VIDEO | Ensuring Reasonable Executive Compensation
By The C3 Team
Approach executive compensation with confidence.
We’ve outlined three key steps to help guide your organization.
Thoughtful stewardship of nonprofit resources is a core board responsibility, and establishing reasonable executive compensation is at the core of doing so.
In our latest video, C3’s Nanci Hibschman discusses how to establish the rebuttable presumption of reasonableness and outlines a clear process nonprofits can follow to protect their organization and ensure executive pay remains compliant, competitive, and reasonable.
VIDEO TRANSCRIPT
Hi, I’m Nanci Hibschman, President and Managing Director with C3 Nonprofit Consulting Group. C3 exists to partner with the world’s most impactful organizations to navigate people and culture solutions. Our vision: a society in which nonprofit employment is synonymous with meaningful work, thriving culture, and competitive, fair, and sustainable pay.
As nonprofit board members, you have a fiduciary duty to ensure your organization’s resources are used properly. A key aspect of this duty involves setting reasonable executive compensation. When compensation is excessive, your organization risks penalties under Section 4958 of the Internal Revenue Code, which addresses excess benefit transactions, or if you’re a board member of a private foundation under Section 4941, which addresses self-dealing rules.
Section 4958 established intermediate sanctions – significant excise taxes that can be imposed on executives who receive excessive compensation and on board members who approve it. These penalties can reach up to 200% of the excess benefit amount for the executive, and up to 10% for board members who knowingly approved excessive compensation.
Fortunately, the IRS provides a safe harbor known as the rebuttable presumption of reasonableness. When you follow three steps as outlined under the safe harbor, the burden shifts to the IRS to prove compensation is unreasonable. Private foundations, while not able to benefit from the safe harbor given different regulations govern them, will still benefit from following these steps. They are:
First, compensation decisions must be made by an independent board or committee thereof with no conflicts of interest regarding the compensation arrangement.
Second, you must rely on appropriate comparability data before approving compensation –and this typically involves the use of compensation surveys compiled by independent firms and/or provision of an independent study performed by a qualified third party. And valuation of total compensation, not just salary, but all forms of current and deferred cash compensation, as well as the value of all benefits.
Third, you must thoroughly document your decision-making process contemporaneously, meaning at the time the decision is made. Your documentation should include the terms of the compensation package, the date of approval, board members present and their votes, comparability data relied upon and how it was obtained, and actions taken by members with potential conflicts of interest.
This documentation is ideally completed within 60 days of the decision and approved at the next committee or board meeting. As a best practice, C3 recommends establishing a regular review cycle for executive compensation and maintaining careful records – demonstrating your diligence and following these procedures.
Remember, reasonable compensation doesn’t mean low or less competitive compensation. It means any compensation that falls within the range of what similar organizations are paying for similar services under similar circumstances.
By following these procedures, you protect both your executives and yourselves from penalties while ensuring your organization engages in appropriate stewardship of its resources.
