A common misconception is that directors who run not-for-profit organizations work for free. Though some may view their work as a charity, many directors do get paid. The process for paying a director while maintaining a nonprofit's status is determined by the IRS.
How Nonprofits Work
A nonprofit corporation is a business organization that serves a public purpose. Although it can make a profit, the profits must be put back into the organization and not distributed to owners and shareholders like they are in a corporation. A nonprofit is incorporated under its particular state's laws, but it receives tax-exemption status from the IRS. The most common tax-exemption application is under 501(c)(3) of the IRS code, for organizations that do charitable, educational, scientific or religious work.
Paying a Director
A director of a nonprofit can be paid a salary. The rules regarding this salary are not determined by state law but by the IRS. According to the IRS, a director's salary must be a reasonable compensation for services rendered. This salary must also be determined by people not having a financial interest in the decision.
The IRS does not define exactly what reasonable compensation for services rendered means. However, in general the IRS requires that for compensation to not be excessive, the director must have an actual job description and the required level of education or experience is commensurate to his salary. The nonprofit organization must keep records regarding the charity's overall budget and the number of hours the director worked. All these can be considered to determine whether the director's pay is reasonable.
IRS Three-Step Process
A nonprofit can follow a three-step process described by the IRS in its Form 990, in order for the IRS to assume that the director's compensation is fair without needing further evidence. The first step is having an independent committee review the director's compensation package, which includes not only the salary but benefits as well. The second step is that the committee must use comparable data when deciding the salary. In other words, the committee must compare the director's salary to that of people in similar occupations. Finally, there must be documentation of the committee's decision-making process, such as minutes of its meeting.
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