What You Need to Know About Executive Compensation By Michael E. Batts

5 Best Practices for Nonprofit Executive Compensation

The approach a nonprofit organization takes to executive compensation setting is extremely important for a number of reasons. Two very significant reasons are tax compliance and public relations.

Under federal tax law, a leader of a nonprofit 501(c)(3) organization who is compensated excessively can be subjected to severe financial penalty taxes, as can organizational leaders who approve them.

Scrutiny can come from a variety of sources – from the traditional news, media, from bloggers, from ta authorities, or sometimes from an organization’s own constituents. The ability to provide solid, well-developed responses to scrutiny can often determine whether in the inquiring part will purse the matter further.

Preparedness for scrutiny should be a key element of a nonprofit board’s diligence in the area of executive compensation setting

Here are the five best practices for setting executive compensation:

(1) The compensation should be evaluated and established by the organization’s board of directors (or equivalent) or a committee authorized by the board.

The board or committee should be composed entirely of people who have no conflict of interest with respect to determining the CEO’s compensation. (e.g., no family members of the CEO, no subordinates of the CEO, no individuals whose compensation is determined by the CEO, etc.)

If such persons serve on the board and the board is the compensation setting body, they should be excused from the CEO compensation setting process.

(2) The board or committee should obtain valid comparability date reflecting what similar organizations pay similarly qualified people for performing similar duties.

Comparability data may come from surveys, from forms 990 of comparable organizations, or from other sources such as privately commissioned studies.

(3) The board or committee should contemporaneously document its decision about the CEO’s compensation.

This practice includes justification for approving pay above that suggested by the comparability data.

(4) The full board of directors (or equivalent) should generally be made aware of or should approve the CEO’s total package on an annual basis.

If a committee is utilized, the board should determine the extent to which the full board should be involved in the process.

(5) The organization should have a well-developed and clear communications plan for responding to inquiries about the compensation of it leadership.

Preparedness and diligence in executive compensation setting are well worth the effort – a fact becomes readily apparent when a reporter calls or the IRS announces that it plans to examine your organization.

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Michael E. Batts is the managing partner of Batts Morrison Wales & Lee Certified Public Accountants (BMWL). He has served on and chaired the boards of nonprofit organizations, both nationally and locally. Mike currently serves as the chairman of the board of ECFA. This post is an excerpt from his newest book release, Nonprofit Financial Oversight: The Concise and Complete Guide for Boards and Finance Committees (Accountability Press 2017).

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