Q&A #54 – What comparability data must a small 501(c)(3) organization review when determining executive compensation?
Question: I serve on the Board of Directors of a small 501(c)(3) organization and we are in the process of reviewing a compensation package for our Executive Director. The Executive Director will be paid a relatively low salary, but I see that Part VI, Line 15 of the Form 990 asks whether we follow a process for determining compensation that includes reviewing “comparability data.” What type of data will satisfy this standard?
Answer: For small organizations, the rule for reviewing comparability data when determining compensation amounts is relatively easy to satisfy. This Form 990 question is based on Treasury Regulations issued under the “excess benefit transaction” rules. Treas. Reg. § 53-4958-6 provides that organizations with less than $1 million in annual revenue (averaged over the three prior tax years) can satisfy this standard by reviewing “data on compensation paid by three comparable organizations in the same or similar communities for similar services.”
This data is readily available by searching for Forms 990 on Guidestar, the Candid 990 Finder, or the IRS exempt organizations database. Make sure to use data from organizations that are of similar size to your organization, work in similar program areas, and are based in the same or a similar geographic region. Also, look closely at Part VII of their Forms 990 to make sure that their Executive Directors are working a similar number of hours as yours (the compensation paid to a full-time Executive Director might not be an appropriate comparison if your Executive Director works part-time).
Larger organizations generally use a more rigorous process that involves reviewing compensation surveys from a wide variety of organizations or hiring compensation consultants who specialize in compensation benchmarking reports. It is also common for smaller organizations to use compensation surveys (some of which are available at relatively modest cost) as part of their due diligence process, but merely using three good examples is sufficient for organizations within the $1 million annual revenue threshold.
Planning Tip – Pay close attention to the other elements of the process described in Part VI, Line 15 of the Form 990, particularly “contemporaneous substantiation of the deliberation and decision.” This is where good habits for keeping Board and committee meeting minutes is very important. The minutes should specify the approved compensation terms, the date the arrangement was approved, the Board members who were present at the meeting during review and approval, the data that the Board obtained and how it was obtained, and whether any Board members had a conflict of interest with respect to the arrangement. Lastly, in order to satisfy the “contemporaneous” standard, the minutes must be drafted before the later of the next Board meeting or 60 days after the date the compensation was approved.
Keep in mind that this process is not strictly mandatory. Following the process described in Treas. Reg. § 53-4958-6 results in a “rebuttable presumption” that the compensation is “reasonable” (and therefore not in violation of the excess benefit transaction rules). Failure to follow this process should not pose a legal problem in the context of a modest salary that is clearly not an overpayment. However, following this process and checking “yes” to Part VI, Line 15 of the Form 990 is undoubtedly a best practice that is highly recommended.
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