All teams need strong leadership in place to thrive, and nonprofits are no different. Unlike private, profit-driven businesses, tax-exempt nonprofits are expected to pay executives a fair and reasonable rate. But how should a nonprofit determine something that seems so subjective?

Putting the Board in Control

The nonprofit’s board of directors should be in charge of hiring executive leadership and setting compensation. If the board of directors is large, consider forming a hiring and/or compensation committee that can focus on the task and make the process move more quickly.

In cases where there is a potential conflict of interest—such as when a family member of a job candidate sits on the board—those individuals should recuse themselves from the discussion. The board or committee must follow any applicable bylaws throughout the process as well.

Determining Executive Pay

The IRS expects nonprofits to pay their CEO or executive director an amount that is “reasonable and not excessive.” To determine what an appropriate compensation package would include, the board or committee in charge of the hiring and compensation process should research organizations in the region with a similar size, scope, and budget.m

Compiling this data should provide an idea of the level of compensation for executives in similar organizations. Once that information is gathered, it can be used alongside other factors, such as a job applicant’s education and experience, in determining a fair compensation package.

Finalizing and Documenting the Process

The board or committee in charge of hiring and/or setting compensation must document all aspects of the process including the basis for the final determination. The full board of directors should take a vote on the recommendation, and any debate, conflicts of interest, and other notable discussions should be included in the documentation. When the nonprofit files its annual IRS Form 990, documentation for the process of selecting an executive and compensation package will be reported.

Ensure you’re properly establishing an executive compensation plan early on so that you can eliminate compliance issues in the future and focus on what really matters—achieving your mission.