Executive Compensation

Best Practices for Setting Executive Salary and Benefits

By ANAFP Member Deepak Butani, CPA, LLM

It is the responsibility of the Board of Directors to set the compensation and benefits package of the CEO/Executive Director. The key focus should be that the compensation be reasonable and not excessive. There must be comparison compensation and benefits data from other peer organizations of similar budget sizes and sectors. Conducting such a peer review and documenting the process creates a rebuttable presumption that compensation is reasonable and not excessive. Nonprofits filing the IRS Form 990 must describe the process they use to approve the Executive Director compensation as part of the nonprofit’s responses on the 990, Part VI, Section B, line 15.

Boards that engage in and document an annual performance review of the CEO/Executive Director will protect the not for profit from possible IRS review. Comparable compensation and benefits data of peer not for profits can be found on GuideStar and Candid websites. The IRS has recommended that not for profits follow the below review process to establish a rebuttable assumption about reasonableness of CEO/Executive Director compensation (See Treas Reg. § 53.4958-6(a)):

-An independent consultant or an independent compensation committee should investigate and rely upon comparable salary and benefits data of other similar not for profits having similar budget sizes and sector in the same geographical area.

-An independent body should document is involved in the process and the basis and reasonableness of the decision on the CEO/Executive Director compensation and benefits. No member of this independent body should have any conflict of interest. This process needs to be explained on Schedule O of Form 990

The documentation should include the terms of the transaction, date of its approval and proof of comparable peer review data. Other concurrent documentation includes a description of the compensation and benefits, a listing of the members of the independent board of directors who were present and voted at the meeting including, any conflicts of interest and dissents and the final approval of the compensation and benefits. If the board has hired a new CEO/ Executive Director, the written job offers and job description should be kept on file in addition to any records of telephone calls about inquiry into compensation and benefits at other not for profits. The IRS may refute the presumption of reasonableness if sufficient contrary evidence exists to rebut the probative value based on a facts and circumstances standard. Failure to satisfy the requirement could result in intermediate sanctions.

Many not-for-profit do not have a regular practice of evaluating the performance of the CEO/ Executive Director. It is always a good idea that the Board prepare and document an annual performance appraisal that highlights achievements, challenges, areas of improvements and growth. Preparing and documenting an annual performance review will demonstrate the independence of the Board of Directors.