Nonprofit 411: Best Practices for Developing Compensation for Non-Profit Organizations

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By Michelle Y. Hatch, CPA, Principal at BlumShapiro

Non-profit compensation can often be a challenge for many organizations who want to recruit top leadership talent. They want the best and brightest to lead their organization, but they also must stay within reasonable compensation ranges to avoid scrutiny and misuse of donor’s dollars. That is why the IRS asks questions on how compensation is set on their annual form 990.  An organization’s form 990 can be accessed by the public, and includes questions on how compensation is determined and discloses compensation for the organization’s highest paid employees.  Therefore, it’s critical that non-profit boards and executive committees understand the steps to take to determine fair and reasonable executive compensation.

Per the IRS standards, if an organization follows the following three steps to determine compensation, then it is assumed to be reasonable:

  1. The compensation arrangement is approved in advance by an authorized body of the organization, which is composed of individuals who do not have a conflict of interest concerning the transaction.  This is typically done through the executive or compensation committee of the board.
  2. Prior to making its determination, the authorized body obtained and relied upon appropriate data as to comparability.  Comparability data typically can be obtained through a compensation study in addition to looking at compensation for similar organizations in and the same geographic area.
  3. The authorized body adequately and timely documented the basis for its determination concurrently with making that determination.  This is typically done through minutes of the meeting.

The documentation should include the following:

  • Terms of the transaction and the date of its approval
  • The members of the authorized body present during the debate and vote on the transaction
  • The comparability data obtained and relied upon
  • The actions of any members of the authorized body having a conflict of interest
  • The documentation of the basis for the determination

By following the above guidelines, organizations are able to shift the burden of proof to the IRS to show that compensation is not reasonable.

Based upon the above guidelines and the focus on executive compensation by the government and public in general, if your organization is not following this process when setting executive compensation, then you should work with your board to implement these practices in the near future. As a board member you should be reviewing your organization’s form 990 and the related disclosure on compensation to ensure you are property responding to these questions.  As management, you can work with your board to implement these policies and can use the form 990 as a starting point for this discussion and review each year.

Michelle Y. Hatch, CPA, is a principal with BlumShapiro, the largest regional accounting, tax and business consulting firm based in New England, with offices in Massachusetts, Rhode Island and Connecticut. The firm serves as business advisors for today’s leading companies, non-profit organizations and government entities, working to strategically tailor and consistently deliver tested solutions for unlocking an organization’s full potential. For more information about BlumShapiro, visit blumshapiro.com. 

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