Executive Compensation Practices

While excessive corporate salaries have been generating headlines recently, not-for-profit salaries were in the spotlight not all that long ago. The negative publicity was a blow that, for a time, undermined the public’s trust.

Since then, transparency and accountability have become top priorities for the not-for-profit sector, and best governance practices have been developed.

The IRS’s Role
The IRS has a role in monitoring executive compensation. Although not-for-profit governance is not regulated directly by the IRS, if an executive receives compensation that the IRS deems to be excessive, costly penalties may be assessed. IRS regulations spell out steps that public charities can take to avoid paying compensation that is considered an “excess benefit transaction.”

A compensation arrangement should be approved in advance by the board of directors or other governing body composed entirely of individuals who do not have a conflict of interest.
The board should base compensation on data from similar organizations and must adequately document its process for determining compensation.

Oversight Committee or Board
Your compensation practices say a lot to the public about your commitment to your charitable mission. In smaller organizations, compensation is generally set by the board of directors. Large notfor-profits may create a separate compensation committee. In either case, it is imperative to avoid conflict of interest.

When establishing a separate compensation committee, members should be chosen carefully. Select board members who are practiced in goal setting and familiar with the metrics used to gauge performance.

Throughout the year, the board and committee should meet in executive session to discuss compensation issues. Individuals charged with overseeing compensation should have access to whatever resources they need to ensure that they understand the legal requirements and relevant issues.

Compensation Philosophy
A compensation “philosophy” outlines how an organization, in keeping with its charitable mission, uses all forms of compensation (salary, benefits, and perquisites) to attract, retain, and motivate highly qualified employees. If your organization does not have a compensation philosophy, establishing one will provide a solid basis for making current and future compensation decisions. Develop a set of guidelines and policies to implement your philosophy. Be sure to document this process.

Total Package
In addition to setting the salaries of the CEO and other executives, the compensation committee or board is responsible for overseeing all benefit arrangements (including qualified and nonqualified retirement plans and severance, if provided) and perks that executives receive. These less transparent types of compensation should be carefully reviewed to ensure that they are compatible with your compensation philosophy and charitable mission, and that each executive’s total compensation package is reasonable.

Reimbursement of executive business expenses can be a gray area. In the eyes of the IRS, certain reimbursements may be considered compensation in disguise. To avoid problems, establish clear, enforceable guidelines. Have your auditor report directly to the board regarding this issue.

Compensation Comps
Compensation benchmark data is available in many forms. IRS regulations state that small organizations with annual gross receipts of under $1 million may rely on data of compensation paid by three comparable organizations in the same or similar communities for similar services. Larger organizations often use surveys or consultants.

Document, Document, Document
The board should carefully and thoroughly document the basis for compensation decisions. When a transaction is approved, the documentation should include the terms of the transaction and the approval date, the members who were present when the transaction was debated and the members who cast a vote, and the comparability data that were used in the decision and how the data were obtained. Also document the actions taken with respect to consideration of the transaction by anyone who is otherwise a member of the board or committee but had a conflict of interest.

Meeting Expectations
The public expects charities to uphold high standards in return for the support the organizations receive. The expectations for executive compensation can be stated quite simply: that it be set according to a fair and transparent process and that amounts be reasonable.