How To Draft Your Nonprofit Compensation Policy
For many new nonprofits, one question looms large. That question is, "How do nonprofits pay their employees?"
To answer this question, most nonprofits draft and set in place a compensation policy, especially for their executive employees. A nonprofit compensation policy can go a long way in providing the structure and reasoning behind payroll figures, both current and future. It can also ensure that the organization stays within the IRS’ operating limits.
Drafting your own nonprofit compensation policy can seem like an immense task. Depending on your experience, you may not know where to start. If that is the case, you have come to the right place. This article discusses:
- What Is a Nonprofit Compensation Policy?
- Nonprofit Compensation Requirements
- How To Structure Your Nonprofit Compensation Policy
- Nonprofit Compensation Policy Samples
- What About Other Employees?
- Final Thoughts
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What Is a Nonprofit Compensation Policy?
A nonprofit compensation policy outlines the process by which salaries and benefits are determined for executive staff members. Unlike with a for-profit company, the way that a nonprofit organization pays its executive employees must meet certain requirements and restrictions. Specifically, the IRS says that nonprofit executive salaries must be "reasonable" and "not excessive." Otherwise, it looks like the nonprofit is serving its employees and not its cause.
Most often, the board of directors drafts and agrees upon the compensation policy. Keeping the executive removed from this process ensures impartiality. It also looks fair in the eyes of the public.
Pro Tip: How much do nonprofit employees make? Maybe you want to know the answer to this question before you commit to a nonprofit role. You can usually find nonprofit employee salaries within public tax records. However, if your position is not among the highest-paying positions, you may have to get creative. For example, you can look at what nonprofit employees report to Glassdoor.
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Nonprofit Compensation Requirements
Being tax-exempt means nonprofits must abide by the IRS’ compensation regulations. These requirements act as overarching guidelines, giving nonprofits parameters to use as a starting point when they are drafting their compensation policies.
Sadie is wondering what the IRS' regulations are.
As we mentioned previously, the IRS uses "reasonable" and "not excessive" to describe executive salaries. This wording creates an intentional gray area, as it does not specify what is "reasonable" and what is "excessive." This allows nonprofits to determine their own compensation rates. Yet, it does place a burden on nonprofits to justify the amounts that they pay their executive employees.
The term "compensation" encompasses more than just a salary. For example, within the salary for a program manager, a nonprofit may also include an annual bonus. Bonuses, paid leave, health insurance, continuing education, and other benefits all make up a compensation package.
The IRS requires you to submit these compensation packages for a number of executive employees. These include:
Five highest-paid employees, making over $100,000
Up to 20 other key employees, making over $150,000
Nonprofits must disclose these numbers on their annual tax return — Form 990 — as a way to enter them into the public record.
Pro Tip: The IRS is not the only entity that may require reporting. For example, if you use a grant to pay your nonprofit employees, the grantor may want information on how you divvied up their funding. If you accept any outside funds, make sure that you are aware of their stipulations.
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How To Structure Your Nonprofit Compensation Policy
It is all well and good to say that your nonprofit organization needs a compensation policy. However, setting one up is a different animal entirely.
To help you understand what goes into a nonprofit compensation policy, we have defined the following elements. While these basic sections can help establish the framework of your policy, feel free to add more sections as you see fit. The more specific you are, the better.
Emily is excited to structure her nonprofit's compensation policy!
Commonly found at the top of the compensation policy, the overview simply introduces the goals of the document. In other words, it states that the following information is the procedure to follow to come up with executive compensation for the specified dates.
Not everyone in a nonprofit organization needs to know what is contained within the compensation policy. Only those who the policy directly affects need to see it. These individuals include the executives whose compensation is decided with the document and the board members who approve the compensation.
The next part of the document lays out how to go about finding compensation rates. "Reasonable" and "not excessive" are relational, so you must look at what other nonprofit organizations are offering. Focus on the ones with a similar mission and in the same locale.
You can conduct this research in a few ways. The easiest way is to look at 990 forms because they are publicly available. You can also contact organizations individually to see if they are willing to discuss their process for selecting executive compensation.
Finally, the board of directors can hire an independent firm to perform this research. This is an additional expense, so we really only recommend this route if you are struggling to find salary information or if your board is too bogged down with other important matters.
So, you know how to conduct compensation research, but what do you do once you have that data? Usually, the board meets to look over the data and make compensation suggestions. At the end of the meeting, the board members vote to agree to a particular package. The board secretary should document this entire process in the meeting minutes in case anyone has questions about it later on.
Pro Tip: "Can I pay myself in a nonprofit organization?" The answer is "yes" and "no." As an employee, yes, you can get paid. However, to ensure impartiality and fairness, have the board, HR department, or someone else weigh in on the exact amount.
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Nonprofit Compensation Policy Samples
Sometimes, referencing an example can help get the wheels turning. If you are unsure what wording or structure to use in your policy, take a look at the following samples.
National Council of Nonprofits
Short and succinct, this compensation policy document from the National Council of Nonprofits provides a basic structure that you can pull from for your own policy. As you can see, this type of document does not have to be long-winded to outline specific details.
The first two paragraphs of this sample follow the overview outline we discussed above. The "Board Approval" section denotes how the board of directors comes to an agreement on what fair compensation entails. Finally, the "Concurrent Documentation" section goes into the details about how the board proves that what it agreed to is fair.
Now, let’s take a look at another policy — this one from Venable LLP. This policy is just one part of a larger document from Venable LLP that describes and shows the overall governing policies for nonprofits.
The entire first page is dedicated to listing and describing every individual who this policy affects. This extra detail shows the IRS and the public your commitment to transparency. The "Procedure for Approving Compensation" section outlines the whole research and approval process from start to finish with clear organization and a lot of detail.
Pro Tip: As important as specific language can be for organizational policies, it might be valuable to build a bit of wiggle room into the wording of this document. You can use words like "discretion" and "pending approval" to give the governing body a chance to slightly modify the procedure as needed.
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What About Other Employees?
If an employee is not at the executive level, you technically do not have to have a written policy on how you compensate them. However, we recommend enlisting your HR department’s help to gather salary data for every position you have. This type of written documentation ensures fairness, which looks good in the eyes of your employees, your supporters, and the government.
When you go to draft this document, you do not have to start from scratch. Reference your executive compensation policy. You can follow a similar process minus getting board approval.
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Your nonprofit compensation policy is about transparency at its core. It helps you develop your compensation guidelines and abide by the IRS rules and regulations. Once you have created this policy, it is a simple process of upholding it in the years to come!
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💡What goes in a nonprofit compensation policy?
A nonprofit compensation policy usually includes an overview followed by sections on the affected individuals, the research process, and the approval process. Find out more.
🔑 How much can nonprofit executives make?
There is no cap for how much a nonprofit executive can make. All the IRS specifies is that the salary is "reasonable" but "not excessive." Find out more.
📝 Who decides nonprofit compensation?
The nonprofit’s board of directors usually determines the executive’s compensation. This ensures impartiality because the executive is not involved in the process. Find out more.