When Is Executive Compensation Too Much?

Nonprofit organizations have to attract quality employees just like other businesses. This is often hard to do with just a compelling mission. Attracting the best requires offering attractive salaries and benefit plans. But when is it too much?

Congress holds that a salary package must be “reasonable.” Compensation is presumed to be reasonable if the arrangement is (1) pre-approved by an authorized body whose members do not have any financial interest in the compensation arrangement, (2) appropriate data for comparability is used, and (3) the basis for the determination is well documented.

If the salary is deemed to be beyond what’s reasonable, the IRS may assess penalty excise taxes against the recipient of the salary and the board members and can revoke a nonprofit organization’s tax-exempt status. The IRS takes these matters so seriously that it is a focus of every audit it conducts of 501(c)(3) organizations.

Even with threat of penalty, questionable executive compensations show up in the news regularly. Recently, the Charlotte Observer reported that David Cerullo, the chief executive of Inspiration Networks, a nonprofit Christian broadcaster, is paid nearly $2.5 million in total compensation (the organization’s total budget is more than $95 million). The organization argues that Cerullo’s pay is determined by a largely independent committee that selects the salary by studying executive compensation at similar organizations. But many argue that the study inappropriately includes for-profit businesses and that similar organizations with larger budgets compensate their chief executives far less.

The IRS hasn’t ruled on the reasonableness of this salary yet, but we expect an investigation will be prompted by the publicity the organization has received. In the meantime, make sure your nonprofit is taking the steps necessary to ensure that all salaries will meet the presumption of reasonableness.