The Rebuttable Presumption of Reasonableness, Explained for Nonprofit Boards

When a board approves its executive director’s pay, it can’t know whether the IRS will ever question the figure, but it can control how it reaches the decision. Section 53.4958-6 of the Treasury regulations sets out three requirements for that decision, and if the board meets them, the pay is presumed reasonable (§53.4958-6). The presumption is called “rebuttable” because the IRS can still overcome it, though only by finding enough evidence to rebut the comparability data the board relied on (§53.4958-6(b)).

This page explains each requirement in detail and then covers where the protection stops. For the whole pay-setting process in order, from the first conflict check to the Form 990, see How to set nonprofit executive compensation.

Why boards use it

The reason to use the presumption is what §4958 does when pay turns out to be too high. The executive owes a tax of 25% of the excess over reasonable pay, and a further 200% if the excess isn’t corrected in time. Board members and other managers who participated knowing it was an excess benefit can owe 10% of the excess, up to $20,000 per transaction for all of them together (§4958). Excess benefit transactions and IRC 4958 explains those taxes in full.

The presumption changes who has to prove what. The IRS’s 2013 report on its college and university examinations describes it as a way to “shift the burden of proving unreasonable compensation to the IRS” (Colleges and Universities Compliance Project final report). It protects board members too, because 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, that alone creates no inference that the pay was an excess benefit (§53.4958-6(e)), and the pay is then judged on all the facts and circumstances (IRS, Rebuttable presumption).

Approval without conflicts

The first requirement is that the pay be approved in advance by an “authorized body” made up entirely of people without a conflict of interest (§53.4958-6(a)(1)). That body can be the board or, where state law allows it, a board committee or another party the board authorizes under its own procedures (§53.4958-6(c)(1)(i)).

The conflict test reaches well past family ties. A member has a conflict if any of these is true (§53.4958-6(c)(1)(iii)).

• The member is the executive, a family member of the executive, or another insider who benefits from the pay arrangement.
• The member works under the executive’s direction or control.
• The member receives pay or other payments that the executive approves.
• The member has a material financial interest affected by the decision.
• The member has approved a benefit for the executive, who in turn has approved or will approve one for the member.

A member with a conflict can still meet with the body to answer questions, but must leave before the discussion and the vote (§53.4958-6(c)(1)(ii)).

Comparability data

The second requirement is that the body obtain and rely on “appropriate data as to comparability” before it decides (§53.4958-6(a)(2)). The regulation doesn’t fix what that data must be, and instead counts it as appropriate if, given the members’ knowledge and expertise, it is enough to judge whether the whole pay arrangement is reasonable (§53.4958-6(c)(2)(i)). The examples it gives include these.

• Pay at similarly situated organizations, taxable and tax-exempt, for functionally comparable jobs.
• The availability of similar services in your geographic area.
• Current compensation surveys compiled by independent firms.
• Actual written offers from similar institutions competing for the person.

Whatever the source, the data should say what it measures, since in its college and university examinations the IRS counted it as a weakness when a survey didn’t say whether its figures were salary alone or total pay (IRS final report). How to set nonprofit executive compensation walks through choosing comparable organizations and building the set.

Under $1 million

Smaller organizations have their own rule for how much data is enough. An organization with annual gross receipts, including contributions, of less than $1 million has appropriate data if it has pay data from three comparable organizations in the same or similar communities for similar services (§53.4958-6(c)(2)(ii)). It may average its gross receipts over the three prior years, but it must include the gross receipts of any entity it controls or that controls it, including a for-profit subsidiary (§53.4958-6(c)(2)(iii)).

Because the test is gross receipts, which is a different figure from budget or total expenses, check it on your own Form 990 before relying on the rule. If you use PeerSet, keep in mind that its budget tiers, such as $500K to $1M, are based on total expenses.

The written record

The third requirement is that the body document the basis for its decision at the time it makes it (§53.4958-6(a)(3)). The records must show four things (§53.4958-6(c)(3)(i)).

1. The terms of the approved arrangement and the date it was approved.
2. The members present during the debate, and those who voted on it.
3. The comparability data obtained and relied on, and how it was obtained.
4. Any actions taken by a member who had a conflict of interest.

If the body sets pay above or below the range of its comparability data, the record must also give the basis for that decision. The records count as concurrent if they are prepared before the later of the body’s next meeting or 60 days after its final action, and the body must then approve them as reasonable, accurate and complete within a reasonable time (§53.4958-6(c)(3)(ii)).

An example timeline

The Riverside Literacy Council is a fictional $3.2 million organization setting its executive director’s salary for the year starting April 1. Here is how the three requirements fit around one committee meeting.

Had the committee set pay above the highest figure in its data, the March minutes would also need to say why.

Bonuses decided later

A payment the board decides later, such as a discretionary bonus, is what the regulation calls a non-fixed payment. The presumption for it normally arises only when its exact amount, or a fixed formula for it, is set and the three requirements are met at that time (§53.4958-6(d)(1)). If the contract caps the bonus, the timing changes, because the board can then establish the presumption when it approves the contract, provided its data shows that fixed pay up to the maximum the contract allows would be reasonable (§53.4958-6(d)(2)).

The Form 990

Your Form 990 asks about each of these requirements. Part VI, line 15a asks whether the process for setting the top executive’s pay included approval by people without a conflict, comparability data, and contemporaneous documentation, and line 15b asks the same about other officers and key employees. A yes means describing the process on Schedule O and giving the year it was last done (Form 990 instructions).

If your organization files Schedule J, Part I, line 3 asks which methods it used to set the top executive’s pay. One of the boxes is “Form 990 of other organizations.” Line 9 asks whether an initial contract was approved through the presumption’s procedure (Schedule J instructions). How to read executive pay on Form 990 covers the rest of those pages.

What it doesn’t cover

The presumption covers §4958 only, so meeting it changes nothing under other law. Missing it doesn’t relieve anyone of other federal or state law either (§53.4958-6(e)). Directors still owe the duties their state’s law gives them.

Questions boards ask

What does the IRS consider reasonable compensation?

The regulation defines it as the amount that would ordinarily be paid for like services by like enterprises under like circumstances (§53.4958-4(b)(1)(ii)(A)). Everything in the package counts toward that figure, including salary, bonuses, severance, deferred compensation, insurance and most fringe benefits (§53.4958-4(b)(1)(ii)(B)).

What are intermediate sanctions for nonprofit organizations?

Intermediate sanctions is the IRS’s name for the §4958 excise taxes on excess benefit transactions, which fall on the insider who received the excess and on the managers who participated knowing it was an excess benefit, not on the organization. The IRS may still propose revoking the organization’s exemption, whether or not it imposes the taxes (IRS, Intermediate sanctions).

Is the rebuttable presumption a safe harbor?

Not in the usual sense, because the IRS can rebut it. The regulation does use the words “safe harbor” for the three-organization rule for small organizations, but that rule settles only what counts as enough data (§53.4958-6(c)(2)(ii)).

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