For a variety of reasons, most directors of nonprofits do their work on a voluntary basis. As a volunteer, a nonprofit’s director can set an example for the community by donating time and energy to the success of an organization that likely will ask many others to do the same. In rare cases, compensating a director may be considered appropriate. For example, if a director runs a service business that can be of help to the organization (real estate brokerage, accountancy, and so on). The potential for abuse is high in these circumstances, and the compensation should be negotiated by the other directors, without the involvement of the director to be compensated.
Paying directors for their work raises a mixture of state and federal rules. At the federal level, tax issues should be a key concern. IRS rules allow a nonprofit’s directors to be paid reasonable compensation for their personal services as directors. Such compensation must be “reasonable and necessary” and cannot cross the boundary of what the IRS would deem “excessive.” Note that a nonprofit director’s compensation package will be subject to public disclosure on the organization’s annual IRS Form 990, Form 990-EZ, or Form 990-PF.
A determination of what is “reasonable and necessary” and not “excessive” must be made on a case-by-case basis in light of factors like the organization’s financial circumstances, the competitive landscape for director-level talent, and the unique benefits the director will bring to the organization. Because relatively few nonprofits pay their directors, an organization may have few peers to compare itself against.
Like the IRS, the California Franchise Tax Board does not explicitly ban the compensation of nonprofit directors. California law governing nonprofit corporations specifies that any compensation to directors must be fair and reasonable in light of the services being provided. A director’s compensation package must be reviewed and approved by the other directors following a rigorous and well-documented process.
Paying a director can create numerous additional pitfalls that an organization must consider. By paying a director the director may need to be excluded from board votes about certain matters. Contracts between a compensated director, the director’s family, or the director’s outside business may be more likely to trigger scrutiny from regulators and the IRS as self-dealing transactions.
It’s important to bear in mind that a director can always be reimbursed for direct expenses incurred on behalf of the organization or in connection with the director’s work as a director. Things like travel expenses, lodging, and meals might be included in regular reimbursement. Every nonprofit should have a reimbursement policy in place to ensure that everyone seeking reimbursement does so according to a predetermined process, in part to prevent individuals from incurring costs that are inappropriate or outside the organization’s budget.
The Church Law Center of California helps nonprofit boards resolve complex governance questions. If your organization is thinking about compensating some or all of its directors, give us a call to discuss the pros and cons. We can be reached at (949) 689-0437 or through our contact page.