Setting Executive Compensation: How Much is Too Much?

This is part of a series of articles focused on issues relevant to non-profit boards of directors

shutterstock_46389259In recent articles, I have outlined the roles and responsibilities of non-profit boards and focused on the legal and ethical responsibilities of individual non-profit board members. Now, I want to spotlight one very important task non-profit board members must complete carefully and strategically: setting executive compensation.

A non-profit’s chief executive is often the heart, soul and public face of the organization. The chief executive is responsible for leading and coaching staff members; overseeing revenue-generating and fundraising activities; making final strategic decisions to ensure the organization’s mission is advanced; and countless other day-to-day tasks.

Clearly, the chief executive position is vitally important to the overall success of any non-profit organization. So, how do you put a dollar value on something so important? In today’s hyper-competitive environment, non-profit organizations across the country are struggling to answer that question.

As we discussed in my previous article, the board of directors has the responsibility of hiring and setting compensation for executive leadership.

Study the marketplace: Of course, every non-profit organization wants to hire their first choice for the executive director role–but many quickly learn they’ve only budgeted for their third, fourth, or fifth choice.

Before going through the process of selecting a new chief executive, non-profit boards must find out the “going rate” for that position. That means analyzing the salaries and benefits of comparable positions in private, public, and non-profit sectors and comparing those salaries to what the organization is prepared to offer. Having in-depth knowledge of the current marketplace will help your board set expectations and budget appropriately.

Protect your bottom line: The board needs to find middle ground between compensation that attracts the top talent and cost-cutting strategies that help the organization fund its services. That means offering a salary range that the IRS calls, “reasonable and not excessive.”

The National Council of Nonprofits encourages non-profit boards to think carefully before finalizing a deal with a new executive leader and ask itself: “Are the assets of this non-profit being used prudently and to advance the mission?”

Play by the rules: The IRS has rules and regulations that aim to prevent non-profit organizations from overpaying their executive staff. If the non-profit board knowingly overpays an executive a salary the organization can’t afford, the IRS sees that as “excess compensation.” Penalties range from hefty fines to an organization losing its tax-exempt status.

Keep detailed records: Hiring a chief executive is one of the most important decisions a non-profit board has to make, and it should be documented as such. Non-profit board members will be asked by donors, supporters, reporters and perhaps the IRS to explain their hire and justify their salary and benefits.

Guidestar recommends a three-step process to ensure the board complies with IRS regulations and board members remain unbiased:

  • The board should approve compensation before an offer to the candidate is made and to ensure no board member has a conflict of interest related to the transaction.
  • The board should research comparable positions before approving compensation.
  • The board should document the decision-making process throughout the process.

Guidestar’s recommendations follow the IRS “rebuttable presumption of reasonableness” rules. In other words: The board is doing its due diligence and covering its bases while it makes a strategic, well-thought-out decision on executive compensation.

 

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Michelle Hatch is a partner in our Non-Profit Services Group. She oversees audit and accounting engagements for non-profit organizations, including independent schools, trade associations, health and human service organizations and art, cultural and membership organizations. Michelle is also a member of the Employee Benefit Assurance Group and oversees audits for 401(k), 403(b) and defined benefit retirement plans.

 

The firm, with over 400 professionals and staff, offers a diversity of services, which includes auditing, accounting, tax, and business advisory services. In addition, BlumShapiro provides a variety of specialized consulting services, such as succession and estate planning, business technology services, employee benefit plan audits, litigation support, and valuation.  The firm serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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