How to Set Nonprofit Executive Compensation

One of a nonprofit board’s central responsibilities is setting the executive director’s pay. Doing it responsibly is harder than it sounds, because few board members set executive salaries for a living and there’s no posted price for the job. The same title can cover very different work, such as running a $2 million literacy program or a $40 million health center. The person whose pay you’re deciding is usually the one the board works with most closely, which can make the conversation awkward. Whatever figure you settle on goes on your Form 990, where anyone can look it up.

Most of all, the decision has to hold up if the IRS ever examines it. This guide starts with what the IRS can do when pay is too high, then walks through the process that lets a board’s decision be presumed reasonable.

What’s at stake

Under IRC §4958, if an executive is paid more than is reasonable for the job, the difference is an excess benefit, which the IRS can tax (§4958(c)(1)). The rule covers 501(c)(3) public charities, 501(c)(4) social welfare organizations and certain health insurance issuers (§4958(e)), as Excess benefit transactions and IRC 4958 explains. The executive owes a tax of 25% of the excess, and a further 200% if the excess isn’t repaid in time (§4958(a)(1), (b)).

Board members can owe tax too, though only if they participated in the transaction knowing it was an excess benefit. A board member or other manager in that position can owe 10% of the excess, unless the participation was not willful and was due to reasonable cause, with the tax capped at $20,000 per transaction for all the managers together (§4958(a)(2), (d)(2)).

The rebuttable presumption

However, the Treasury regulations under §4958 set out a process for approving executive pay, called the rebuttable presumption of reasonableness, and if your board follows it, the IRS presumes the pay is reasonable (§53.4958-6).

Normally, if the IRS questions an executive’s pay, it falls to the executive and the organization to show the pay was reasonable. The presumption reverses that, because the IRS can then overcome it only if it finds enough evidence to rebut the comparability data the board relied on (§53.4958-6(b)). The IRS’s own 2013 report on its examinations of colleges and universities describes the process as a way to “shift the burden of proving unreasonable compensation to the IRS” (Colleges and Universities Compliance Project final report).

The process has three requirements (§53.4958-6(a)).

1. The pay is approved in advance by a board or committee whose members have no conflict of interest.
2. Before deciding, the board or committee gets and relies on appropriate comparability data, such as what similar organizations pay for similar jobs.
3. It documents the basis for its decision at the time it makes it.

Following the process protects board members as well. When the board has met the requirements, a member’s participation is ordinarily not “knowing,” and so not subject to the 10% tax (§53.4958-1(d)(4)(iv)). If a board misses a requirement, the pay is judged on all the facts and circumstances (IRS, Rebuttable presumption), with no inference that it was too high (§53.4958-6(e)).

The rest of this guide walks through how a board meets the three requirements, in the order the work usually happens, most of it before the meeting where the board votes.

Who decides

The first requirement is that the people approving the pay have no conflict of interest, so the first decision is who those people will be. The regulation calls that group the “authorized body,” which can be the full board or, if state law allows it, a board committee or another party the board authorizes under its own procedures (§53.4958-6(c)(1)(i)). This guide says “the board” for whichever one your organization uses.

Some conflicts are obvious, like being the executive’s spouse, but others are easier to miss, such as being paid for consulting work on invoices the executive director approves. The regulation describes five kinds of conflict (§53.4958-6(c)(1)(iii)), which the guide to the rebuttable presumption lists in full. Checking each member against them a week or two before the meeting leaves time to change who serves if someone has a conflict.

What counts as comparable

For the second requirement, comparability data, the first step is deciding which organizations count as comparable, before anyone looks at a salary. A peer group chosen after the pay figures are in looks as if it was picked to fit them, so write the criteria down in a short note first.

The IRS found problems of this kind when it examined private colleges and universities. In its 2013 report, it said that about 20% of the private colleges and universities it examined used comparison schools that were not similarly situated, and that studies often didn’t say why the schools in them were chosen (IRS Colleges and Universities Compliance Project final report).

Describe a comparable organization in four ways.

• Mission. Organizations doing similar work, usually grouped by NTEE sector. A food bank belongs with other human services organizations, not with hospitals.
• Size. Annual budget is the common measure. Many compensation consultants use a band from about half to about twice your budget, though no regulation sets one.
• Geography. The labor market you’d hire from, which may be your metro area or the whole country, depending on how you’d recruit.
• Role. The job as your executive actually does it, described in a sentence or two.

Then add which tax years you’ll use and how many organizations you want, a number consultants commonly put at 15 to 25. Date the note and keep it with the board’s file. If anyone later asks how the peers were chosen, it shows the criteria came first.

The comparable set

With the criteria on paper, the next job is finding organizations that fit them and seeing what they pay. The first kind of comparability data the regulation lists is pay at similarly situated organizations, taxable and tax-exempt, for functionally comparable jobs, though independent compensation surveys and written offers from similar institutions competing for the same person count too (§53.4958-6(c)(2)(i)). Form 990 filings are a common source for that first kind, because a Form 990 lists every officer, director and trustee with their pay, plus key employees and the highest-paid employees above set pay thresholds. How to read executive pay on Form 990 explains where those figures appear on the form.

If you use PeerSet, its benchmark search takes the role, sector, budget range, geography and tax years from your note and returns the matching organizations from more than 1.3 million IRS Form 990 filings from tax years 2023–2025, with their reported pay. Each filing is public and signed under penalty of perjury.

Whoever built the set, read down the list of organizations, because some will meet your criteria on paper without being real peers, such as a hospital system that happens to share your sector code. Tighten the criteria until it drops out. If you keep it, note why in the file, since the figures will include it.

Reading the range

Once the set is settled, the board works out where in its range to pay. The median is the middle of what your peers pay, but no regulation makes it the target. Where your executive belongs in the range depends on what the figures can’t show, such as experience, tenure, the scope of the job and the organization’s results. If you use PeerSet, it shows the set’s median, its 10th, 25th, 75th and 90th percentiles, its mean and its full range.

Before comparing anything, be clear about what the figures measure, since in the college examinations the IRS counted it as a weakness when a survey didn’t say whether its figures were salary alone or total pay. A figure for salary and bonus should be compared with your executive’s salary and bonus, not with a total that includes retirement contributions and benefits. If you use PeerSet, its figures are Form 990 Part VII, Column D, reportable compensation from the organization, which is salary, bonuses and other taxable pay, as the methodology explains.

The IRS judges the whole package, though, counting salary, bonuses, severance, deferred compensation, insurance and most fringe benefits when it decides whether pay is reasonable (§53.4958-4(b)(1)(ii)(B)). So alongside the salary comparison, the board should look at the rest of the package and record what it reviewed.

Check how current the figures are, too. If they come from Form 990 filings, they describe pay from a year or two ago, because filings usually appear 12 to 24 months after the year they cover. If pay for jobs like yours has been rising since, the board can allow for that and say so when it records its reasons.

Setting the salary

With the range in front of it, the board settles on a figure, or a range to negotiate within, and writes down its reasons. To keep the presumption, the regulation requires those reasons when the board sets pay above or below the range of the data it relied on (§53.4958-6(c)(3)(ii)). It doesn’t define that range by percentiles, though, so many boards record their reasons whatever the figure. The strongest reasons are ones someone outside the room could check.

• “Fourteen years leading organizations of similar size, six of them as chief executive.”
• “Since the last review, direct reports grew from three to seven. The budget the executive manages rose by $2.4 million.”
• “A written offer of $X from a similar organization, which the board has seen.”
• “We hire locally, where the peers in the set pay more than the national ones.”

If the package includes a bonus the board will decide later, the timing of the presumption depends on whether the bonus has a cap. With a cap, the board can establish the presumption when it approves the contract, as long as its data supports the total pay at the cap (§53.4958-6(d)(2)). Without one, the presumption for the bonus waits until its amount, or a fixed formula for it, is set (§53.4958-6(d)(1)).

Before the meeting

The regulation asks members to rely on the data before they decide (§53.4958-6(a)(2)), which is hard to do with a spreadsheet handed out at the meeting. Send the comparison and the proposed terms a few days ahead, and keep the email, since it shows the members had the data before they voted.

If you use PeerSet, its Benchmark Summary PDF, downloaded from your results, can be the attachment. It sets out your criteria and tax years, with the median, the 10th to 90th percentiles, the range and the mean of the set’s Column D pay and, for 50 or fewer, lists every organization, along with the methodology and data sources. With fewer than five organizations, it shows the list and their mean.

The vote

At the meeting, the executive whose pay is being set and any member with a conflict can answer questions, but they leave before the discussion and the vote (§53.4958-6(c)(1)(ii)). The members who remain then discuss the data and vote, with a quorum as your bylaws require.

The motion should name the data the board relied on, as in “Having reviewed Form 990 pay data for 18 comparable organizations, the board approves a base salary of $X for [name] as Executive Director, effective [date].”

Because the regulation asks for approval in advance (§53.4958-6(a)(1)), set an effective date on or after the vote, and talk to counsel first if the board wants a raise to reach back to an earlier date.

The minutes

The third requirement is documenting the decision as it’s made, which means the record has to be prepared before the later of the board’s next meeting or 60 days after its final action. The board then approves it as reasonable, accurate and complete within a reasonable time (§53.4958-6(c)(3)(ii)).

The minutes should show four things (§53.4958-6(c)(3)(i)).

1. The terms approved and the date they were approved.
2. The members present during the discussion, and those who voted.
3. The comparability data the board relied on, and how it was obtained.
4. What any member with a conflict did, such as leaving before the vote.

If the pay falls outside the range of the data, the minutes also give the reasons the board recorded when it chose the figure. Keep the minutes with the rest of the file, which by now holds these pieces.

The Form 990

On your next Form 990, Part VI, line 15a asks whether the process for setting the top executive’s pay included review and approval by people without a conflict, comparability data, and contemporaneous documentation, which closely track the three requirements above. If the answer is yes, you describe the process on Schedule O and give the year it was last done, so anyone reading the return can see how old the study is (Form 990 instructions).

Organizations that file Schedule J also report there which methods they used to set the pay, as How to read executive pay on Form 990 explains.

The next review

Because the return shows when the study was last done, put the next review on the board calendar now. Many compensation consultants refresh a study every two to three years, and sooner when the job or the budget changes a lot. When that review comes, the board can start from this round’s criteria note and update it for whatever has changed.

Informational only. Not legal, tax or compensation advice. No guarantee of accuracy.