Examining Executive Compensation in Nonprofits

Issues of executive compensation and governance are closely intertwined thanks to the influence of the Sarbanes-Oxley Act (SOX). The IRS is always concerned as to whether governing boards of nonprofit organizations exercise a sufficient degree of due diligence in setting the compensation for leaders of their organizations. The media seems to delight in reporting on executives of both private foundations and public charities who are receiving what many consider to be unreasonably large compensation packages.

When talking compensation, the IRS believes that exempt organizations should focus on five key governance areas:

• Creating legal structures: Every board should strive to set compensation in advance by disinterested board members on the basis of appropriate comparability data.

• Reporting all the benefits: This means timely reporting of all economic benefits to officers, directors, and key employees on IRS Form 990.

• Being timely: Organizations should take care to report the benefits in the time period that they're paid.

• Staying accountable: Boards that delegate compensation issues to committees still have the ultimate responsibility over the compensation decision.

• Avoiding payments to private individuals: The Internal Revenue Code says that the assets of an organization can't be diverted for the benefit of private individuals. If an organization pays or distributes assets to insiders in excess of the fair market value of the services rendered, it's running afoul of this rule, and the organization can lose its tax-exempt status.

Exempt organizations are generally safe if they develop and follow procedures for setting compensation and if they make honest, responsible efforts in line with their size and revenues to determine what the appropriate level of compensation is.

Neither a public charity nor a private foundation can pay more than reasonable compensation without running afoul of IRS issues. And reasonable compensation is determined by weighing all facts and circumstances, considering the market value of the services performed. Generally, reasonable compensation is measured with reference to the amount that would ordinarily be paid for comparable services by comparable enterprises under comparable circumstances.

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