Broker Check

Confused about non-profit executive compensation? You’re not alone.

June 02, 2021

Evaluating Your Executive Compensation

Ideally, your mission is the main reason top-tier talent are drawn to your non-profit organization. But when it comes to recruiting and retaining high-performing executives, non-profits find themselves competing with the private sector and their lucrative salaries. That’s where executive compensation — salary plus benefits — comes into play.

Unlike the private sector, however, non-profit organizations must walk a fine line between attracting executives with generous compensation, without attracting the ire of your donors, volunteers, or the IRS. So just what amount should you be paying your executives — and how much is too much? For non-profit organizations, that question comes with a tangle of complications.

Is Your Compensation Reasonable?

The amount of compensation awarded to non-profit executives is publicly available and listed on the Form 990 that every non-profit organization is required to file with the IRS. Reward your executives too much, and you could be looking at a public relations fiasco — not to mention serious backlash from your donors and volunteers.

It’s not just the public who may have issue with the amount you pay your executives; the IRS also scrutinizes the executive compensations of non-profits. If the IRS finds that you’ve overpaid an executive, substantial fines can be levied on those involved. In worse-case scenarios, the offending organization may even be stripped of its non-profit status. And that’s definitely not an effective recruitment or retention strategy.

The IRS wants to make sure you’re compensating your executives a reasonable amount. The burden of proving the reasonableness of your executive compensation rests entirely with you. To meet that burden, non-profit organizations are required to include a description of their process for approving reasonable yet appropriate compensation amounts on their Form 990.

Typically, the IRS recommends following these three steps when detailing your executive compensation process:

  1. Set up an independent body or compensation committee to review the amounts, and ensure there’s no conflict of interest among that committee.
  2. Compare the salary and benefits data of other similar non-profit organizations.
  3. Document who’s involved in the compensation review, and how the review was conducted.

For non-profits with limited time and resources, meeting these requirements can be complicated, confusing and a serious drain. For this reason, many organizations choose to hire compensation experts to help them develop, implement and document their compensation review process.


The 411 on 457(f) Plans

Your obligations don’t end with a compensation review. When determining your executive compensation, you’ll also need to consider the benefits package— including retirement plan — you’re offering. While private companies use 401(k) retirement plans, many non-profit organizations offer their executives 403(b) plans that allow for modest retirement benefits from an executive view point. Supplemental plans may be necessary if an executive is able to replace a reasonable percentage of his or her salary upon retirement.

Complications arise here as well. Organizations in the public sector have a choice between a 457(b) “eligible” plan and a 457(f) “ineligible” plan. Mostly offered to government employees, 457(b) plans limit the amount of compensation that can be deferred each year; deferred compensation is taxed when it’s paid or made available to the beneficiary, resulting in an increased tax burden.

For this reason, many non-profit organizations offer their executives 457(f) plans. Commonly known as “golden handcuffs,” 457(f) plans are contingent on how long and well an executive serves in his or her leadership role. 457(f) plans are attractive to executives because they allow compensation to be deferred from taxation. What’s more, executives are not limited in the amount of compensation that may be deferred each year.

There is, however, a catch: If the executive fails to meet service duration or performance requirements, his or her compensation is at risk of forfeiture. Because of this, 457(f) plans are also a powerful retention tool — hence the golden handcuffs. Once the compensation becomes vested and is no longer at risk of being forfeited, it becomes taxable gross income.

Attractive as a 457(f) may be to both executives and the non-profit organizations looking to recruit them, these plans do come with added complexity and potential pitfalls. Adding to the confusion, the IRS has recently issued new guidelines under Code Section 409A affecting deferred compensation plans. For this reason, many non-profit organizations turn to outside experts for guidance on navigating unfamiliar 457 territory.

Executive Compensation without the Complexity

Form 990s, 457(f) ineligible plans, deferred compensation, risk of forfeiture — it may all sound like a foreign language to you. At StoneKimbro, it’s a language we speak fluently. For more than 40 years, we’ve been advising non-profit organizations on a range of financial matters, including retirement planning and executive compensation.

Staying ahead of the latest IRS guidelines, we’ve developed an approach to help ensure you have the right review process in place to appease the IRS. We’ll also help you avoid the pitfalls of 457(f) plans so you can attract and retain top-tier talent who are as dedicated to your mission as you are. If you’re ready to improve or review your executive compensation process, we’re ready to offer our professional guidance to help you make informed choices. Contact us today.