Directors serving on nonprofit boards typically do so in an unpaid, volunteer capacity. While it is not uncommon for board members to be reimbursed for out-of-pocket business expenses or even for services provided to the nonprofit separate and distinct from their service as directors—subject to the nonprofit’s conflict of interest approval process—it is rare for public charities to pay or compensate directors solely for board service. Indeed, past IRS guidance has stated that “[c]harities should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service.”
Today, in the context of broader discussions surrounding diversity, equity, and inclusion (DEI) at nonprofit organizations, some boards are grappling with the unintended effects of requiring unpaid time, energy, and labor from board members; specifically, boards are concerned about the disproportionate impact these demands may have on low-income or working-class individuals, individuals from diverse or historically underrepresented backgrounds, and/or individuals that represent or have experiences relevant to the organization’s mission or core constituencies. Offering stipends, salaries, or other forms of compensation is one strategy that boards are considering to make board service more inclusive and realistic for individuals from diverse, mission-relevant, or historically underrepresented backgrounds.
The decision to pay directors will trigger a number of challenging ethical and optical considerations for your organization, including how doing so might affect intra-board dynamics and how the decision to compensate will be perceived by donors, funders, the IRS, and the public at large. Compensating directors will also trigger a number of complex legal concerns. Seven key considerations include:
1. Restrictions in Governing Documents: While paying nonprofit directors is legal in most jurisdictions, many nonprofits voluntarily prohibit these arrangements in their articles of incorporation or, more commonly, in their bylaws. You may need to amend these governing documents before creating a compensation plan.
2. Navigating Conflicts of Interest: The IRS has strict rules prohibiting nonprofit leaders from influencing or approving compensation arrangements that provide a personal benefit. The decision to compensate directors should be made by an independent committee of the board that does not include any individuals who will be eligible for the compensation or have any other personal, family, or business relationships with individuals who are eligible for the compensation. Once the decision to compensate directors has been approved, directors receiving compensation will also be more prone to conflicts of interest as they exercise fiduciary oversight over the nonprofit’s financial systems and must be recused from board deliberations relevant to their own compensation.
3. Avoiding Overcompensation: The IRS has important safeguards around the amount of money that can be paid to nonprofit leaders, designed to ensure that individuals receive only “reasonable” compensation in light of the labor and services they provide in return. If a board chooses to compensate directors, it should abide by the IRS’s executive compensation approval process and ensure that directors are not overcompensated based on the amount of work they perform and the compensation practices of similarly situated organizations.
4. Maintaining Board Independence: IRS best practices, and some state laws, require that a majority of the board be “independent” from the organization, meaning that they should not receive compensation from the nonprofit or be related to an individual who does. The decision to compensate board members may reduce the number of independent board members and cause the organization to fall below the 50 percent independence threshold.
5. Antidiscrimination/Civil Rights Considerations: When deciding which directors are eligible for compensation, nonprofits should avoid classifying eligible groups based solely on protected characteristics—including race, color, sex, age, and a number of additional characteristics—which may be covered by civil rights and antidiscrimination statutes in the context of director compensation.
6. Insurance and Liability Concerns: As volunteers, unpaid directors enjoy a high degree of statutory protection from civil lawsuits under both federal and state/D.C. law. Receiving compensation will likely disqualify directors from these protections, making it even more essential to purchase directors and officers (D&O) liability insurance and to communicate your compensation arrangements to your insurance provider.
7. Employment Status and Filings: As essential members of your nonprofit’s leadership team, paid directors may be classified as W-2 employees for tax, withholding, and other compliance-related purposes. Your organization may be required to issue tax forms to these individuals and to report their compensation on IRS Form 990 and in some state charitable solicitation filings.
While the decision to compensate board members may support an organization’s efforts to recruit and retain an effective board, it also comes with significant downsides and legal risks that must be carefully navigated.