Running a nonprofit means balancing mission with money, and nowhere does that tension show up more than in how leaders get paid. Recent figures paint a telling picture: median executive compensation reached $189,088 in Washington, DC, in 2023, while nationwide, nonprofit executive director pay was around $98,000, according to 2025 data. The same report tracked over 217,000 compensation records and found average salary increases across the sector hovering near 4.77%, keeping pace with for-profit trends. Yet compensation still varies widely by mission, region, and organization size, leaving many boards asking the same question: How much is too much?
That question carries real legal weight. The IRS enforces strict “intermediate sanctions” and reasonableness standards under Section 4958, meaning excessive pay can trigger penalties for both the organization and its leadership. For nonprofits across the United States trying to stay compliant while remaining competitive employers, understanding these rules isn’t optional. Well-known firms, such as The Chisholm Firm law office, work with organizations navigating exactly these questions, helping boards set compensation that satisfies both mission and legal obligation. The sections below break down what boards and executives need to keep in mind when setting pay.
Reasonable Compensation Is the Starting Point
The Internal Revenue Code permits a tax-exempt organization to pay reasonable compensation for legitimate services. Reasonable compensation means the amount a similar organization would pay for comparable work under similar circumstances. The analysis considers duties, experience, geographic location, organizational size, budget, and the executive’s time commitment.
A nonprofit should not set pay based on personal need, loyalty, fundraising success alone, or pressure from a senior employee. Compensation should match the actual role and the organization’s resources. A written job description helps the board compare the position with similar nonprofit roles and determine whether the salary is in line with the assigned responsibilities.
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Why Is Legal Review Necessary
Legal counsel can help a board review its process before an agreement is signed. Law firms can assist with governance questions, compensation policies, and compliance planning. Independent legal review is useful when an executive also serves as a founder, director, family member, or major donor. Early advice can also help directors identify conflicts and correct weak approval procedures before they create larger problems.
The Board Must Use an Independent Process
The board, or an authorized compensation committee, should approve executive pay without participation from the executive or anyone else who benefits from the decision. Disinterested decision-makers should review the proposed salary, benefits, employment terms, and incentive payments.
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Minutes of Meetings
The board should document the approval date, the participating directors, the materials reviewed, and the vote. Minutes of meetings should explain why the board approved the arrangement instead of recording only the final amount. This record shows that directors acted carefully and protected the nonprofit’s interests.
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Conflict of Interest
A conflict-of-interest policy should guide the process. The affected director or officer should disclose the conflict, leave the discussion when appropriate, and abstain from voting. The organization should retain the disclosure, comparison materials, minutes, and signed agreement in its corporate records.
Use Comparable Pay Data
The board should collect reliable compensation information before approving salaries. Useful comparisons include nonprofit salary surveys, publicly available Form 990 filings, compensation reports, and data from organizations with similar missions and budgets.
A comparison becomes less useful when the organizations differ sharply in revenue, staffing, location, or program scope. The board should record why each source applies to the position under review. A short written analysis can explain adjustments for unusual duties, expanded operations, housing, travel, or fundraising responsibilities.
Compensation data should support the decision, not dictate it. The board must also consider whether the proposed package fits the nonprofit’s budget and mission. A salary that appears ordinary at a large metropolitan organization can be unreasonable for a small community nonprofit.
Understand the Rebuttable Presumption
Tax law gives organizations a helpful protection when they follow a documented approval process. The process generally requires approval by an independent body, use of appropriate comparison data, and timely documentation of the decision.
This process creates a rebuttable presumption that compensation is reasonable. But it does not prevent the Internal Revenue Service from reviewing the arrangement or excuse incomplete records. Directors should treat the presumption as the result of proper governance, not as a substitute for careful analysis.
If compensation exceeds a reasonable amount, the arrangement can create an excess benefit transaction. The executive may face an excise tax, and participating managers could face penalties when they knowingly approve an improper benefit. The nonprofit can also face reputational harm and additional scrutiny.
Review Benefits and Related Payments
Salary is only one part of executive compensation. The board should review bonuses, retirement contributions, health benefits, vehicle allowances, housing, deferred compensation, personal expenses, and severance payments.
Every benefit should have a business purpose and appear in the compensation analysis. Consider the following examples:
- A housing arrangement requires careful review because special tax rules can apply.
- Personal expenses should never pass through the organization without clear authorization and accurate reporting.
Employment agreements deserve the same attention. Automatic raises, long severance periods, change-in-control payments, and performance bonuses can affect whether the total package remains reasonable. The board should set review dates so compensation does not continue indefinitely without reassessment.
Meet Reporting and State Requirements
The nonprofit must report certain executive compensation and related transactions on its annual Form 990. The organization should maintain consistent records so reported amounts match payroll files, board minutes, agreements, and accounting records.
State charity regulators and corporate laws can impose additional governance duties. Requirements differ by jurisdiction, especially for charitable solicitation, related-party transactions, and director approval. A nonprofit operating across state lines should review the rules that apply where it is incorporated and where it conducts activities.
Conclusion
Executive compensation compliance depends on process, documentation, and periodic review. A nonprofit board should adopt a written policy, identify independent decision-makers, collect relevant comparison data, and record its reasoning before approving pay. Directors should review the complete compensation package and confirm that annual filings match the underlying records. Before negotiating a new agreement or increasing benefits, the board should conduct a documented review with nonprofit counsel and retain the supporting materials.