What is reasonable compensation for private foundation board members, executives and key employees?
Private foundations should exercise caution when they compensate board members, executives and key employees due to potential conflict of interest issues. The concern here is that the compensation can go beyond what is reasonable and become excessive—this issue is more salient because foundations are commonly controlled by a small related group such as a family or a business enterprise. Private foundations are charitable organizations that exist to serve the public, not to line the pockets of foundation insiders with easy money. Of course, what constitutes reasonable compensation and what is excessive varies widely depending on all the underlying facts and circumstances—there is no definitive formula. Let’s consider some protocols regarding how foundations can assure compensation is set at a reasonable level when there are potential conflicts of interest.
Any compensation paid to board members arouses an inherent complication. The board of directors is responsible for making the top-level decisions about the management of the organization—this includes the responsibility to set the compensation of the board itself. There is an inherent conflict of interest for anyone charged with setting their own compensation. As a result, the board members should use an arms-length approach to compensation meaning they should try to set compensation at a level that two unrelated parties would agree is fair and in their independent self-interest. During this process the board members should endeavor to be conscientious, conservative, and deliberate. Bear in mind that compensation comes in a variety of arrangements (e.g., salary, stipends, health benefits, retirement plans, etc.) so all facets of a compensation package should be considered.
Setting reasonable and fair compensation depends on a wide variety of factors including:
• The job description and responsibilities involved
• The skill required to perform one’s duties
• Time demands to fulfill duties (full time or part-time)
• The foundation’s complexity of operations
• The foundation’s endowment size
• The methods of grantmaking and the complexity of programs
• Geographic location (pricey New York City or affordable Oklahoma City)
• Compensation paid at other foundations for similar positions
After taking stock of the many factors that go into setting a reasonable compensation amount, a foundation should acquire comparable compensation data. Finding good comparable compensation data is the most important element in determining whether an individual's compensation is reasonable so significant effort should be spent here. Many organizations compile and publish compensation surveys specifically focusing on private foundations. Regrettably, most of these surveys are secured behind paywalls. Nonetheless here are links to two well-regarded surveys (both require payment):
• Council on Foundations—2021 Grantmaker Salary and Benefits Report
• Exponent Philanthropy—2022 Foundation Operations and Management Report
Aside from compensation surveys it is also possible to review the annual tax returns (Form 990-PF) of peer foundations for compensation information. Private foundations are required use this form to report compensation paid to board members, trustees, officers, managers and the five highest paid employees. Form 990-PF is almost always available on database websites such as Candid and ProPublica Nonprofit Explorer and is sometimes available on a foundation’s own website. Private foundations also have to option of hiring a compensation consultant with more data to ensure that any compensation is justifiable and fair—this is more common with the larger foundations. Foundations using a compensation consultant oftentimes refresh the recommendation every few years to make sure everything is up-to-date.
After the board arrives at a proposed compensation amount it is a good idea to conduct a quick reality check. Does the proposed compensation seem reasonable if it is broken down into an hourly rate basis? Would an independent third party pay the proposed compensation for the services being provided? The answers to these questions must be sensible and justifiable.
In order to finalize the process, the board must formally approve the compensation package. Setting board member compensation requires a board meeting so naturally board minutes are required to record the discussion and the results of the vote. In addition to the board minutes, the entire process of establishing compensation should be documented—the best kind of documentation is contemporaneous. The documentation should show what resources were consulted and why any compensation data is comparable to the foundation’s circumstances.
The process for setting compensation for executives and key employees is basically the same as it is for setting board member compensation. When the executives and employees are family members or another class of disqualified person, the foundation should be particularly vigilant in setting their compensation. Sometimes a private foundation is nestled alongside a family office or an operating business with the employees serving both the foundation and the for-profit organization. In these cases, the foundation should take great care to ensure the work performed by the executives and the employees is actually rendered on behalf of the foundation and not for the related company. In setting a compensation amount, the foundation should consider the same factors listed above such as the job description and comparable compensation paid at other foundations for similar positions. The foundation will need to hold a board meeting to set the compensation of the executives but may not need one for employees. Of course, there still is an obligation to document the entire process.
Private foundations that allow excessive compensation to occur can find themselves in a world of trouble ranging from bad publicity to severe fines to the loss of their tax exemption. Remember that private foundations are required to report compensation information each year on their annual tax return (Form 990-PF). This is a public document and it is very easy here in the 21st century to look up online. Anyone from a nosy neighbor to an investigative journalist can look up the tax return of almost any private foundation in a matter of minutes. Aside from potential bad press and reputation risk, the governmental authorities at the federal and state level can take enforcement actions if they believe a private foundation is being defrauded or being used as a vehicle of personal enrichment. The IRS is likely to view excessive compensation as a form of self-dealing, which can result in severe financial penalties and even the revocation of the foundation’s 501(c)(3) status. Likewise, the various state attorney general’s offices ordinarily have the power to levy severe fines, remove board members and, in egregious cases, the ability to shut down a foundation in its entirety. Disciplinary action of this kind is exceptionally rare. The overwhelming majority of foundations operate in a principled manner and endeavor to only pay reasonable compensation.
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