Nonprofit organizations face increasing pressure from a number of directions with respect to compensating their executives. The interplay between federal and state tax law, state corporation law and federal securities law forces nonprofit organizations to focus on two main issues: Who is responsible for setting the compensation and how is that done, and the fairness of the compensation that is ultimately determined. Major factors in the first issue include whether the body establishing the compensation level is “free of conflicts of interest” under tax law and “disinterested” under corporation law, and the independence of the advisors and resources upon which they may rely. Another major factor is considering what other, similarly situated organizations are paying their executives and documenting that consideration in minutes or other writings.
If a nonprofit organization fails to take these factors into consideration, the repercussions may be severe: a 25 percent tax on the executive based on the amount of compensation that is considered excessive (which may be increased to 200 percent if not corrected); a 10 percent tax on the person approving the excessive compensation based on the amount of the compensation that is considered excessive; and possible loss of tax-exempt status by the organization.