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To Pay or Not to Pay: Compensating Nonprofit Directors and Officers

Posted by Wagenmaker & Oberly on Oct 10, 2017 2:30:00 PM

 

This guidance applies to directors and officers serving on a nonprofit board, often as volunteers, and not necessarily to senior management leaders for whom other responsibilities may apply.

May directors and officers get paid by the nonprofit organizations they serve?  This question often arises when a nonprofit’s founder seeks compensation for his or her services to the organization, as well as occasionally when payment to others seems warranted.  The answer is generally “Yes,” but with several caveats.

Check the Bylaws and Corporate Policies

A nonprofit’s bylaws may or may not address the question of director and officer compensation.  Some bylaws prohibit any payments except for (a) reimbursement of expenses or (b) services provided other than as a director or officer.  The organization’s conflict of interest policy, which all nonprofits should have, also impacts payments to directors and officers.  Each of these considerations is next addressed in turn.

Reimbursement – No Problem

Paying reimbursement to directors and officers for their expenses incurred while serving the nonprofit is legally appropriate, such as for travel or donor-related expenses.  It is not compensation, but rather merely coverage for legitimate nonprofit expenses.

As a matter of internal policy, some nonprofits may ask their directors and officers to personally pay for these expenses themselves, but such practice is not legally required.  Note too that volunteer directors and officers who cover such expenses themselves may treat them as tax-deductible expenses, to the extent confirmed by the nonprofit through a charitable receipt.

Multiple Roles, Potential Employee Status for Officers

A nonprofit director or officer may serve a nonprofit in multiple roles, such as director and food caterer, musician, or teacher.  None of these additional roles involve governance of the organization, as does a director or officer position.  Accordingly, a director or officer serving in such additional capacity is not serving as a paid director or officer, but rather as a paid caterer, musician, teacher, etc. 

As explained below, however, a director or officer who is paid for such additional work may neither be involved in the Board’s deliberations on whether to hire him or her, nor vote on such decision, including compensation aspects.  In addition, if the person is an officer of the nonprofit, then he or she is automatically deemed to be an employee of the nonprofit – as a bright-line matter of law.  In that case, the nonprofit must pay him or her as an employee, not as an independent contractor, regardless of the actual work performed.

Conflicts of Interest – Putting the Nonprofit First

All directors and officers owe a legal “fiduciary” duty of loyalty to their nonprofit organizations.  Stated differently, they must continually ask the question:  Is “X” fair to the organization, and in the organization’s best interests?”  Structurally speaking, this question may only be answered by disinterested, independent-thinking leaders, not directors or officers who have their own financial, business, or family interests potentially impeding their judgment.

A paid director or officer thus is necessarily conflicted, since he or she has an obvious self-interest in getting paid (no matter how small the paycheck).  Such conflicts are generally of great concern to the IRS, since part of its charge consists of making sure private individuals do not unfairly receive charitable assets that should be used instead for publicgood.  (That also makes for bad press.)

Consequently, if a director or officer is to be paid, then the conflict should be recognized, and he or she should excuse himself or herself from the board’s decision on such compensation decision.  Any other conflicted directors or officers likewise should be excused, such as the spouse, other family members, or business partners of the leader to be paid.  Ideally, at least two independent, non-conflicted directors should be available to determine whether the leader is the best person for the job, and whether the proposed compensation amount is fair and in the organization’s best interest.  (A three-person board with only a founder, the founder’s spouse, and a friend are thus ill suited to determine any director compensation.)

The board members who engage in such decision-making must fulfill their corresponding fiduciary duty of due diligence, or due care.  Such due diligence may include evaluation of other potential job applicants.   In addition, compensation amounts should be compared for similar positions, with due regard for varying skills, experience, and education of the people compared.  An excellent source of compensation data is www.guidestar.org, which makes nonprofits’ Form 990s available to the general public, including executive compensation data reported via Form 990.

Getting Paid - Lower Personal Liability Threshold

A director or officer who serves as a volunteer generally enjoys broad legal protection against personal liability, arising from the nonprofit’s activities (e.g., slip and fall accidents, car accidents, trademark infringement, defamation).  Exceptions are generally limited to his or her “gross negligence” (a/k/a “wanton misconduct”), intentional misconduct, or liability under specific statutory schemes (e.g., personal liability for knowingly misusing employment taxes).

If a director or officer is paid, however, then this legal bar is lowered, with potential liability available against a director or officer based on a finding of “ordinary negligence.” What is the difference between “ordinary” and “gross” negligence, sufficient for personal liability?  Unfortunately, that question is squarely one for the jury, and jury verdicts are notoriously unpredictable.

Directors’ and officers’ insurance policies may provide significant legal protection, especially if paid compensation is a high priority.  But for nonprofits that are inclined to pay directors and officers small stipends or honoraria for their board service, this differing legal standard for personal liability may be worth careful consideration.  Better to keep them as volunteers!

To Pay or Not to Pay?

Paying a nonprofit director or officer may be good and entirely appropriate.  If your nonprofit does so, then make sure to have a conflict of interest policy, to apply it through independent and diligent board deliberations, to treat paid officers as employees, and to check the organization’s directors’ and officers’ insurance coverage.


This article originally appeared on Wagenmaker & Oberly Law Firm's Blog.

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