Nonprofit organizations rely on dedicated individuals to oversee their mission and finances, a responsibility known as governance. This oversight role often creates a tension between the board member’s fiduciary duty to the organization and any potential for personal financial gain. While board service is generally voluntary and uncompensated, strict regulatory rules permit exceptions under specific, heavily monitored conditions.
The General Rule of Unpaid Board Service
The foundational principle guiding tax-exempt 501(c)(3) organizations is that board members serve in a voluntary capacity without expectation of remuneration for their governance duties. This standard practice reinforces the board’s fiduciary duty, ensuring decisions are made solely in the organization’s best interest rather than for individual profit. The commitment to uncompensated service helps maintain public trust and reinforces the charitable nature of the organization’s activities.
Distinguishing Compensation from Expense Reimbursement
A clear distinction exists between paying a board member for their work and simply covering costs they incur while fulfilling their governance obligations. Compensation refers to a salary, fee, or any payment made for services rendered. In contrast, expense reimbursement covers reasonable and necessary costs, such as travel, parking, meals, or lodging, directly related to attending board meetings or performing approved duties. Reimbursement is typically allowed without extensive regulatory scrutiny, provided the board member maintains thorough documentation, including receipts and detailed logs, to substantiate the expenditure.
When Board Members Can Be Paid for Non-Board Services
A board member can receive payment from the nonprofit, provided the compensation is for services rendered in a capacity entirely separate from their role in governance. This exception allows the organization to hire a board member as an independent contractor or employee for a specific, necessary function, such as legal counsel, accounting work, or specialized consulting. The organization must demonstrate that the transaction is both reasonable and necessary for the nonprofit’s operations. The payment must be for bona fide services actually delivered, not merely a disguised distribution of the charity’s assets.
The Internal Revenue Code Section 501(c)(3) strictly prohibits any part of the net earnings of a charitable organization from inuring to the benefit of any private individual, a concept known as private inurement. Excessive payments to a board member could jeopardize the organization’s tax-exempt status. The organization must also guard against private benefit, where the transaction primarily serves the board member’s private interest rather than the public good. Any compensated engagement must withstand rigorous scrutiny to ensure the payment is solely for the value of the non-governance work performed.
Ensuring Fair Market Value and Arm’s Length Transactions
When a nonprofit engages a board member for compensated services, it must document that the payment does not exceed the Fair Market Value (FMV) of the service provided. This demonstrates the transaction was conducted as if the parties were unrelated, known as an arm’s length transaction. Determining FMV requires due diligence, involving the collection and review of comparable data. This research might include obtaining multiple competitive bids from non-board vendors or reviewing salary surveys for similar professional roles in the geographic area.
The board must maintain detailed written records proving the board member’s bid was either the lowest cost option or offered superior quality justifying a higher rate. This documentation provides evidence that the organization exercised prudence and did not award the contract based on personal relationship. Without this documented effort, the transaction can be viewed as an improper benefit conferred to the interested board member.
Navigating Conflicts of Interest
The formal process for approving a compensated transaction is governed by the organization’s written Conflict of Interest Policy. The interested board member has a duty to disclose the potential conflict before any discussion takes place. Once disclosed, the board member must be entirely recused from the discussion regarding the proposed contract. The interested party must leave the meeting room and should not attempt to influence the decision of the remaining board members.
The final approval must be made by a vote of disinterested board members. A majority of the individuals voting must not have any personal or financial stake in the outcome of the deal. Minutes of the meeting must meticulously document the disclosure, the interested party’s recusal, and the basis for the board’s decision, confirming the transaction served the organization’s best interest. This procedure prevents self-dealing and protects the integrity of the board’s decision-making process.
Consequences of Excessive or Improper Payments
Failure to adhere to rules regarding fair compensation and proper procedure can trigger severe penalties for both the organization and the individuals involved. The Internal Revenue Service (IRS) enforces compliance through Intermediate Sanctions, governed by Internal Revenue Code Section 4958. This section imposes excise taxes on “disqualified persons,” including board members, who benefit from an “excess benefit transaction.” The initial tax levied on the disqualified person is 25% of the excess benefit.
If the excess benefit is not corrected promptly, a second-tier tax of 200% can be imposed on the disqualified person. Organization managers who knowingly approved the improper payment can also face penalties. While the most severe consequence is the revocation of the nonprofit’s tax-exempt status, the IRS typically applies Intermediate Sanctions first for compensation issues.
Alternatives to Paying Board Members
Given the regulatory complexity and the potential for severe penalties, many nonprofits seek alternatives to directly compensating a sitting board member. One option is to require the board member to formally resign before entering into any compensated service contract. This eliminates the conflict of interest inherent in the board-member relationship. Another common practice is to hire a close relative of the board member, such as a non-board-affiliated spouse or family member, for the service. While this requires full disclosure and application of the conflict of interest policy, it moves the transaction outside the immediate board structure, reducing the appearance of self-dealing.