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Compensation Rules for Charities

September 2010

Did you know that nearly 52 percent—170,568, to be exact (according to the July 29, 2010, IRS master file of exempt organizations)—of charities that file Form 990 and 990-EZ have fiscal years that end in December? Which means it’s budget time for these organizations.

And did you know that nearly 31 percent—101,248, to be exact—of these charities have incomes of $100,000 or more? They are the organizations most likely to have paid staff. And setting compensation is an important part of the budget process. Which means it's a good time to review the rules related to compensation for executives who lead tax-exempt organizations.

Five Basic Concepts

  • Exempt organizations can pay their executives market rate.
  • "Market rate" is determined by researching what someone in a similar position would earn at an organization that is of the same size and has a similar mission or field of activity.
  • Exempt organizations can look at for-profit compensation when determining market rate, as long as the job, organization size, and organization mission/purpose are comparable.
  • The IRS has no standard formula, such as percentage of total revenues or expenses, for determining compensation.
  • If the IRS finds that an executive at an exempt organization has been overpaid, it can fine both the executive and the board members who approved the overpayment, or even revoke the organization's tax-exempt status if the board has not (1) based its decision on appropriate research and (2) documented its decision-making process at the time it approved the compensation.

That last one is the kicker, especially when you consider that the IRS is looking more closely at nonprofit compensation every day. Which means that, if your organization pays its top staff, it's time to get:

The Nitty-Gritty Details

Download our free resource on nonprofit compensation, "The Private Inurement Prohibition, Excess Compensation, Intermediate Sanctions, and the IRS's Rebuttable Presumption: A Basic Primer for 501(c)(3) Public Charities." This report:

  • Defines private inurement and the situations that fall into this category.
  • Examines excess compensation, the most common form of private inurement.
  • Describes how a charity can ensure that the compensation it pays its executives is "fair and reasonable."
  • Outlines the financial consequences ("intermediate sanctions") that can result from private inurement.
  • Identifies the persons on whom the penalties can be levied.
  • Explains how a charity can establish a "rebuttable presumption" that will demonstrate to the IRS that the organization followed appropriate steps in setting compensation for its executives.

The report was written by Karl E. Emerson, an attorney with Montgomery, McCracken, Walker & Rhoads, LLP in Philadelphia, a nationally recognized speaker on nonprofit compliance issues, and the past director of the Pennsylvania Bureau of Charitable Organizations.

Download the report

Suzanne E. Coffman, September 2010
© 2010, GuideStar USA, Inc.

Suzanne Coffman is GuideStar's editorial director and editor of the GuideStar Newsletter.