Navigating Director Compensation in Private Foundations
The topic of director compensation in private foundations is one that elicits varied opinions, driven by both ethical considerations and practical necessities. While the majority of foundations do not compensate their board members for routine service, a notable portion of them do (around 25%), with compensation practices influenced by the foundation's size, type, and the nature of the board's responsibilities. This discussion explores the complexities surrounding director compensation, distinguishing it from reimbursement, examining the legal frameworks, and weighing the arguments for and against compensating board members. Ultimately, the decision to compensate directors must be carefully weighed against the foundation's mission, ethical standards, and public perception.
Understanding Compensation and Reimbursement
The terms "compensation" and "reimbursement" are often used interchangeably, yet they represent different concepts in the context of private foundations. Compensation generally refers to fees paid to directors for their service on the board, as well as for providing professional services such as legal, accounting, or investment management that are essential to the foundation’s mission. Reimbursement, on the other hand, covers expenses that directors incur while performing their duties. These might include travel expenses for site visits, conference fees for relevant workshops or seminars, and the cost of office supplies used in the course of foundation work. These expenses can vary significantly depending on the frequency of meetings, the geographical location of directors, and the scope of their responsibilities. While reimbursing directors for their out-of-pocket expenses is a common practice, compensating them for their services is less so.
Legal Aspects of Director Compensation
Legally, directors of private foundations may be compensated for "personal services," provided that these services are necessary for the foundation’s charitable operations and that the compensation is reasonable. The Internal Revenue Code governs the scope of allowable personal services, which predominantly includes professional and administrative services. For instance, directors may be compensated for legal advice, accounting work, financial management, or overseeing the foundation’s operations. However, tasks such as routine maintenance, physical labor, or clerical work fall outside the scope of "personal services" and are not eligible for compensation under this provision. Notably, the types of services that are eligible for compensation favors professional and managerial roles.
Arguments Against Director Compensation
Many argue against compensating directors, citing both ethical concerns and potential drawbacks. One of the primary arguments is that compensation diverts financial resources away from grants, thus reducing the foundation’s impact. Additionally, compensation may create conflicts of interest, as directors might prioritize personal gain over the foundation’s mission. There is also the notion that serving on a foundation board is a privilege and should be viewed as volunteer service, aligning with the broader principle that foundations are charitable institutions. Furthermore, issues with excessive compensation can also lead to negative public perception, potentially diminishing the foundation's reputation within its community. Lastly, family foundations, in particular, may face tensions if board members become dependent on compensation, which could undermine the effectiveness of their service and disrupt board dynamics.
Alternatives to Compensation
If the board determines that direct compensation is not appropriate or desired, there are several alternatives that can effectively honor and encourage ongoing service.
One option is to allow directors to make discretionary grants. This gives each director the opportunity to allocate a small number of grants to nonprofits of their choice, empowering them to support causes they are passionate about and deepening their engagement with the foundation’s philanthropic goals. Another alternative is matching grants, where the foundation matches a director’s personal donation to a nonprofit, often on a one-to-one basis, up to a specified amount each year. This approach not only encourages directors to contribute personally to charitable causes but also amplifies the impact of their donations.
Offering professional development opportunities can also serve as a valuable non-monetary benefit. By providing access to conferences, seminars, or training sessions relevant to the foundation’s mission, directors can enhance their skills and knowledge, which benefits both the foundation and its leadership. Covering the costs of these opportunities is both a reward for their service and an investment in the foundation’s future.
Lastly, reimbursement for reasonable expenses should be a standard practice. While not a substitute for compensation, ensuring that directors are not personally out-of-pocket for costs incurred in service to the foundation—such as travel, accommodation, and office expenses—shows respect for their time and commitment. Clear guidelines for reimbursable expenses should be established to maintain transparency and consistency.
Arguments in Favor of Director Compensation
Proponents of director compensation argue that it can serve as an incentive for diligent board service, particularly for younger or less privileged members who may be unable to serve without pay. Compensation can also recognize extraordinary service and commitment, attract non-family members with essential expertise, and encourage a serious commitment to board responsibilities. Additionally, compensation may help diversify the board by attracting individuals from various cultural, socioeconomic, and professional backgrounds who might not otherwise consider serving. It can also address the perceived risks associated with board service, making it a more appealing option for potential directors. By compensating board members, foundations may also establish expectations of professionalism and commitment similar to those seen in for-profit boards.
Developing Policies for Compensation and Reimbursement
For foundations that decide to compensate their directors, it is crucial to establish clear and fair compensation policies. These policies should include a rationale for compensation, position descriptions for board members, and specific guidelines on how compensation will be determined and paid. Additionally, foundations should define reimbursement limits and non-reimbursable expenses to avoid misunderstandings. Decision-making authority regarding compensation and reimbursement should be clearly outlined, with some foundations opting to involve outside advisors to ensure fairness and avoid family resentments.
Fairness and Transparency in Compensation
If the board decides in favor of compensating directors, it must ensure that the payment is fair and justifiable. Compensation should be reasonable when compared to similar roles in similar organizations. Additionally, compensated directors should be able to account for their time and justify their fees in terms of billable hours. Foundations should also strive to keep administrative costs proportionate to their charitable contributions. Transparency is critical, as compensation information is publicly disclosed on the foundation’s annual tax return. This means foundations must act as if their compensation practices are under public and media scrutiny.
To support fairness and transparency, it is advisable to develop a specific policy addressing key issues. Although such a policy does not guarantee compliance with the IRS’s “reasonable and necessary” guidelines, it provides the board with a clear framework for when compensation or reimbursement will be provided and when it will not.
Here are some ideas for such a policy:
1. Position Descriptions: The policy should include detailed position descriptions specifying the duties, responsibilities, and required skills for each director or leadership role. This not only helps the foundation justify compensation levels but also ensures that directors understand the expectations tied to their roles.
2. Compensation Caps: Consider setting maximum compensation limits based on the foundation’s size, budget, and the complexity of the directors' duties. This helps maintain equity among directors and ensures compensation remains within reasonable bounds.
3. Regular Reviews and Adjustments: Establish a process for regularly reviewing and adjusting compensation levels to reflect changes in the foundation’s financial status, industry standards, and directors’ responsibilities. This ensures compensation remains fair and competitive over time.
4. Expense Reimbursement Guidelines: The policy should clearly outline which expenses are reimbursable and the process for submitting claims. Specific limits on reimbursable expenses, such as travel or lodging, should be included to avoid misunderstandings and ensure consistency.
5. Independent Oversight: To enhance objectivity, consider involving an independent committee or outside advisors in the compensation-setting process. This can help avoid potential conflicts of interest and ensure compensation decisions are fair. Hiring outside consultants to provide benchmarking data and help set reasonable salary amounts is a common practice, ensuring compensation levels are aligned with industry standards and comparable organizations. This step adds an extra layer of credibility and fairness to the compensation process.
Conclusion
The question of whether to compensate directors in private foundations is a complex and multifaceted issue. While compensation can incentivize board service and attract diverse, qualified members, it also presents significant ethical and practical challenges. Foundations must carefully consider the impact of compensation on their mission, public perception, and internal dynamics. By developing clear policies and maintaining transparency, foundations can navigate the delicate balance between fair compensation and their commitment to charitable service. Ultimately, the decision to compensate directors should be guided by a foundation's values, goals, and the best interests of the communities it serves.
Seeking expert guidance? We're here to help!
At CPA KPA, we're passionate about magnifying the positive impact of foundations. Feel free to reach out to us anytime at 888-402-1780 for a complimentary and obligation-free conversation. You can also conveniently submit your questions and inquiries through our contact page. Let's connect today and explore how we can help your foundation have a lasting and meaningful impact!
