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Nonprofit organizations are vital to our communities. Rather than focusing on profit, nonprofits dedicate their energy and resources to tackling society’s most pressing challenges — whether that’s supporting families in crisis, advancing education, protecting the environment, providing health care, championing human rights or enriching our cultural lives. Despite their importance, a persistent myth surrounds nonprofit compensation that leaders and key staff are routinely overpaid, unchecked by any robust oversight. This misconception not only undermines the public trust in such organizations but also makes it harder for nonprofits to recruit and retain the top talent required to fulfill their charitable missions.
The reality of nonprofit pay
Contrary to popular belief, nonprofit organizations exist in a highly regulated legal space and are subject to strict rules and oversight when it comes to executive and key employee compensation. The expectation that nonprofit employees should work for significantly less than their counterparts in the for-profit sector creates a talent gap that can jeopardize an organization’s effectiveness.
Competitive and fair wages are essential for attracting and retaining skilled executives and specialists, reducing turnover and maintaining operational stability. For these reasons, nonprofit boards shoulder a significant responsibility — securing talented leaders without paying excessive salaries, all while stewarding limited resources and minimizing the time and cost involved in executive searches.
Public scrutiny and legal standards
Executive compensation at nonprofits is often the subject of public scrutiny. Critics may not realize that the Internal Revenue Service (IRS) enforces clear standards for determining “reasonable” pay. Unless exempt, all 501(c)(3) organizations (public charities included) are required to report executive compensation annually using the Form 990, Return of Organization Exempt from Income Tax, a public document. On Form 990, organizations are required to list all current officers, directors, and trustees regardless of compensation, current key employees with compensation over $150,000, and the five highest compensated current employees (other than officers, directors, trustees, and key employees) who earn over $100,000.
This transparency is designed both to reassure the public and to help organizations avoid stiff tax penalties under Section 4958 of the Internal Revenue Code (also known as the “intermediate sanctions” rules).
Internal Revenue Code Section 4958 specifically prohibits public charities from providing excessive compensation to any employee who can exercise substantial influence over the organization’s affairs. If an organization is found to have overpaid an executive, the consequences can include penalties for both the employee who received the excessive compensation and the board members who approved it.
The IRS safe harbor process
To help nonprofits navigate these complexities, the IRS has established a “safe harbor” process for setting executive and key employee compensation. By following these steps, an organization creates a legal presumption that its compensation decisions are reasonable. This shifts the burden of proof to the IRS if questions arise.
The safe harbor steps:
- An independent body, such as the nonprofit board or a designated compensation committee, must oversee the compensation review. Importantly, individuals who stand to benefit from the compensation cannot participate in the process.
- The committee should collect and review data on comparable salaries and benefits from similar “peer” organizations. Factors considered might include organizational size, revenue, location, job responsibilities and staffing levels.
- The entire review process must be thoroughly documented. Minutes or written records should state who was involved, what data was considered and the basis for the final compensation decision.
Following this approach not only keeps nonprofits compliant with IRS regulations but also provides transparency and accountability, which are essential for maintaining public trust.
Striking the right balance
Nonprofit boards must walk a fine line when setting executive pay. Compensation should be high enough to attract and retain talented leaders but not excessive so that the nonprofit’s assets can be dedicated to its charitable mission. Boards are encouraged to use market data, establish clear policies and maintain thorough documentation for every compensation decision. With these guardrails in place, nonprofits can confidently recruit the best leaders, remain compliant with federal regulations and assure donors and the public that their resources are being managed responsibly.
By adhering to IRS guidelines and best practices, nonprofit organizations can ensure that executive compensation aligns with their mission, values and the expectations of the communities they serve.•
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Springer is a partner and Phillips is an associate for Faegre Drinker.
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