Few board responsibilities feel as uncomfortable as deciding how much to pay the person who leads your organization. It touches money, relationships, and the IRS all at once. Handled poorly, it breeds resentment, invites scrutiny, and can even trigger penalties. Handled well, it protects the organization, respects the executive, and demonstrates exactly the kind of stewardship donors and regulators expect.
This is squarely a board job. The executive director should never set their own pay, and the board should never treat the decision as a rubber stamp. Here is a practical framework for getting it right.
Why the IRS Cares
Nonprofits exist to serve a mission, not to enrich insiders. When compensation for a top executive is unreasonably high, the IRS treats it as an "excess benefit transaction." Under intermediate sanctions rules, the individual who received the overpayment and the board members who approved it can face excise taxes. In extreme cases, an organization's tax-exempt status is at risk.
The good news: the law gives boards a clear path to protection called the rebuttable presumption of reasonableness. If you follow three steps, the IRS presumes your decision was reasonable, and the burden shifts to them to prove otherwise.
The three steps are:
- The compensation is approved in advance by an authorized body (the board or a committee) made up of people with no conflict of interest.
- That body relies on appropriate comparability data before making the decision.
- The body documents the basis for its decision, in the minutes, at the time it is made.
Miss these steps and you lose the presumption. Meet them and you have a strong shield.
Step One: Get the Right People in the Room
The executive director cannot participate in setting their own pay. Neither can anyone with a financial or personal conflict, such as a family member or a business partner.
Many boards delegate the initial work to a small committee (sometimes the executive committee, sometimes a dedicated compensation committee), which then brings a recommendation to the full board. That is fine, as long as the deciding body is free of conflicts.
Practical steps:
- Ask the executive director to leave the room during the discussion and vote.
- Confirm that no one voting has a disqualifying relationship.
- Note in the minutes who was present, who was absent, and who recused.
Step Two: Gather Real Comparability Data
This is where many boards stumble. "It feels about right" is not data. You need evidence of what similar organizations pay for similar roles.
What counts as appropriate comparability data:
- Salary surveys for nonprofits of similar size, mission, and region. Several reputable compensation surveys exist, and some are free through state nonprofit associations.
- Form 990 filings from comparable organizations. Compensation for the highest-paid staff is public on Part VII, and you can pull peer filings from free databases.
- Data reflecting the local labor market and cost of living, not a national average that ignores your geography.
For smaller organizations (generally under one million dollars in gross receipts), the IRS applies a lighter standard: data from three comparable organizations can be enough. Larger organizations should gather more.
When you compare, compare the whole picture. Total compensation includes base salary plus bonuses, retirement contributions, health benefits, housing allowances, and any other perks. A modest salary paired with generous benefits can add up to more than it appears.
Step Three: Document at the Time You Decide
Documentation created after the fact carries far less weight. Your minutes should capture the reasoning while it is fresh.
Good compensation minutes record:
- The terms approved (salary, benefits, and effective date).
- The comparability data relied on and where it came from.
- The members who were present and how they voted.
- Any member who recused and why.
- The board's rationale for landing where it did.
You do not need pages of prose. A clear, specific paragraph is far better than a vague sentence.
Beyond Compliance: Doing It Well
Meeting the legal test is the floor, not the ceiling. Compensation decisions are also about fairness, retention, and the message you send to staff and donors.
A few practices that separate strong boards from anxious ones:
- Tie pay to a real performance review. Compensation should flow from a documented evaluation of the executive's goals and results, not from habit or a cost-of-living reflex. If your board does not conduct an annual review, start there.
- Set expectations before the conversation. Agree in advance on how raises, bonuses, and benefits will be considered so the decision does not feel personal or arbitrary.
- Talk about the whole package. Retirement contributions, professional development, and flexibility can matter as much to an executive as base salary, and they may cost the organization less.
- Revisit annually. Comparability data ages. A benchmark from five years ago no longer reflects the market. Build the review into your yearly calendar.
- Be transparent within reason. The board should be able to explain, in plain terms, why the executive is paid what they are. If that explanation would be uncomfortable to share, dig deeper before you approve.
A Word on Founders and Long-Tenured Leaders
Compensation gets especially delicate with a beloved founder or a long-serving executive who is also, effectively, a peer to many board members. Friendship can push pay up ("they've given so much") or, just as often, hold it down ("they'll accept less because they care"). Neither impulse serves the organization.
The discipline of comparability data cuts through both. Anchor the conversation in what the role is worth in your market, evaluated against actual performance, and you protect both the mission and the relationship.
When to Bring in Help
Most boards can handle this process with good survey data and careful minutes. Consider outside help when:
- Total compensation is large enough to draw regulatory attention.
- You are structuring bonuses, deferred compensation, or unusual benefits.
- The board lacks confidence in the comparability data available.
A compensation consultant or a nonprofit attorney can review your process and confirm your numbers are defensible. The cost is small next to the risk of getting it wrong.
The Takeaway
Setting executive pay is not about generosity or thrift. It is about defensible judgment. Get conflicted parties out of the decision, ground the number in real comparability data, and write down your reasoning while you make it. Do those three things every year, tied to a genuine performance review, and you will pay your leader fairly, protect your board, and be ready if anyone ever asks how you decided.