are you tired of hearing, "That nonprofit pays its employees too much!" If every nonprofit board followed IRS guidance on setting the compensation of its key staff leaders, perhaps we wouldn’t hear that refrain as often. So board members, please do your part by embracing your role as defenders of the nonprofit sector’s right to pay its employees reasonably and fairly. Help us change the conversation from, "What compensation is excessive?" to "What compensation levels will help our organization build its capacity by hiring and retaining terrific staff?"

First, know the process for reviewing the annual compensation of the executive director. Second, be aware of the downside of NOT engaging in an annual compensation review. (Bad press, lack of donor confidence, and potentially IRS penalties….need we say more?)

Background: Under federal law, a charity may not pay more than "reasonable" compensation for services rendered. Although the Internal Revenue Code does not require charities to follow a particular process for determining the appropriate level of salary and benefits, it is clear that compensation for board members, officers, key employees (and others in a position to exercise substantial influence over the affairs of the nonprofit) should be determined by persons who are informed about what comparable nonprofits pay their employees, and who have no financial interest themselves in approving the compensation. (Source: IRS, Governance and Related Topics - 501(c)(3) Organizations 3-4 (2008)). These are the general guidelines offered by the IRS – but the IRS Form 990 offers specifics.

The IRS Form 990 asks nonprofits about the three-step process used to approve the compensation of the executive director/CEO (and certain other key employees): Did the process for determining compensation of the following persons include a (1) review and approval by independent persons, (2) comparability data, and (3) contemporaneous substantiation of the deliberation and decision?(See Section VI, Part B, line 15, of the Form 990.) Nonprofits that follow this three-step process are generally able to take advantage of what the IRS refers to as a "rebuttable presumption" that the compensation is reasonable, thereby protecting the nonprofit and the board members from sanctions that can be imposed by the IRS if it finds that the compensation was not reasonable.

Visit the National Council’s website for more information on how to measure comparability of compensation, and visit the IRS website for background on what can happen if a board fails to demonstrate it followed this 3-step rebuttable presumption process [hint: intermediate sanctions].

Demonstrating that your nonprofit has approved the compensation of the executive director/CEO in a thoughtful, deliberative process is a basic fiduciary responsibility of every nonprofit board. Here are some pointers:

• The process of reviewing executive compensation should recur whenever there is an adjustment to the executive director/CEO’s compensation.

• Having a written policy can help keep the process on track. ( See sample policy).

• The "executive compensation review" should be conducted by persons who are "independent" (not paid by the nonprofit). Many nonprofits use a sub-committee, such as a "compensation committee" made up of board members and volunteers, or the executive committee, to conduct the initial review and then make a recommendation to the full board.

• Having the full board approve the compensation of the executive director/CEO is consistent with being a transparent and accountable organization.

• Documentation of what the board’s decision was based on (such as comparability data) and of the fact that the board carefully deliberated and approved the CEO’s compensation is critical. Minutes of the meeting should include enough details so that if the board’s decision is questioned, the process the board used to determine that compensation is "reasonable" will be clear.

• "Compensation" means both salary and benefits, so if an executive director receives a salary but also other fringe benefits such as insurance, or a car or housing allowance, all those elements must be totaled together to determine the annual compensation.

There are many more resources on the National Council’s website, including a sample Policy for Review of Executive Compensation and a link to a virtual seminar on this topic presented at a symposium at Columbia Law School for state charity regulators by legal experts on executive compensation for tax-exempt organizations.

Read about additional governance policies that your nonprofit’s board should be aware of.

Nonprofit Misconception: Sense of Entitlement

The Albany Times Union featured the following blog post by Wally Altes from Wally’s Bottom Line, who is the former president of the Albany-Colonie Regional Chamber of Commerce. His post, titled The Non-Profit Shake-out, highlights some growing trends in the sector, but also puts forward a problematic misconception with the following statement: Oh, and one other thing–maybe this will help non-profit management get past its highly developed sense of entitlement. Read his blog post below and New York Council of Nonprofits CEO Doug Sauer's response posted on his blog.

Wally's Bottom Line:
A number of months ago I wrote about the difficulties I felt non-profits would be facing as the economic situation worsened. I suggested that many would not survive and that consolidations, mergers and alliances would be built among the surviving non-profits.


This past week we received letters from two non-profits which we have supported in the past. One non-profit suggested that it might be only weeks from closing its doors. The other indicated that it wanted to raise an amount well into six figures within the next three months. Obviously, both requested money. Neither of these organizations have yet had their financial difficulties covered in the press. But there have been other non-profits such as Gilda’s Club whose difficulties have recived press coverage.

I have long felt that there are simply too many non-profits. Many have been created which serve small niches and survive because of a limited but devoted following of contributors and volunteers. Their survival is most in danger. But non-profits which cater to a larger base are also feeling the financial squeeze. They typically have higher operating costs and usually have a significant amount of ‘earned income’ but it is inadequate to insure survival.


We are about to hit a period of donor fatigue; all non-profits will be asking for money. Contributors are feeling much poorer than they did a year ago and will not support as many organizations as formerly nor will they be as generous when they choose to support one. There will be a shake-out; the only question is how painful will it be. Frankly, a shake-out will be good. Let the Darwinian approach reach the non-profits as well as other segments of society. Oh, and one other thing–maybe this will help non-profit management get past its highly developed sense of entitlement.

The following is NYCON CEO Doug Sauer's response posted on the blog:
The New York Council of Nonprofits, Inc. is providing leadership throughout the state in encouraging nonprofits to restructure and assisting with the process. It is unfortunate that Wally’s valid point about the need for some nonprofits to consolidate, merge and build alliances during these tough times became badly tainted at the end with his Darwinian prejudice toward how society should function (including I assume how the poor and vulnerable among us should be treated) and his caustic attitude toward nonprofit leaders.


What is interesting is the context in which he presents his remarks. It is essentially about him as a fatigued donor who is bemoaning the difficulty in making charitable choices when there are many requests and when organizational survival may be at stake. He sees many nonprofits existing because of “niches”, donors and volunteers. Left out of his equation, is mission and need.
Wally is right in saying that many contributors have less to give. What he misses is the fact that in difficult times, many donors step up their giving; reaching deeper into their pockets for the charities and religious organizations that truly care about and touch their lives. It may surprise Wally to know that this is particularly true among the less affluent, who donate a higher proportion of their income than people of higher means. And, many do so without taking charitable tax deductions. The average donor also does not seek recognition through serving on an honorary committee, receiving a plague, or having their picture taken in the Social Scene section of the Times Union.

With respect to the “sense of entitlement” that he thinks nonprofit leaders possess, he fails to recognize the fact that the vast majority of professionals in the sector devote their lives to service for substantially less income and benefits than what they would make in the private or government sector.

The message Wally sends is the wrong one and overwhelmingly negative. This is a time for community leaders to encourage greater giving and as President Obama has suggested, to become actively involved with community nonprofits. Time to step up, not step down.