Establishing Executive Compensation for your Ministry

Establishing compensation for the top executive of a ministry—the CEO is often the board’s only employee—is one of the key challenges for governing boards. How much is enough and yet not too much? Should a portion of the compensation be fixed and another part be variable based on the attainment of certain goals? How does the organization determine the relationship between the pay of the CEO and other employees in the ministry? How should executive compensation compare with other similar nonprofit or for-profit organizations?

Based on the public perception that some charity leaders are paid excessively, there continues to be a keen interest in the compensation of nonprofit executives. While attention centers on high salaries and benefits, many nonprofits experience too many needs and too few resources. This often results in executive compensation that is exceedingly low.

Establishing a fair and reasonable compensation plan for executives is not accomplished in one step; it a process. If an organization is embarking on this process or is reviewing its existing plan, the following compensation planning checklist may be helpful:

  • Follow ECFA's Policy for Excellence in Compensation-Setting and Related-Party Transactions. ECFA's Standard 6 is a model policy that is recommended for all churches and ministries whether or not they are accredited by ECFA.

  • Prepare a compensation philosophy statement.  A clear, well-articulated executive compensation statement serves many beneficial purposes, including the following:

    • The philosophy can demonstrate the value the ministry places on spiritual leadership—possibly the most valuable contribution a CEO or other executive can make to your ministry.

    • The philosophy can reflect the long-term principles by which executive compensation will be determined. Although subject to periodic board review, this consensus should survive both annual board turnover and fluctuations in personal viewpoints on compensation issues.

    • The philosophy should support the ministry’s foundational strategies. There should be linkage between the compensation philosophy and the satisfaction of the charitable mission or the ministry.

    • The philosophy can provide greater stability to the executive compensation arrangement, which will assist in recruiting and retaining executive talent.

    • The philosophy can demonstrate the ministry’s commitment to measure compensation based on comparable levels of responsibility, performance, and results, which will help to negate any perceptions concerning overly generous compensation.

    • The statement can articulate the ministry’s view on executive pay in relation to other levels of employees. For example, some organizations address this matter by establishing limits on the variance between the highest and lowest paid employees in the organization in terms of salary multiples, e.g., the CEO will not be paid more than 10 times the pay the lowest paid employee receives.

  • Determine comparable compensation data for other organizations. Try to compare like services provided to like organizations under like circumstances. In your comparisons, consider the duties, amount of time devoted to work, size of organization (gross revenues, staff, program services), experience, familiarity with the organization’s mission, educational requirements, economic conditions, and even public stature.

  • Research organizations that appear to have successful compensation strategies. The CEOs of other ministries often will share information on their compensation plans. But do not expect to replicate their plans, because each organization is different.

  • Be clear that compensation is more than base salary. It is important to understand the components of taxable compensation so you can report the proper amount for payroll reporting purposes (Forms 941 and W-2). However, there are a host of compensation elements that must be considered in addition to taxable compensation.

    When determining whether compensation is reasonable or excessive, certain fringe benefits (e.g., contributions to qualified retirement plans, health benefits, and the like) and the reimbursement of business-related (as opposed to personal) expenses (e.g., moving expenses, meals or lodging provided for the convenience of the employer, expenses reimbursed under an accountable plan, and educational expenses) are not generally considered. However, some compensation elements that must be considered include:

    • Value of the personal use of an organization-owned vehicle

    • Bonuses and incentive pay

    • Nonaccountable business expense reimbursements, advances, or allowances

    • Below-market rate loans of $10,000 or more by the organization to the executive

    • Below-market rate transfers of property by the organization to the executive

    • Reimbursement of any portion of a minister’s self-employment taxes

    • Taxable fringe benefits

    • Assignment of income

    • Christmas and other special occasion gifts

    • Retirement gifts and most severance pay packages

    • Forgiveness of debt

    • Sabbatical pay

    • Personal expenses of an executive that are paid by the organization

    • Employer reimbursements of travel expenses for an executive’s spouse or children not representing bona fide business expense

  • Strive for independence in setting compensation.  There should be clear evidence that the CEO’s salary and benefits are set in an "arm’s length" agreement. The CEO should not have undue influence over the board in setting his or her own compensation level. Records should reveal that the board has acted independently, without any conflict of interest.

    Many organizations establish a board subcommittee for compensation review. No one on the committee should be a staff member, related to staff, or have any relationship with staff that could present a conflict of interest. It is often helpful to include one or more committee members who are knowledgeable on compensation matters.

  • Understand the "excessive compensation" rules.  Federal law prohibits charities from paying unreasonable compensation to any officer or employee. A violation of this standard can jeopardize the charity’s tax-exempt status. In addition, the IRS can impose "intermediate sanctions" against officers who receive excessive compensation, as well as against the board members who authorize it.

    Officers and governing boards may rely on a "presumption of reasonableness" with respect to a compensation arrangement, if it was approved by a board of directors (or committee of the board) that: (1) was composed entirely of individuals unrelated to, and not subject to the control of, the disqualified person involved in the arrangement; (2) adequately documented the basis for its decision; and (3) obtained and relied upon objective "comparability" information, such as (a) compensation paid by similar organizations, both taxable and tax-exempt, for comparable positions, (b) independent compensation surveys by nationally recognized independent firms, or (c) actual written offers from similar institutions competing for the services of the disqualified person.

  • Involve the entire board in the compensation-determination process.  The responsibility for compensation of the CEO begins and ends with the nonprofit board. Consistent with the principles of openness and accountability, it is important that all board members, not just the executive committee or a salary committee, know the full details of the CEO’s compensation package and have the opportunity to discuss and approve it.

    The board’s determination of non-CEO salaries and fringe benefits generally depends on the size of the organization. In smaller ministries, direct board involvement in salary administration below the CEO level may be more extensive. In many larger nonprofits, the board generally only approves the compensation package for the CEO, or in some situations, the CEO and the first tier of executives who report to the CEO.

  • Review executive compensation annually.  The full board should annually review, discuss, and approve executive compensation. The board often will delegate the performance evaluation to a subcommittee, which then will bring a recommendation to the board. The affected executives and any other related parties should not be present when the executive compensation package is discussed or voted. The results of the compensation review should be formally recorded.

  • Put the agreement in writing.  Once agreement has been reached concerning executive compensation, formalize the agreement with a written document executed by the organization and the executive(s). This may be in a document separate from the employment agreement or contract; for example, when compensation changes are made more frequently than changes to the basic employment agreement are made.

  • Decide how to treat outside honoraria.  Many nonprofit executives speak at various conferences and events. They often receive honoraria for such appearances. Should the executive keep these honoraria? If so, what if any impact should this have on the executive’s compensation? If the executive is not permitted to retain the honoraria, what happens to them? If they are assigned back to the employer, have you taken steps to be sure that they are not reported as taxable income to the executive as a result of the "assignment of income" doctrine? Such a result can be avoided if the organization or executive informs the payer prior to the date of the appearance that any honorarium should be paid directly to the employer.

  • Decide how to handle publications or music produced "on ministry time."  Executives who are authors or composers often are shocked to learn that their employer may be the copyright owner of works that they create. Section 201 of the Copyright Act specifies that "the employer . . . is considered the author" of a "work made for hire" and "owns all the rights comprised in the copyright," unless the employer and the employee "have expressly agreed otherwise in a written instrument signed by them." The Act defines a “work made for hire" as "a work prepared by an employee within the scope of his or her employment." Governing boards should establish a "work made for hire policy" that addresses ownership of works produced by executives and other employees, within the scope of their employment.

Summary.  Excessive compensation for executives is rarely an issue for Christian ministries. Conversely, low executive compensation frequently threatens the development and maintenance of essential services provided by members.

The challenge to ministry boards remains to carefully establish and document the executive compensation process, then balance fair and reasonable compensation within the budgetary constraints of the organization.

 

Steps to Take in Planning and Fulfilling an Executive Compensation Plan

  1. Determine the executive compensation philosophy for your organization and put it in writing.

  2. Obtain data on comparable positions in other organizations.

  3. Set the compensation amounts, including all fringe benefits, for executives in an independent setting at the governing board level. Annually review executive compensation.

  4. Place all specifics of the compensation package(s) in writing, including the treatment of outside honoraria and published works created on ministry time.

  5. Be alert to the dangers of excessive compensation.

  6. Determine if competency-related pay plans would be effective for your ministry.

 


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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