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Most corporate bylaws require at least one meeting to be held each year by the board of directors. In this meeting, the board of directors are responsible for making several key decisions, including how much to compensate executives of the organization. Creating a policy for compensating these executives will help the process to be more transparent, protect board members from potential legal exposure, and avoid fines that may be associated with excessive compensation of executives. In general, the trust agreement and documents for an organization formed as a trust will also determine how the trustees are to make compensation decisions.  While the decision is made by trustees instead of board members, the amount of compensation is still subject to the same fines for excessive compensation paid to those involved in the organization’s activities.

How Much Compensation to Pay?

Any compensation paid to officers, directors, trustees, key employees, and others in a position to exercise substantial influence over the affairs of the charity for services rendered to the organization must be considered reasonable.  “Reasonable” carries the stipulation that the compensation paid cannot be in excess of the individual’s responsibilities and position. When making these decisions it is important to note that compensation includes both salary and benefits paid on behalf of the executive.

What is Considered Reasonable?

A three-step process known as the “rebuttable presumption” is used to establish reasonableness of compensation.  The requirements of this process are to conduct a review of similarly sized organizations, in the same geographic location, with a similar charitable purpose.  Additionally, the review should be performed by an independent body.  This means that the person or persons being compensated cannot be part of the review process. The persons reviewing the compensation can be a selected compensation committee, made up of board members, the executive committee, or a third party consultant. Lastly, the independent body should document everyone involved in the review process, along with a statement of their “independence” based on their relationship, or lack thereof, to the individual(s) being compensated.

Avoiding Potential Problems

In order to ensure that the compensation meets the requirements of the IRS, and penalties are not assessed for providing excess compensation, the following are key steps to include.  First, the board should create and approve a written policy for determining compensation.  This policy is recommended to require the entire board’s approval.  Second, when the meeting is held to approve of the compensation, the process, decision, and statements of independence should be reflected in the organizations written board meeting minutes. Lastly, creating a conflict of interest policy can establish a form of transparency that ensures that everyone involved in the decision making process is independent and, if they are not, that the policy will ensure they are removed from the process immediately.

A well-implemented compensation approval process can ensure that your organization properly reviews compensation, maintains independent processes, and meets all IRS guidelines. For further information on how to implement these policies, contact your L&B professional at 858-558-9200.

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