The IRS’s reasonable compensation rule sometimes may seem like an obstacle to attracting and retaining qualified nonprofit executives. Although the rule is intended to prevent “private inurement” or “excess benefits,” it ultimately restricts what you can offer a candidate. Of course, some nonprofits simply don’t have the means — or their donors object to using nonprofit funds for higher compensation. Either way, recruiting executives, particularly from the for-profit world, can be challenging for boards.
But creative compensation packages can help. If you’re having trouble finding and keeping effective leaders, consider offering more than just a salary.
Apples to apples
According to Charity Navigator’s 2016 Charity CEO Compensation Study, the median compensation for a nonprofit CEO is $123,362. But compensation varies widely, depending on the type, size and location of the organization — with research and educational nonprofits in the Northeast generally paying executives much higher compensation than the median.
This last point is important, because the IRS expects nonprofits to base their own compensation models on those of comparable peers. A small social-services charity, for example, should refer to compensation offered by other small social-services organizations (and possibly for-profit businesses) in the local area, not private universities on the West Coast. Documentation is critical. Your board needs to keep records of the comparable data it relies on, and then report on your annual Form 990 the compensation decision process and the amounts and forms of compensation awarded.
Non-salary benefits generally count toward total compensation numbers reported to the IRS. But perks related to retirement may be regarded more favorably by regulators and stakeholders than mere salary.
For example, you might consider offering your executives a 457(b) plan. These plans help make up for the fact that the level of benefits offered by 403(b) and other common nonprofit retirement plans are restricted for higher-paid employees. In general, 457(b) plans allow executives to defer taxes until retirement on plan contributions of up to $18,000 or 100% of income annually, whichever is less.
You might also offer a supplemental executive retirement plan (SERP). These aren’t deferred compensation plans but act as a type of pension account funded by employers. SERPs are considered “ineligible,” meaning that contributions don’t vest immediately to the executive and, like pensions, funds are at risk of forfeiture before retirement.
Nonprofits are obliged to use surplus revenue to forward their mission rather than distribute profit or dividends to employees. But paying bonuses or incentives to executives generally is acceptable as long as:
- It furthers your organization’s goals and exempt purpose,
- It’s based on meeting measurable performance goals,
- Payment doesn’t reduce services to constituents, and
- The total compensation package still qualifies as “reasonable” according to IRS rules.
If you offer bonuses, keep in mind that the amount can be based on gross profits or other goals attained. But to discourage nonprofits from cutting services to pay bonuses, the IRS prohibits bonuses based on net earnings or profits.
Depending on the executive, other perks may actually have more value than the usual salary and benefits. For example, if a new executive must move to accept the job with your organization, consider covering relocation expenses.
Some candidates may have student loan debt that you can help to repay. Or you might offer to cover the costs of attending school part-time for an advanced degree related to your nonprofit’s mission. And don’t forget about work-life balance. Many executives will accept less pay for a shorter full-time workweek (such as 35 instead of 40 hours) or the opportunity to telecommute or work on a flexible schedule.
Understand what you’re offering
Before you offer an executive deferred compensation, a bonus plan or fringe benefits, make sure you understand potential tax and compliance issues associated with them. Our firm can help ensure that your proposed compensation package is reasonable and that you’ve correctly reported the details to the IRS.
To learn more about how our firm can help you craft an executive compensation package, please contact me at (302) 254-8240.