January 7, 2020
Many nonprofit directors serve on boards for altruistic reasons. But it can be a huge commitment and the issue of compensation often comes up.
Compensating nonprofit board members is rare. One survey suggested that just 2% of organizations pay their directors. Another study found that 96% of nonprofit boards are voluntary. Survey results and anecdotal experience indicate that compensating directors is more common among private foundations, professional and trade associations and educational and cultural institutions.
Note: This article deals only with domestic organizations. The situation in foreign countries may be different.
Reasons to Compensate
Advocates of compensation argue that it isn’t enough to rely on an individual’s well-meaning charitable inclinations. The work is arduous, they note, and participants should be rewarded, albeit on a relatively modest level. This can be important in attracting prominent professionals who posses the wherewithal and experience a nonprofit desires. Moreover:
- Directors are often busy people with distinguished careers being asked to devote precious time to an organization,
- Some may expect to be compensated for that time, and
- Compensation becomes even more important as groups expand and try to remain competitive.
Importantly, compensating directors establishes a contractual obligation that can be enforced and can help reduce any temptation to redirect funds for their own personal purposes.
Some observers say compensation leads to greater diversity among board members. Certainly, younger people who aren’t as wealthy as many older board members might be willing to commit time if they’re paid.
And, of course, it makes sense to pay directors for the risks they take, ranging from public criticism to lawsuits that could include personal exposure.
Reasons against Compensation
On the flip side, those arguing against compensation for board members feel that serving should be a true expression of dedication on behalf of the cause. It enables participants to exhibit philanthropy and put personal interests aside. Some consider it a badge of honor.
Critics say that compensating board members may smack of hypocrisy and a double standard. They question why directors would need financial rewards if they’re trying to do good for others.
Paying directors also calls into question how a nonprofit uses its funds. Arguably, any money being used to pay board members could be better spent elsewhere. Others question how much effect compensation really has on attracting and retaining top candidates. Individuals who truly believe in a charity’s mission should be willing to serve without financial benefit, they suggest. On top of this, there doesn’t appear to be any concrete evidence that compensated boards are any more effective than voluntary ones.
How Much to Pay?
So, assuming your group decides compensation is a good idea, the question becomes: how much? Two issues stand out here:
- You’ll want to provide reasonable compensation based on the commitment required, and
- The IRS may challenge amounts it considers unreasonable.
The tax agency is charged with enforcing the Federal Private Inurement Prohibition, which strictly forbids a tax-exempt organization’s board members, trustees, officers, or key employees from receiving unreasonable benefits from the group’s income or assets. Excessive compensation paid to nonprofit directors is the most common violation of this prohibition and it can cause the IRS to levy hefty penalties on the persons involved.
To maintain public trust and mitigate risk, tax-exempt organizations must be aware of the regulations governing compensation, ensure that their practices follow these rules, document their compliance with them, and be prepared to explain to the IRS and the public why the salaries and benefits they offer their leaders are appropriate.
The IRS states that payments are presumed to be reasonable if an organization meets the following three requirements:
- The compensation arrangement must be approved in advance by an independent body of the organization composed of individuals who don’t have a conflict of interest concerning the transaction.
- That body should review comparable salary and benefits data, such as data available from salary and benefit surveys, to learn what nonprofit employers with similar missions, and of a similar budget size in the same, or a similar geographic region, pay their leaders.
- The body conducting the review should document who was involved and their independence (they aren’t compensated by the nonprofit). The documentation should demonstrate that the board took the comparable data into consideration when it approved the compensation.
In addition, consider the following steps:
- Document the type of work to be performed and the necessary qualifications. Be as detailed as possible. For instance, documentation might include the number of annual meetings to attend, hours spend on charitable endeavors monthly, the nature and complexity of those tasks and the experience required to perform them.
- Remind directors of their fiduciary duties. Regardless of the amount they’re paid, they must always act in the best interests of your organization.
- Double-check the compensation amount to ensure it’s within professional standards. Keep in mind that the information will become available to the public, which could affect your group’s reputation, not to mention IRS penalties.
- Write down the details. Everything should be reflected in the board minutes, including the final compensation amounts, a summary of the discussions, the actual vote, the factors used to determine salary and the date compensation was approved. This will help board members review the details in the future.
In summary: There’s no definitive right or wrong answer to the issue of compensation of directors of nonprofit organizations. Each organization must do its own due diligence and determine whether board members should be compensated. Take as much time as you need.