A recent survey found that 73% of nonprofit organizations have a formal policy to review executive compensation.  As a human resources and management consultant to nonprofits, what I found striking about this statistic is that it means 27% of organizations do not have a formal policy.

In recent years, the compensation of nonprofit organization executives has come under increasing scrutiny by public and governmental entities and the media.  It seems each month brings new stories of executives whose compensation — which may include salary, bonuses, deferred compensation, benefits and perquisites — is under question.  A quick glance through my bookmarks from the past few months reminds me of recent stories about the compensation of Massachusetts nonprofit healthcare executives and the president of a nonprofit housing organization in Chicago.

Some trace this increased focus back as far as the early 1990s when a widely publicized scandal erupted around the long-time CEO of the United Way of America who was ultimately convicted of misusing the organization’s resources to finance a lavish personal lifestyle.

The adoption of the Sarbanes-Oxley Act in 2002 marks another milestone in scrutiny of organizational finances and executive compensation.  Most provisions of Sarbanes-Oxley, which was enacted in the wake of major corporate and accounting scandals, apply only to publicly traded corporations.  Yet, there is little doubt of its influence on the nonprofit sector.

The Internal Revenue Service serves as the nonprofit fiscal watchdog.  Ultimately at stake is each organization’s tax-exempt status.  Further, under the agency’s intermediate sanctions provisions, nonprofit executives and board members may be found personally liable if they receive — or even approve — transactions construed as excess benefits.

Recently, the IRS has taken steps to strengthen its enforcement efforts.  In 2009, the agency hired 155 new employees focused on nonprofit organizations.

IRS Form 990, Return of Organization Exempt from Income Tax, which must be filed annually by most nonprofits, is the primary tool for collecting information about an organization’s finances.  For the 2008 tax year, the IRS significantly redesigned the form with an emphasis on enhancing transparency, promoting tax compliance and minimizing the filing burden.  The 2009 tax year brings another round of changes and clarifications.

The Form 990 changes relating to executive compensation include expansion and clarification of Part VII, which captures information regarding the compensation of officers, directors/trustees, other key/highly paid employees and independent contractors.

The redesigned form also introduces Schedule J, Compensation Information, which must be completed by organizations who pay any individual more than $150,000 or who meet certain other criteria.  Schedule J not only requires further quantitative breakdown of compensation paid, but it also collects qualitative information regarding compensation policies and practices.  This includes close examination of executive perquisites, expense reimbursements, retirement benefits and contingent compensation.

It is in light of this media, public and governmental scrutiny that I find it remarkable that more than a quarter of nonprofits have no formal executive compensation policy.  This unnecessarily creates the potential for significant financial and reputational liabilities for the organizations as well as for their executives and board members.

Fortunately, Schedule J can also serve as a blueprint for actions a nonprofit can take to strengthen governance of executive compensation thereby enhancing the transparency and appropriateness of its practices and minimizing liability.  Specifically, the form asks which of the following tools and processes are used to establish the compensation of the organization’s CEO/Executive Director:

•  Compensation committee

•  Independent compensation consultant

•  Form 990 of other organizations

•  Written employee contract

•  Compensation survey or study

•  Approval by the board or compensation committee

By being able to answer “yes” to as many of these as possible, organizations can go a long way toward establishing rebuttable presumption that compensation paid is reasonable, which is a key step in heading off intermediate sanctions and other IRS actions as well as media and public scrutiny.

All nonprofit executives and board members should consider whether their organization has covered its executive compensation bases. Is your organization among the 27% with no formal policy?  If a policy does exist, are there further steps that your organization can take?

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Joe Brown is the Principal and Founder of Slope Resources, LLC. Slope Resources provides a range of human resources and organization management consulting services to nonprofit organizations of all types and sizes. Joe is also the author of the blog Done by People, which focuses on human resources and organization management in the third sector, and will be a presenter at the 2010 Nonprofit Human Resources Conference. For more information about Joe Brown and Slope Resources, please visit sloperesources.com.

photo credit: stuseeger

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Last updated on April 20th, 2010 at 01:40 pm