Bringing on the right executive is one of the most important steps you can take for growing your nonprofit. Setting compensation for that new executive, however, can be a complicated process. 

While publicly traded companies can attract leaders with stock options, and private businesses can decide their own compensation practices internally, nonprofits have limited resources and must follow a unique set of regulations. 

To help your nonprofit HR team overcome these challenges, we’ve put together a guide going over the ins and outs of executive compensation for nonprofits. 

Nonprofit Executive Compensation Compliance

Before setting your policy, your team needs to understand the IRS’s policies for nonprofit executive compensation. 

Plan your process around these core requirements:

  • Reasonable compensation standard: Pay for executives must be “reasonable” for the work they do. The IRS judges this by comparing it with what similar organizations pay for similar roles. For example, the IRS would accept that the executive directors at national nonprofits with multiple locations across the United States would have similar  salaries, but would be suspicious if a newly established local nonprofit paid its executive director the same rate as those large organizations. 
  • Board approval and documentation: The nonprofit’s board must approve executive pay and document the reasoning behind its decision. Additionally, the nonprofit must verify that there are no conflicts of interest, such as a current executive voting on their own salary. 
  • Form 990 disclosure: Nonprofits must report how much they pay executives and other top employees on their annual Form 990. As Jitasa’s guide to Form 990 notes, returns remain publicly available for at least three years, allowing individual donors to review your financials and draw their own conclusions about whether they feel your executive pay strategy makes sense. 

Given that your nonprofit must follow these regulations to prevent legal penalties, consider working with a compensation consultant if you’re ever unsure whether your nonprofit is compliant. These experts are knowledgeable about national, state, and local compensation laws, so they can help you navigate your specific situation. 

Understanding Executive Responsibilities

To provide reasonable compensation for your executives, you first need an accurate picture of what each role entails. Part of the compensation process involves researching executive salaries and benefits at other organizations for similar roles. 

However, just because two individuals share a job title, they don’t necessarily perform the same work. For example, a regional food bank’s executive director might oversee several warehouses and a delivery fleet, while one at a small arts council runs a two-person office.

Take a close look at your executives’ work and make note of their exact responsibilities. How many people report to them? What is their annual budget? Which programs and sites do they manage? Then, consider what skills are required to complete their responsibilities, including soft skills like project management and communication, as well as hard skills like financial literacy. 

Outlining skills and responsibilities can also help you focus your executive search if you’re currently looking to hire new leadership. 

Benchmarking and Market Analysis

Benchmarking and market analysis is the process of identifying comparable organizations and assessing their executive pay structures to determine what your own should be. As part of the IRS’s requirements for nonprofit executive compensation, your board must review this data as part of its decision-making process. 

For nonprofits on a budget, it may be tempting to use publicly available data. However, be cautious as this information may be outdated, incorrect, or misleading. 

Instead, partner with a compensation consulting firm. These organizations can provide you with reliable information, launch custom surveys to gather market data specific to your nonprofit, and analyze the results to help inform your compensation policy. 

As Astron Solutions’ compensation consulting guide points out, compensation consulting is a broad topic, and there is an extensive number of firms to choose from. Look for consultants who specialize in nonprofits and offer specific executive compensation-related services. 

Determining Your Compensation Philosophy

Market data shows what other organizations pay their executives, but it’s ultimately up to your nonprofit what you do with this data. Your compensation philosophy outlines what your nonprofit’s pay strategy is and why. This approach ensures executive pay is consistent, explainable, and tied to your mission. 

Your philosophy should include these elements:

  • Market position: Determine whether your nonprofit will aim to pay at, above, or below the market midpoint, and how that choice fits your budget. For example, a small nonprofit with a tight budget might knowingly pay below market rate but try to make up for it and keep executives motivated by providing other benefits. 
  • Internal equity: Ensure leadership pay feels fair to staff by determining how executive pay will relate to the rest of your pay structure. For example, you might have a policy that executives can earn a maximum of ten times an entry-level employee’s salary. 
  • Incentives: If you offer variable pay, tie it to measurable, mission-based goals the board sets, such as program outcomes, organizational health, or strategic milestones. Avoid bonuses based on a percentage of funds raised, which can raise ethical concerns.

Many nonprofits can benefit from taking a total rewards philosophy to compensation. This approach helps nonprofits stay competitive with for-profit businesses, even if they can’t match them on salary, by instead offering a holistic package that includes in-demand benefits. For example, a few common perks nonprofits with a total rewards compensation model provide include:

  • Health and wellness programs
  • Retirement contributions
  • Professional development and growth opportunities
  • Flexible scheduling or generous paid time off
  • The fulfillment of working for a good cause

Board Review and Approval

After collecting market analysis data and using your compensation philosophy to create a recommended executive compensation strategy, your HR team will present its plan for board approval. 

Your recommendation package should include:

  • Role summary: The updated job description and scope.
  • Market analysis: A list of the comparable organizations chosen, an overview of how your data was sourced, and a brief analysis of these comparable organizations’ pay strategies. 
  • Proposed package: Your suggestions for base pay range, benefits, and any incentive structure, tied to your compensation philosophy.
  • Rationale: How the proposal reflects your organization’s budget, mission, and market position.

To maintain compliance and demonstrate strong governance, the vote must be fully documented and free of any conflicts of interest. Take notes of how the board assessed the data presented to it and their reasoning behind their final decision. 

Along with ensuring you meet the IRS’s regulations, documenting this process also helps you streamline future executive compensation decisions as you’ll have a recorded, standardized procedure to follow. 

Striking a balance between high executive compensation that brings in valuable leaders and pay that fits your nonprofit’s budget can be tricky. If you’re having trouble figuring out the right compensation strategy, need help understanding relevant laws, or are looking for reliable market data, consider partnering with a professional nonprofit compensation consultant.