Whether a non-profit organization can pay its board members is a complex issue at the intersection of tax law, corporate governance, and public trust. While board service is generally expected to be voluntary, the Internal Revenue Service (IRS) permits exceptions under strict conditions that protect the organization’s charitable mission and tax-exempt status. Navigating these rules requires careful adherence to federal regulations and a comprehensive understanding of the difference between appropriate compensation and prohibited private benefit.
The Legal Baseline: Unpaid Service and IRS Scrutiny
The foundational principle for all tax-exempt public charities is the prohibition against private inurement, which is a core requirement for maintaining status under Internal Revenue Code Section 501(c)(3). This rule dictates that no part of the organization’s net earnings can benefit any private shareholder or individual who has a close relationship with the charity, such as a board member. The purpose of the non-profit must remain exclusively charitable, educational, or religious, not a vehicle for the private gain of its insiders.
A transaction that violates this rule is termed an “excess benefit transaction” under Internal Revenue Code Section 4958. This occurs when an economic benefit provided by the organization to a “disqualified person,” which includes all voting board members, exceeds the value of the consideration the organization receives in return. Paying a board member more than the fair market value for any service would trigger such a transaction.
Violations of Section 4958 carry financial consequences known as intermediate sanctions, which are excise taxes levied directly against the individuals involved rather than the organization. The disqualified person who receives the excessive payment faces an initial tax equal to 25% of the excess benefit. If the amount is not corrected by repaying the excess to the charity within a specified time, an additional penalty tax of 200% of the excess benefit is imposed. Board members, as organizational managers, who knowingly approve the transaction can also be subjected to a 10% tax on the excess benefit amount.
Compensation Versus Reimbursement of Expenses
It is important to clearly distinguish between paying a board member for services and merely reimbursing them for out-of-pocket costs related to their board duties. Compensation is defined as a payment for services rendered, whether for their fiduciary role or other professional work. Reimbursement covers actual, necessary, and reasonable expenses that the board member incurs while performing their duties, such as travel, parking, meals, or lodging for attending meetings or events.
Properly handled reimbursement is not considered compensation and is generally allowed by the IRS as long as the expense is legitimate and properly documented. The organization must operate an accountable plan, which requires the board member to substantiate the expenses with receipts and return any excess advance payments. When a reimbursement plan meets all IRS requirements, the payments are not considered taxable income to the board member.
When Compensation is Permitted: Reasonable Payment for Professional Services
A non-profit organization can compensate a board member, but only when the payment is for services rendered outside of their traditional fiduciary duties as a director. For example, an attorney serving on the board could be hired to provide legal counsel to the organization. The services must be specialized and distinct from the governance and oversight duties expected of a volunteer director.
The payment for these services must meet the legal standard of “reasonableness,” which is the amount that would ordinarily be paid for like services by a comparable organization under similar circumstances. Determining this fair market value requires the board to conduct due diligence, such as researching compensation data for similar positions in the non-profit sector or obtaining bids from external vendors. If the compensation exceeds this comparable market rate, the payment constitutes an excess benefit transaction.
Navigating Conflicts of Interest and Documentation
The process for approving any compensation to a board member must follow rigorous governance procedures to establish that the transaction is not an act of private inurement. The non-profit must have a formal, written conflict of interest policy that governs these types of transactions. The policy requires the interested board member to fully disclose their financial interest and recuse themselves from any discussion or vote concerning the compensation arrangement.
The decision to compensate a board member must be made by an authorized body, typically the full board or a designated committee, composed entirely of individuals who do not have a conflict of interest. Meeting minutes must clearly document the procedural steps taken, including the date the compensation was approved and the comparability data relied upon to determine the payment’s reasonableness. This thorough documentation creates a “rebuttable presumption of reasonableness” in the event of an IRS audit.
State-Specific Rules and Fiduciary Duties
While federal tax law governs the non-profit’s tax-exempt status, state non-profit corporation acts govern the organization’s incorporation and the duties of its directors. Many state laws specifically address director compensation, and some may require that compensation provisions be explicitly included in the organization’s bylaws or articles of incorporation. Certain states, such as California, limit the number of compensated board members, requiring that no more than 49% of the board be compensated or related to a compensated person.
State law also imposes fundamental fiduciary obligations on all board members, primarily the duty of care and the duty of loyalty. The duty of care requires directors to act in good faith and with the prudence that an ordinary person would use in a similar position. The duty of loyalty mandates that directors act in the organization’s best interest, placing the charity’s welfare above their personal financial gain.
Ethical Considerations and Best Practices
Even when compensation to a board member is legally permissible and properly documented, non-profits must consider the ethical and reputational implications of such payments. Paying a director can negatively impact public perception, potentially eroding donor confidence in the organization’s commitment to its charitable mission. Since the public often views non-profit board service as a purely volunteer endeavor, compensation can lead to questions about the organization’s priorities.
Best practices suggest that compensation should be limited to instances where a board member possesses highly specialized skills that are difficult to procure from an outside source at a better rate. To maintain a strong appearance of independence, organizations should strive to maintain a majority of uncompensated board members. The organization must prioritize transparency by clearly disclosing all compensation paid to directors on its annual public filing, Form 990.