Nonprofit Executive Pay: Reasonable, Documented, Approved
How a charity sets compensation for its leaders without triggering the excess benefit excise taxes, the three-step process that creates a presumption of reasonableness, and the tax on pay above $1 million.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A tax-exempt organization may pay its executives and insiders reasonable compensation. Pay above that is an excess benefit transaction: the insider owes a 25 percent excise tax on the excess (200 percent if not repaid), and board members who knowingly approve can owe 10 percent. A three-step approval process shifts the burden of proof to the IRS.
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Who is covered, and what is the penalty?
| Element | Rule |
|---|---|
| Disqualified person | Anyone in a position to exercise substantial influence at any time in the five years before the transaction — voting board members and top executive and financial officers automatically; founders and major donors depending on the facts — plus their family members and 35-percent controlled entities |
| Excess benefit | The amount by which compensation or any transaction's value to the insider exceeds what the organization received in return |
| Tax on the insider | 25 percent of the excess; 200 percent more if not corrected (repaid with interest) within the taxable period |
| Tax on managers | 10 percent of the excess for managers who knowingly approved it, up to $20,000 per transaction |
| Reporting | Excess benefit transactions must be disclosed on Form 990 (Schedule L, Part I); the insider and managers report and pay the taxes on Form 4720 |
| Applies to | 501(c)(3) public charities, 501(c)(4) social welfare organizations, and 501(c)(29) health insurance issuers; private foundations have the separate self-dealing rules |
What creates the rebuttable presumption?
- Independent approval. The compensation is approved in advance by the board or a committee composed of individuals with no conflict of interest in the arrangement.
- Comparability data. The body relies on appropriate data — salary surveys, Form 990s of similar organizations, written offers from comparable employers — for similar positions at organizations of similar size and budget. Organizations with annual gross receipts (including contributions) under $1 million can rely on data from three comparable organizations in the same or similar communities.
- Contemporaneous documentation. Minutes record the terms, the date, the members present and voting, the comparability data, and how any pay above the range was justified — prepared before the later of the next meeting or 60 days after the decision.
When all three are met, the IRS must prove the pay was unreasonable; otherwise the organization must prove it was reasonable.
What counts as compensation?
Salary, bonuses, deferred compensation, benefits, expense reimbursements outside an accountable plan, loans, housing, and personal use of organization property. Taxable benefits must be clearly treated as compensation when paid — reported on Form W-2, 1099, or 990, or set out in a written contract — or they are automatic excess benefits regardless of amount; nontaxable benefits such as health coverage and retirement contributions are exempt from that reporting requirement.
What about pay above $1 million?
Separately, Section 4960 imposes a 21 percent excise tax (the corporate rate) on the organization for remuneration above $1 million paid to a covered employee (and on certain excess parachute payments), excluding pay for medical or veterinary services by licensed professionals. Through 2025 covered employees were the five highest-paid (plus anyone covered in an earlier year); for taxable years beginning after December 31, 2025, P.L. 119-21 extends the tax to every current or former employee (employed in any year after 2016), so from 2026 anyone paid over $1 million is covered.
Frequently asked questions
Can a founder be paid a salary?
Yes, if reasonable for the work and approved under the process above with the founder recused.
Are bonuses tied to fundraising results permitted?
Incentive pay is allowed if the total remains reasonable and the arrangement does not amount to a share of net earnings; percentage-of-revenue deals are scrutinized.
Does the presumption protect the board from the 10 percent tax?
Managers who follow the process in good faith are generally not "knowing" participants.
Do these rules apply to volunteers who are reimbursed?
Reimbursements under an accountable plan are not compensation; unsubstantiated allowances are.
Official sources
The IRS explains: “An excise tax equal to 25 percent of the excess benefit is imposed on each excess benefit transaction between an applicable tax-exempt organization and a disqualified person. The disqualified person who benefited from the transaction is liable for the tax.” — Internal Revenue Service, Intermediate sanctions - Excise taxes, https://www.irs.gov/charities-non-profits/charitable-organizations/intermediate-sanctions-excise-taxes
The IRS explains: “If an organization meets the following three requirements, payments it makes to a disqualified person under a compensation arrangement are presumed to be reasonable, and a transfer of property or the right to use property is presumed to be at fair market value.” — Internal Revenue Service, Rebuttable presumption - Intermediate sanctions, https://www.irs.gov/charities-non-profits/charitable-organizations/rebuttable-presumption-intermediate-sanctions
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk assembles the comparability file and the minutes template that create the presumption for nonprofit boards. See pricing or book a free fit call.
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U.S. and Canadian filings prepared together by our U.S. and Canadian Tax Desks.
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