How to Avoid Excessive Payments and Politicking at Your Nonprofit Organization - dummies

How to Avoid Excessive Payments and Politicking at Your Nonprofit Organization

By Stan Hutton, Frances N. Phillips

Paying excessive compensation and engaging in campaign politics can get a charitable nonprofit organization in trouble. It doesn’t happen often, but you need to be aware of the rules.

Determining reasonable pay and benefits

In past years, if the IRS discovered wrongdoing in a nonprofit, it had little recourse but to take away the organization’s tax-exempt status. However, when revised tax laws were passed in 1996, the IRS gained the authority to apply “intermediate sanctions” when nonprofits provide excess benefits to certain staff members or other disqualified persons. Board members and their family members — really anyone who can influence the organization’s activities — are disqualified persons.

Excess benefits can include excessive salaries for staff members or a business deal arranged to benefit a disqualified person in which the nonprofit overpays for a service. So, if you sit on a board of directors that decides to rent office space from your uncle at two or three times the going rate, you and your uncle may be in trouble. If you do decide to rent from your uncle, be sure you can document that you’re paying a market-rate rent (if not less). Also, you shouldn’t participate in the board vote about renting the space.

An excessive benefit for a nonprofit staff member is any sum that’s above a “reasonable amount.” You’re probably thinking, “What’s a reasonable amount?” and you’re right to ask the question. In the case of executive compensation, it’s up to the board of directors to find out what a fair salary is for nonprofit managers in your area and for an organization of your size and scope.

If the IRS finds that someone in your nonprofit has received an excessive benefit, the financial penalties are severe. The IRS levies a 25 percent tax on the excess amount, and the employee must pay the full excess amount (including interest and the 25 percent tax) back to the organization. If payment isn’t received by that time, the tax can go up to a whopping 200 percent. Board members also may be liable for penalties for approving excessive compensation.

These three tips can help you avoid excess benefits problems:

  • Don’t allow board members to participate in decisions that may benefit themselves or their family members. And, certainly, don’t let the executive director participate in setting her own compensation.
  • Rely on credible independent information about reasonable costs in business deals and compensation matters.
  • Document the reasons that you make the decisions you make.

Don’t be frightened by visions of huge tax bills. We’re not saying that you can’t pay nonprofit staff well or that you have to undertake a scientific study to determine fair compensation. Use your head, be reasonable, and exercise caution.

Document board decisions by keeping minutes of board meetings. You don’t need to keep a verbatim record of board deliberations, but you want your minutes to reflect the discussions you have and the decisions you make. Maintain what’s known as a board book — a binder that contains copies of your articles of incorporation, IRS letter of determination for tax exemption, bylaws, amendments to bylaws, notices sent to announce board and membership meetings, and a chronological record of your board-meeting minutes.

Using caution when getting involved in politics

We aren’t saying that you shouldn’t get involved in politics, because it’s your right to do so. If you want to give your personal support and endorsement to a candidate, by all means do it. But be sure to separate yourself from your nonprofit organization when you do. Nonprofits in the 501(c)(3) category can’t support or endorse candidates for political office.

If you want to talk to your legislator about the passage of a bill that benefits your clients, go ahead and make an appointment. But if you find yourself traveling to your state capital or to Washington, D.C., on a regular basis, step back and consider how much organizational time and money you’re spending on the activity. Charitable nonprofits can spend an “insubstantial” amount on direct lobbying activities. If it’s 5 percent or less of your organizational budget, you’re probably within the limits allowed, according to the people who pay attention to these things.

Be more cautious with what’s known as grassroots lobbying, or attempting to influence the general public to vote in a particular way. If lobbying is important to your overall mission as a 501(c)(3) public benefit nonprofit, you can elect the “h” designation, which requires more financial reporting to the IRS but allows you to spend more money on these activities. To do so, file IRS Form 5768 after you have a look at the regulations in IRS Publication 577.

Why all the fuss? Understanding the increased scrutiny

Nonprofit organizations face increasing regulation and public scrutiny in the years to come. Why? Three reasons come to mind:

  • Concern about how nonprofit organizations use contributions that are made for disaster relief efforts
  • A series of widely reported cases in which some nonprofits, both public charities and private foundations, have paid very high salaries to executives and trustees and otherwise pushed the limits of ethical behavior
  • The number and degree of corporate-accounting and insider-trading scandals that have been revealed during the past few years in the for-profit sector

These factors have focused more public and legislative attention on how nonprofit organizations (and for-profit corporations) operate and how their affairs are regulated.

Greater accountability is being asked of nonprofit leaders, both managers and board members, in how money is raised, how conflicts of interest are avoided, and how funds are spent, especially for salaries and expenses. The National Council of Nonprofits has compiled good principles of nonprofit management from several states that provide overall guidance in this area.

If you’re involved with a startup nonprofit that’s operating on a shoestring, you may be asking yourself why you need to worry about getting paid too much. And you’re right; you probably don’t need to worry. But you should stay informed of changes in reporting requirements. You still need to have good, ethical operating policies in place; keep good financial records; and document your organizational decisions with board and committee meeting minutes.

If you’re already involved with a medium or large nonprofit, be aware of the need for independent financial audits and board policies that address excessive compensation, self-dealing, whistle-blowers, and conflicts of interest. The IRS provides a sample conflict of interest policy in the instructions for filing Form 1023. You can also find examples at the Nonprofit Kit Dummies page.

Because the regulatory situation is always changing, and because it varies from state to state, you should visit the websites of Independent Sector and BoardSource to keep abreast of the latest developments. If you have an accounting firm performing a review or audit, it should be able to keep you informed about current legislation and verify that you’re in compliance.