Excessive compensation paid to nonprofit executives and board members is one of the key issues concerning charitable organizations that garner the attention of the general public and Congress. Charitable organizations may pay reasonable compensation to their directors, executive officers and employees for their services without violating applicable federal tax law or state law. The determination of reasonable compensation depends on several factors – the budget of the organization being the most significant factor. Other factors include the number of employees of the organization, the particular sector of the charitable community served by the organization, the geographic location of the organization, the focus of the organization as being national or local, the length of the employee’s service and external market forces.

Even if executive compensation is considered reasonable in light of the foregoing factors, the perception that a charitable organization is paying excessive compensation can be damaging to the organization’s reputation. Some nonprofit executive salaries have reached seven figures, particularly in the larger health care systems and higher education.2 In some cases, the highest paid employee of a charitable organization is not its chief executive officer, but instead may be a senior administrator or key physician of a large urban medical center, a key athletic coach at a Division I university, or a chief investment officer of a university or foundation with a large endowment. Reports of high nonprofit executive compensation have lead the Internal Revenue Service to conduct an Executive Compensation Compliance Initiative in 2004 (with its findings published in March 2007, discussed below), and the Internal Revenue Service continues to scrutinize nonprofit executive compensation. In addition, because nonprofit executive compensation must be reported annually on the organization’s Form 990, the general public, the media, and charity watchdog organizations also scrutinize nonprofit executive compensation. Therefore, it is important for charitable organizations not only to understand the federal tax law governing the payment of reasonable compensation to their directors, officers and key employees, but also to understand their reporting obligations and best practices with respect to executive compensation to avoid undue scrutiny.