Executive compensation at nonprofits is on the rise, according to a recent article by the Wall Street Journal. New data from the IRS shows that the number of seven-figure salaries at charities tripled between 2011 and 2014. The organizations that are paying their employees in the millions range from major hospitals and universities to small online ministries.
So why are salaries rising? Many charitable nonprofits struggle to bring in and retain executives who can help the organization navigate complex challenges. Offering more money may attract much needed talent to these organizations. Some experts say that compensation packages at nonprofits are beginning to mirror corporate CEO contracts. These packages can include bonuses and deferred-compensation arrangements.
When boards do their due diligence, such compensation often can be justified. However, there also are greedy nonprofit executives who abuse their authority to demand large compensation packages from their unsophisticated boards.
Whether these corporate-style compensation packages are offered to bring in the talent that a nonprofit needs or the result of greedy executives, high paydays can come with consequences to the organization if the rules governing “excess benefit transactions” (and the laws of some states) are not followed.
Paying compensation that is not “reasonable” is a type of an excess benefit transaction. Compensation is considered reasonable if it is the amount that would ordinarily be paid for like services by like organizations under like circumstances. In other words, the nonprofit organization must look at what similar executives at similar organizations of a similar size in a similar geographic area are being paid. If an executive is getting paid much more than executives in similar situations, that is red flag that can trigger an IRS audit of a potential excess benefit transaction.
The executive, as well as board members, face potential tax penalties if these rules are not followed. If the IRS audits a 501(c)(3) organization and determines that executive compensation amounts to an excess benefit transaction, the executive may be liable for excise tax penalties up to 225% [sic] of the excess benefit. A nonprofit’s board members face a penalty of up to 10% of the excess benefit. Some states, such as California, also impose penalties on participants in excess benefit transactions.
A board that becomes aware of an excess benefit has a duty to try to “correct” it. Correction takes place when the overpaid executive returns the excess benefit to the nonprofit and otherwise restores it to the same position it would be in had the excess benefit transaction not occurred. That means the high-paid executives may be a position where they must pay back any compensation that is not considered reasonable in addition to tax penalties.
To avoid these pitfalls, nonprofit organizations’ board members and high-paid executives should take care to review all aspects of their compensation agreements. This includes obtaining salary comparisons and careful consideration by the board before its votes to approve six- and seven-figure deals.
For more information, contact the Law Firm for Non-Profits.