Compensating Nonprofit Board Members: What You Need to Know
Compensating nonprofit board members is a topic that raises questions for many organizations. In general, it’s best to avoid compensating board members, but there are times when it becomes necessary. One example is when the nonprofit needs support in a specific area and a board member’s company specializes in that area and offers to provide those services at a reduced rate because of their connection to the organization.
Anytime a nonprofit organization considers compensating board members, it’s important to understand the potential legal pitfalls and take the right actions to ensure compliance.
Understand the risks of excess benefit transactions
When compensating nonprofit board members, nonprofits must avoid what the IRS refers to as “excess benefit transactions.” These occur when a nonprofit organization provides compensation or other benefits to a board member that exceed fair market value.
The penalties for these transactions can be severe for everyone involved. The board member who received the excess benefit can be fined 25% of the excess benefit amount. In addition, any board members who approved the transaction could face a 10% penalty. For example, let’s say a nonprofit board member provides strategic planning services with a fair market value of $2,000 but they are paid $10,000 for their services by the nonprofit. That means the excess benefit is $8,000 or the difference between the determined fair market value of their services and what the nonprofit actually paid the board member. The board member can then be taxed 25% of that amount, which, in this case, is $2,000. Board members who also knowingly approved the payment can be assessed a 10% tax of the excess benefit amount, which is $800 per board member in this case.
If the excess benefit is not corrected within the same tax period that the transaction occurred, the penalties can increase significantly — up to 200% of the excess benefit. These penalties can lead to significant financial and legal challenges for the nonprofit and its board members.
Any excess benefits must also be reported in multiple places on the Form 990 tax return.
Be transparent about conflicts of interest
Transparency is key when it comes to compensating board members. Any potential conflicts of interest should be disclosed immediately. A conflict of interest occurs when a board member personally benefits from a decision, such as awarding a contract to their own business.
When a conflict of interest has been identified, the board should thoroughly discuss the conflict and clearly document it in the minutes. When the board votes on compensating a board member, the board member who will receive compensation should leave the room for the discussion and the vote.
Document everything in board minutes and other records
When compensating board members, documentation is essential to ensure compliance, accountability, and transparency. Board minutes should reflect every detail about the compensation decision: how much was paid, why it was necessary, the services provided, and any additional bids that help establish fair market value for the services. Ideally before the vote, the board, or a committee, conducted due diligence and gathered bids or conducted research to determine if another company or contractor could provide the services to avoid the conflict. If not, that documentation is critical to keep to support why hiring the board member was necessary.
You also need a paper trail for every penny spent when compensating board members for services. This means keeping detailed records of payments, including receipts, contracts, and any other supporting documentation. These records are critical if any questions arise or the organization gets audited.
Do right by your organization, board, and donors
Compensating board members is a sensitive issue and one that requires careful attention. By following best practices to maintain transparency, document decisions, and ensure all transactions comply with IRS regulations, you can protect your nonprofit and its board members from legal and financial risks. Ultimately, doing things the right way safeguards your organization’s reputation and the trust your donors place in your organization.
If you have questions about compensating nonprofit board members, navigating conflicts of interest, or ensuring compliance with IRS regulations, we’re here to help. At Nonprofit Solutions Law, we specialize in providing legal guidance to nonprofit organizations. Contact us today to schedule a consultation.