Q&A #121 – Is a nonprofit permitted to compensate Board members for their Board service?
Question: I am on the Board of a nonprofit organization that wants to have more Board members who are representative of the community we serve. However, many of these people have limited financial means and it would be difficult for them to serve without being paid for their Board service. Are we permitted to compensate certain Board members for normal Board duties such as attending meetings?
Answer: Nonprofit organizations are generally permitted to provide reasonable compensation to Board members for their Board service, provided this is not prohibited by the organization’s Articles of Incorporation or Bylaws, and subject to certain provisions of the applicable state nonprofit corporation statute.
While reasonable Board member compensation is generally permitted, it has traditionally been unusual for nonprofits to compensate Board members for normal Board member duties such as attending and preparing for meetings. However, a growing number of people in the nonprofit community have been reexamining these traditional notions in recognition of the need for more diversity on nonprofit Boards.
Whether Board members should be compensated for Board service is a difficult question that raises issues concerning public perception, independence of Board decision-making, ethics, the dynamics paid and unpaid Board members working together, and organizational culture. The legal analysis, on the other hand, is relatively straightforward.
The first issue is to make sure the organization’s governing documents permit such compensation. Many organizations have Bylaws that prohibit compensating Board members for services provided in their capacity as Board members (as distinguished from compensation for professional services outside the scope of normal Board duties and reimbursement of travel and other Board service expenses). Such Bylaws provisions can be amended to the extent consistent with applicable law in accordance the amendment procedures specified in the Bylaws, but it is important to know in advance whether a Bylaws amendment would be needed.
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Next, the applicable state nonprofit corporation statute should be reviewed. Most states do not prohibit Board compensation outright, but some states restrict certain forms of compensation to Board members (such as loans), have provisions addressing the process for approving Board member compensation, and/or require that at least a majority of nonprofit Board members be unpaid volunteers (California is an example of the latter).
Be aware that compensating Board members will probably result in these Board members losing certain statutory volunteer immunity protections from personal liability under state law and the federal Volunteer Protection Act. D&O insurance generally mitigates these concerns to some extent, but you should consult your insurance broker and other advisors to get a better sense of what the risk exposure will be for compensated Board members.
As mentioned, the federal tax laws governing tax-exempt nonprofit organizations (such as 501(c)(3), 501(c)(4), and 501(c)(6) organizations) do not prohibit compensating Board members for their Board service, so long as the compensation is not more than “reasonable” for the services provided. Nonprofits should always follow proper review processes and establish appropriate guidelines in their conflict of interest policy when compensating Board members, executive staff, and any other “disqualified persons.” Some of the applicable rules are discussed in Q&A #54 and Q&A #55.
Planning Tip – If your organization is planning to compensate a certain segment of Board members for their Board service, the responsibility for reviewing and approving such compensation should be delegated to a committee of independent Board members who do not receive compensation or otherwise an interest in the transaction as described in Treas. Reg. § 53-4958-6. This independent review helps to ensure there are proper checks and balances and mitigates the negative perception that the public, the IRS, and others may have regarding the impartiality of compensated Board members on these matters.
It is also important to consult the organization’s tax preparer about the potential reporting consequences, since Board member compensation must generally be reported on Part VIII and Schedule J of the Form 990 and can in some cases impact the number of directors who are considered “independent” for Form 990 purposes.
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