Your nonprofit’s executives, such as your executive director and CEO, have the vital roles of steering your nonprofit’s direction, reporting to your board, and ensuring your organization fulfills its mission. To retain and attract high-quality talent for these top positions, nonprofits need to offer adequate compensation.
However, executive compensation for nonprofits is often more complex than it is for for-profit companies. While publicly traded companies have stock options to leverage as a potential incentive and privately owned businesses are free to offer whatever executive compensation packages they desire, nonprofits must adhere to specific rules and processes set by the IRS.
In this guide, we’ll explain how to set executive compensation for nonprofits, including what laws to be aware of, how to track this expense, and how to create compensation packages that attract top candidates.
Understand relevant laws.
For U.S.-based nonprofits, the IRS has numerous regulations in place for nonprofit executives to ensure that nonprofits fulfill their missions and operate in good faith. However, to account for nonprofits of all sizes and financial situations, the IRS also often uses general language to describe executive compensation.
If your nonprofit has questions about these regulations, review the instructions for the Form 990—where your nonprofit will need to report its executive compensation rates and processes—or work with a nonprofit consultant who can guide you through the legalities.
Fortunately, the IRS does lay out a few rules for how nonprofits should set executive compensation:
- Executive compensation must be approved by an “authorized body of the applicable tax-exempt organization” that does not have a conflict of interest with the proposed offer.
- The authorized body must review and base its compensation decision on appropriate, comparable data.
- The authorized body must document its decision-making process.
Essentially, this means that nonprofits must conduct benchmarking to ensure their executive compensation offers are within a reasonable range, have the board vote to approve the compensation offering, and document why compensation decisions were made.
Conduct benchmarking.
The IRS states that compensation for nonprofit executives should be “reasonable,” which it defines as: “the value that would ordinarily be paid for like services by like enterprises under like circumstances.”
In other words, your organization will need to conduct benchmarking and market analysis to determine how similar nonprofits are handling executive compensation. To gather accurate, relevant data, ProspectHR’s guide to nonprofit consulting firms recommends partnering with an HR consultant who specializes in nonprofits.
These consultants can help your nonprofit by:
- Providing access to accurate, timely compensation data
- Determining which nonprofits are comparable to yours in terms of size, industry, location, and role responsibilities
- Adhering to other legislation, such as privacy and antitrust laws
While your nonprofit can attempt to conduct executive compensation benchmarking without the help of a consultant, free databases may contain outdated, irrelevant, or even inaccurate information. Basing your offers on bad data can lead potential candidates to reject your offers if they are notably too low, or draw scrutiny from the IRS if they are excessively high.
Get board approval.
Once you have outlined your executive compensation plan, it’s time to present it to your board. YPTC’s guide to nonprofit governance explains that executive compensation, hiring, and evaluation are part of a board’s fiduciary oversight, and that professional boards should be asking questions about financial implications and accountability.
When discussing executive compensation, your board should have benchmarking data on hand to comply with the IRS’s guidelines. Additionally, this data allows your board to make strategic compensation decisions about how to adjust compensation rates to compete with similar organizations. For example, if you know your nonprofit will be asking more from an executive director than the typical nonprofit, you might offer greater compensation. Or, if your nonprofit is on a tight budget, you may purposefully offer a lower rate but make up for it with other benefits.
These board conversations should be conducted on an annual basis ahead of your Form 990 filing. Ensure they are productive by considering all facets of your nonprofit’s employment and compensation strategy to strike a balance between staying on budget and retaining top executives.
Document your process.
Maintain records throughout the entire executive compensation process. Doing so not only ensures your nonprofit adheres to IRS requirements but also provides guidance for future compensation conversations.
A few ways to stay organized when documenting executive compensation include:
- Recording data use. For benchmarking data, record not just what data you use but where it came from and how your nonprofit used it. This will help your nonprofit pull future reports, reassess its compensation strategy, and identify changes in data.
- Creating a calendar. As your executive compensation amounts and decision-making process must be recorded in your Form 990, ensure you plan all relevant compensation conversations well in advance of the filing deadline. For example, if you know that benchmarking and compensation negotiations typically take three months and your Form 990 filing deadline is May 15th, you might start the process in January to provide yourself plenty of time to complete the process.
- Working with a consultant. A compensation consultant can help you create detailed documentation that explains your compensation, benchmarking, and decision-making processes. If your nonprofit is struggling to solidify its processes, consider working with a consultant who can provide a formal structure.
Along with helping your nonprofit stay organized, documentation ensures your nonprofit maintains transparency regarding executive compensation. If there are any questions about why compensation decisions were made, thorough documentation can prove your nonprofit was operating in good faith and making sound decisions to the best of its ability.
Setting competitive nonprofit executive compensation packages that attract top talent and abide by legal regulations. To guide your nonprofit throughout this process, consider working with an HR and compensation consultant who specializes in nonprofits. These professionals can help you navigate IRS guidelines and aid your executive search and recruitment efforts.