Determining Reasonable Compensation for a Nonprofit Job
The IRS guidelines for organizations in PennsylvaniaBy Doug Mentes, Esq. | Last updated on January 11, 2023
Use these links to jump to different sections:
- What Is Reasonable Compensation?
- How Can a Nonprofit Be Sure Compensation Is Reasonable?
- Some Caution Needed for Awarding Fringe Benefits
What Is Reasonable Compensation?“There is no real definition,” says Fleming. “It’s a facts and circumstances test. But essentially, it comes down to what a similar organization in a similar situation would pay for the same types of services.” Fleming provides an example of a nonprofit hospital looking for a new CEO. “To determine what is reasonable [for the CEO], we can look at other hospitals, not just necessarily nonprofits—we can look at for-profit entities to determine what might be reasonable under the circumstances,” Fleming says. “If another organization is out there providing the exact same types of services that we hope to provide—providing those services in a similar community and where all other background is similar—we can then use that for-profit as a comparable to show that’s one of the ways we are arriving at this reasonable compensation.”
How Can a Nonprofit Be Sure Compensation Is Reasonable?The IRS provides a three-step process to gain a presumption of reasonableness for the compensation arrangements they offer. “The burden is on nonprofit to prove to the IRS that what they’ve paid is reasonable,” Fleming says. “If they follow this procedure, called the rebuttable presumption, then they are presumed to be paying reasonable compensation.” The process protects nonprofits, and public charities as a whole, from excessive compensation practices. The three steps to demonstrate compensation is reasonable are:
- Obtain and use comparable compensation data from other organizations that are similarly-situated prior to the determination
- An independent body of the board of directors must review that data—meaning persons with a conflict of interest must not take part
- Document the review process and comparable data in board minutes once the decision is made
Some Caution Needed for Awarding Fringe Benefits“The idea is that just because someone is working for a nonprofit, they shouldn’t have to take a lesser salary,” Fleming says. “They should be entitled to the same compensation they would get at a similarly situated for-profit entity—so retirement benefits, deferred compensation, and other benefits.” The caveat with benefits is that a nonprofit generally cannot distribute dividends as a part of its compensation package because of the IRS restriction on revenue inuring to the benefit of shareholders and private individuals. To steer clear of excessive compensation, whether through pay or benefits, a nonprofit should engage an experienced Pennsylvania nonprofit attorney to assist it in determining and drafting proper compensation packages for higher-level employees. For more information on this area, see our overview of closely held business.
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