12 Mar IRS Defines “Reasonable Compensation” for Board Members
While many board members donate their services to an association, the law does not require it. The Tax Court has stated that, “they are entitled to reasonable compensation for their efforts.”
As such, compensation for service on an association board is quite common, but not without controversy. The controversy reflects the fears that no one is watching expenditures to assure they are going for the purposes for which they are intended. An association that meets the IRS definition of reasonable compensation can allay those fears.
Defining Compensation for an Association Board Member
For the purposes of this discussion, we will be using the IRS definition of the term compensation which includes
–Salary or wages
–Contributions to pension and profit sharing plans
–Unpaid deferred compensation
–Payment of personal expenses
–Rents, royalties or fees;
–Personal use of organization’s property (vehicle) or facilities
IRS Exemptions that Allow Board Member Compensation
As part of its code, the IRS prohibits any direct financial transaction between a non-profit and virtually all persons closely related to the association, such as board members. (The practice is known as self-dealing.”) However, board members may legally be compensated if their services are
–Necessary – The service for which compensation is offered must be consistent with the purpose and mission of the association.
–Personal – The IRS limits what it considers “personal” to only those services that have been clearly identified in Treasury regulations or IRS rulings. These are: general banking services, legal services, accounting services, and/or investment services; services of a broker acting as an agent
Examples of services that are not personal would include commercial property management services, interior decorating, information technology services and many other services provided by independent consultants.
What is Reasonable Board Member Compensation?
A board member’s compensation must be able to pass two different tests:
–An amount test – examines whether the total amount paid is reasonable given the total financial picture of the association
–A purpose test – examines whether the service is reasonable given the nature of the association
The IRS considers 12 factors when performing these tests:
-Nature of duties
-Background and experience
-Knowledge of the business of the association
-Size of the association
-Contribution to the association
-Time devoted to the association
-Economic conditions (local and general)
-Degree of responsibility
-Time of year when compensation is determined;
-Relationship of board member’s compensation to stock holdings
-Whether alleged compensation is in reality, payment for a business or assets acquired
-Amount paid by similar size businesses in the same area to equally qualified employees for similar services
Principles of Good Governance for Non-Profit Associations
Reports of outrageous fees and exorbitant compensation led to an examination of the practice by the Internal Revenue Service and legislative efforts by Congress to limit the abuse. Ultimately, the Senate Finance Committee issued a “Principles for Good Governance” document.
While Congress did not ban compensation outright, the Principles suggest that members of a board should serve without compensation, “other than reimbursement for expenses incurred to fulfill their board duties.”