Boards of directors have the authority to delegate responsibility for maintaining the daily operations of the organization to a chief executive officer. One of the most important responsibilities of the board, then, is to select, supervise, and determine a compensation package that will attract and retain a qualified chief executive. The organization’s governing documents should require the full board to evaluate the performance and approve the compensation of the chief executive annually and in advance of any change in compensation. The board may choose to approve a multi-year contract with the CEO that provides for increases in compensation periodically or when the CEO meets specific performance measures, but it is important that the board institute some regular basis for reviewing whether the terms of that contract have been met. If the board designates a separate committee to review the compensation and performance of the CEO, that committee should be required to report its findings and recommendations to the full board for approval and should provide any board member with details, upon request. The board should then document the basis for its decision and be prepared to answer questions about it.

• One of the board’s primary responsibilities is to select and supervise the CEO, thereby entrusting to him or her the daily management of the organization.
• The board is the supervisor of the chief executive and in that capacity should evaluate the chief executive’s performance annually. 
• Performance evaluation should be a formal, documented process that is based on a clear job description and includes mutually agreed-upon annual goals. 
• Compensation must be reasonable but competitive enough to attract and retain highly qualified individuals. 
• Compensation adjustments should be based on performance and tied to predetermined performance goals.

• Written annual performance assessment can serve as a legal document during employment disagreements. 
• The payment of excessive compensation can jeopardize an organization’s IRS tax exemption. 
• Under the Intermediate Sanctions and foundation excise tax provisions, the IRS can impose tax penalties on CEOs of 501(c)(3) and 501(c)(4) organizations who receive excessive compensation and on board members who approve such compensation knowing it to be excessive. 
• The Intermediate Sanctions regulations set out a process for awarding CEO compensation that can establish a presumption of reasonableness in the event of an IRS audit. This process requires having the decision made by independent board members, using comparable market data to establish reasonableness,and documenting the board decision in minutes.Although not specifically applicable to private foundations, this process under the Intermediate Sanctions regulations can also help establish the reasonableness of private foundation CEO compensation. 
• The Intermediate Sanctions regulations also establish a limited protection for initial compensation decisions that follow certain procedures. There is no comparable provision for private foundations. 
• On the IRS Form 990, the organization must list the compensation of the CEO, as well as other officers, directors, and key employees earning over $100,000. Schedule J must be filled out for those individuals whose total compensation exceeds $150,000. 
• On IRS Form 990-PF, the foundation must list the compensation of the CEO, as well as other officers, directors, trustees, and foundation managers

A charitable organization is permitted under current law to pay reasonable compensation for services provided by its board members, its chief executive officer, and other staff. Reasonable
compensation is defined as the amount that would ordinarily be paid for like services by like
enterprises (whether tax-exempt or taxable) under like circumstances.¹ Charitable organizations are prohibited from providing excessive compensation or economic benefit to executives and other individuals who have substantial influence over the organization’s affairs, and to family members of such individuals.² Private foundations are generally prohibited from engaging in any financial transactions, other than payment of reasonable compensation for services deemed necessary to the foundation’s exempt purposes, with such individuals.³

Federal law specifically encourages public charities to have executive compensation approved in advance by members of an “authorized body” of the organization (such as the board or a board appointed committee), none of whom has a conflict of interest with respect to the transaction.⁴ If the authorized body meets certain independence standards, approves the compensation based on appropriate data that help determine comparability or fair market value and documents the basis for its determination at the time it makes its decision, the
regulations confer a rebuttable presumption of the reasonableness of the compensation.⁵ Although the IRS may not draw any negative inferences simply because an organization chooses not to follow these procedures,⁶ penalties on those who receive, and on charity managers who approve, compensation that is later found to be excessive, may be avoided if procedures are followed.

Federal tax regulations define comparable data needed to determine the reasonableness of compensation or other transactions with disqualified persons as including (1) compensation paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; (2) the availability of similar services in the geographic area; (3) current compensation surveys compiled by independent firms; (4) actual written offers from similar organizations competing for the disqualified person; and, if the transaction involves the transfer of property, (5) independent appraisals of that property and (6) offers received as part of an open and competitive bidding process. Public charities with gross receipts (including
contributions) of less than $1 million may rely on the compensation paid by three comparable
organizations in the same or similar communities for similar services when approving  compensation arrangements.⁷

Board members and other managers of charitable organizations who approve a transaction knowing it provides an excess benefit are generally jointly and severally liable for a tax on the transaction amount for private foundations or the excess benefit for public charities, unless their participation is not willful and due to reasonable cause.⁸ For private foundations, an exception to the general rule provides that if the transaction involves compensation, the penalties are based on a percentage of the excess compensation (not the total compensation).⁹

To impose penalties on public charity or private foundation managers, the IRS must prove that
the organization manager’s actions in accepting or approving an excess benefit or self-dealing transaction were conscious, voluntary, and intentional, and that the manager had actual knowledge of sufficient facts to determine that the transaction would be an excess benefit or self-dealing transaction, was aware that such a transaction would violate federal excess benefit or self-dealing transaction laws, and negligently failed to make reasonable attempts to determine whether the transaction was an excess benefit or self-dealing transaction.¹⁰ A board member or other manager who relies on the advice of legal counsel (or, in the case of public charity managers, certain other professionals)¹¹ is generally not held responsible
for knowing that the transaction was improper.¹² In addition, a board member or other manager of a public charity is generally not held responsible for knowing that a transaction conferred an excess benefit if an appropriate authorized body has met the requirements of the rebuttable presumption procedures with respect to the transaction.¹³

Federal laws do not subject managers of public charities to the excess benefit rules when they are setting the compensation for a new chief executive officer, chief financial officer, or a chief operating officer so long as the new employee was not a board member, key manager, or substantial contributor to the organization in the preceding five years, there is a written agreement governing the terms of compensation before the new executive takes office and the compensation is based on a fixed amount or formula over single or multiple years.¹⁴

Charitable organizations, with some exceptions,¹⁵ are required to report on their Form 990 or 990- PF the name, title, and average hours per week of every board member, officer, and key employee. In addition, the organizations must report the compensation, contributions to employee benefit plans and deferred compensation, expense account, and other allowances paid during the year covered by the report to any current or former board member, officer, and key employee. The instructions to the forms specify that all types of compensation must be reported, including both taxable and nontaxable fringe benefits except for de minimis fringe benefits (for example, property or services provided to the individual of such a small value as
to make accounting for it impractical).¹⁶

¹ Treas. Reg. § 53.4958-4(b)(1)(ii).
² IRC § 4941 and § 4946; § 4958(f ).
³ IRC § 4941.
⁴ Treas. Reg. § 53.4958-6(a)(1).
⁵ Treas. Reg. § 53.4958-6.
⁶ Treas. Reg. § 53.4958-6(e).
⁷ Treas. Reg. § 53.4958-6(c)(2).

⁸  IRC § 4941; IRC 4958.
⁹ IRC §4941(e)(2).
¹⁰ Treas. Reg. §§ 53.4941(a)-1(b)(3), 53.4958-1(d)(4)(i).
¹¹ Public charity managers may also rely on the professional advice of certified public accountants or accounting firms with relevant tax law expertise, and independent appraisers
or compensation consultants who perform such valuation services on a regular basis, are qualified to make valuations of the particular type of property or services involved, and provide
certifications regarding those qualifications. Treas. Reg. § 4958-1(d)(4)(iii).
¹² Treas. Reg. § 53.4958-3(a)(1).
¹³ Treas. Reg. § 53.4958-1(d)(4)(iv).
¹⁴ Treas. Reg. §§ 53.4941(a)-1(b)(3), 53.4958-1(d)(4)(i).
¹⁵ Excluded from this requirement are organizations, other than private foundations and supporting organizations, with annual gross receipts of $25,000 or less, houses of worship
and specific related institutions, specified governmental instrumentalities, and other organizations relieved of this requirement by authority of the IRS. IRC § 6033(a)(2)
¹⁶ IRC § 132(e).

1. In the board’s role as the supervisor of the CEO, what type of support and supervision do we provide to the chief executive?
2. If the board designates a portion of its responsibility to evaluate and compensate the CEO to a committee, what responsibilities must be retained by the full board? 
3. Do we use an adequate process to evaluate the performance of the CEO?                         - Is the full board involved and informed?
   - Is the CEO’s performance always evaluated prior to an increase in compensation?
4. Do we understand and follow the appropriate steps to ensure that the compensation package paid to the chief executive is reasonable? 
5. Have we established a process and documented the information that supports our compensation decisions?

12 Board Independence

14 Separation of CEO, Board Chair, and Board Treasurer Roles