How to Set Nonprofit Executive Compensation: A Board Member’s Guide

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If you’re a board member at a nonprofit, setting executive compensation is one of the most consequential decisions you’ll make. Get it wrong and you risk IRS penalties, public embarrassment, or losing a great leader to an organization that pays fairly. Get it right and you protect your mission, your reputation, and the people doing the work.

Here’s the thing most board members don’t realize until it’s too late: the IRS has a specific process they expect you to follow. It’s called the rebuttable presumption of reasonableness, and if you follow it, the burden of proof shifts away from your organization. If you don’t follow it, you’re essentially flying blind – and the IRS knows it.

This guide walks you through exactly how to set nonprofit executive compensation the right way – with real steps, not vague advice.

Why Board Members Own This Decision

Let’s be clear about something: executive compensation is a board responsibility. Not the ED’s. Not the finance director’s. Not the accountant’s. The board.

Under IRS rules for 501(c)(3) organizations, the governing body is responsible for ensuring that compensation paid to officers, directors, and key employees is reasonable. If compensation is later found to be excessive, it’s the board members who approved it – and the executive who received it – who face potential excise taxes under intermediate sanctions rules.

This isn’t theoretical. The IRS has assessed penalties against both executives and board members who failed to demonstrate that compensation decisions were properly vetted. In one well-known case, a nonprofit CEO received over $1.2 million in total compensation from an organization with a $3 million budget. The board had no comparability data, no documentation, and no independent review. The result was a 25% excise tax on the executive and potential 10% taxes on the board members who approved the arrangement.

The Rebuttable Presumption of Reasonableness: Your Best Protection

The IRS created a safe harbor process that, when followed correctly, creates a “rebuttable presumption” that compensation is reasonable. This means the IRS has to prove your compensation is unreasonable rather than you having to prove it’s reasonable. That’s a massive shift in your favor.

The safe harbor has three requirements. All three must be met. Miss one and you lose the presumption entirely.

Step 1: Independent Body Review

The compensation decision must be approved by an authorized body composed entirely of individuals with no conflict of interest regarding the transaction. In practice, this means:

• The executive director should not be in the room when their own compensation is discussed and voted on
• Board members who are related to the executive (by family or business relationship) must recuse themselves
• If you use a compensation committee, every member must be independent
• The full board can serve this role, as long as conflicted members recuse

I’ve seen boards where the ED sits through the entire compensation discussion, answers questions, and only steps out for the final vote. That’s not enough. The ED can present information and answer factual questions at the beginning, but the deliberation and decision should happen without them present.

Step 2: Appropriate Comparability Data

Before making a compensation decision, the authorized body must obtain and rely on appropriate comparability data. This is where most boards fall short.

“Appropriate comparability data” means compensation data from similarly situated organizations. The IRS looks at factors including:

• Budget size: Compare your $2M organization to other $1M-$4M organizations, not to the Red Cross
• Geographic location: A nonprofit ED in San Francisco legitimately commands more than one in rural Arkansas – cost of living matters
• Type of organization: A hospital CEO and a food bank CEO aren’t comparable even if budgets are similar
• Scope of responsibility: An ED managing 50 staff across three states is different from an ED managing 5 staff in one office

Where do you find this data? Salary benchmarking sources include Form 990 data (every 990 is public), compensation surveys from organizations like GuideStar or the Economic Research Institute, and regional nonprofit salary surveys. You need at least three to five comparable data points to be defensible.

A common mistake: using one data source or pulling numbers from a quick Google search. That won’t hold up. You need actual comparability data from organizations that genuinely resemble yours.

Step 3: Concurrent Documentation

The authorized body must document the basis for its decision concurrently with making that decision. “Concurrently” means by the next meeting of the body or within 60 days, whichever is later. You can’t go back a year later and reconstruct your reasoning.

Your documentation should include:

• The terms of the compensation arrangement (salary, benefits, bonuses, deferred comp – everything)
• The date of the approval
• The members of the body who were present and how they voted
• The comparability data obtained and relied upon, and how it was obtained
• Any actions taken regarding conflicts of interest (who recused and why)
• If compensation is higher or lower than the comparables, the basis for the decision

This last point is important. You’re allowed to pay above the median of your comparables – but you need to explain why. Maybe your ED has 20 years of experience and an MBA. Maybe they’re managing a capital campaign. Maybe you’re in a competitive market. Document the reasoning.

What Counts as “Compensation” (It’s More Than Salary)

When the IRS evaluates whether compensation is reasonable, they look at the total package – not just base salary. This includes:

• Base salary
• Bonuses and incentive pay
• Retirement plan contributions (403(b) match, etc.)
• Health, dental, and vision insurance (employer-paid portion)
• Life and disability insurance
• Housing allowances or parsonage
• Car allowances or mileage reimbursement beyond IRS rates
• Cell phone and technology allowances
• Expense accounts and discretionary spending
• Severance arrangements
• Deferred compensation

I’ve worked with organizations where the board thought they were paying their ED $95,000 – which seemed reasonable for a $1.5M org. But when you added the $12,000 retirement match, $18,000 in health benefits, $6,000 car allowance, and $4,000 in professional development, total compensation was actually $135,000. That’s a different conversation. And it’s the number the IRS will look at.

Make sure your Form 990 compensation reporting captures all of this accurately. The 990 is a public document, and reporters, donors, and watchdog groups know where to look.

Common Mistakes Boards Make

1. Rubber-Stamping Without Data

The most common failure: the ED proposes a raise, the board says “sounds good,” and nobody pulls comparability data. This happens at small nonprofits constantly. The board trusts the ED, doesn’t want to seem adversarial, and just approves the request. That’s not governance – it’s abdication.

2. Using the Wrong Comparables

A $1.5M community health center comparing their ED’s salary to Cleveland Clinic is absurd, but I see the equivalent all the time. Board members who come from corporate backgrounds sometimes pull Fortune 500 comp data because that’s what they know. Nonprofit compensation is a different world. Use nonprofit-specific data from organizations of similar size. If you need help, conduct a proper compensation study.

3. Ignoring Total Compensation

As I mentioned above, base salary is only part of the picture. If your comparables show a median base salary of $100,000, and you set base at $100,000 but then add $40,000 in benefits and perks, you’re actually above market. Compare total comp to total comp.

4. Failing to Document

Even boards that do good work on comparability data sometimes forget to document it. The meeting minutes say “The board approved the ED’s salary at $110,000” with no mention of the data reviewed, the discussion, or the reasoning. If the IRS comes calling five years later, you need that paper trail.

5. Never Reviewing Compensation

Setting compensation once and never revisiting it is a problem in both directions. If you set a salary in 2018 and haven’t reviewed it since, you might be dramatically underpaying your ED (which means you’ll lose them) or you might be out of step with current market data. Review executive compensation annually. It doesn’t have to be a massive undertaking – but you need current data every year.

6. Letting the Executive Set Their Own Pay

This should be obvious, but it happens more than you’d think – especially at founder-led organizations. The founder who built the nonprofit from nothing sometimes also sets their own salary without meaningful board oversight. This is a governance failure and a red flag for the IRS.

A Practical Process for Your Board

Here’s what a solid annual executive compensation review looks like in practice:

60 days before the board meeting: Assign a compensation committee (or the full board minus conflicted members) to gather comparability data. Have them pull data from at least three sources – Form 990 lookups, salary surveys, and regional benchmarking reports.

30 days before: The committee compiles the data into a summary memo that shows the range of compensation for comparable positions, the organization’s current total compensation package, and a preliminary recommendation.

At the board meeting: The ED presents a brief summary of their accomplishments, organizational performance, and any relevant context (new responsibilities, strategic changes). Then the ED leaves the room. The committee presents its findings. The board discusses and votes. Every aspect of this gets documented in the minutes.

Within 60 days after: Final documentation is completed, including the approved compensation terms, the data relied upon, and the rationale. This goes into a permanent file.

Special Situations

Hiring a New Executive

When you’re recruiting a new ED, you still need comparability data before making an offer. Don’t just pick a number that fits the budget. Research what comparable organizations pay, factor in the candidate’s experience and qualifications, and document your process. The rebuttable presumption applies to initial compensation arrangements too.

Performance Bonuses

Bonuses are fine – but they need to be structured carefully. The total compensation including the bonus must still be reasonable. Best practice: establish bonus criteria in advance (tied to measurable organizational goals), document the criteria, and evaluate performance against those criteria before awarding the bonus.

Severance Agreements

Severance is part of total compensation. If you’re offering 6 months of severance, that gets factored into the reasonableness analysis. Excessive severance has been a trigger for IRS scrutiny in the past. Keep severance reasonable – typically 3 to 6 months for a long-tenured executive is within norms.

Founder Transitions

Founders often have compensation arrangements that evolved organically over decades. When a founder retires or transitions out, the board should conduct a thorough review of the entire compensation structure. What made sense for a founder with 25 years of institutional knowledge may not be appropriate for their successor – in either direction.

What to Do If You Haven’t Been Following This Process

Don’t panic, but don’t ignore it either. If your board has been approving compensation without comparability data and proper documentation, start fixing it now. You can’t retroactively create the rebuttable presumption for past years, but you can establish the right process going forward.

Pull comparability data for your executive’s current compensation. If it falls within a reasonable range, document that finding and the data you relied on. If it doesn’t, you need to have a harder conversation – but it’s better to have it now than after the IRS sends a letter.

Consider bringing in a compensation consultant for a one-time review if you’ve never done this properly. The cost – typically $3,000 to $10,000 for a small nonprofit – is worth it for the peace of mind and the documentation it produces.

The Bottom Line

Setting executive compensation isn’t complicated, but it does require discipline. Follow the three-step safe harbor process, use real comparability data, document everything, and review annually. Your ED deserves fair pay. Your donors deserve responsible stewardship. And your organization deserves the protection that comes from doing this right.

The organizations that get this wrong aren’t usually acting in bad faith. They just didn’t know the rules. Now you do.