Yes, you can compensate board members, but should you?

Governance + Leadership,

The Byzantine legal and regulatory landscape governing nonprofit compensation has many organizations frustrated as they seek to answer the seemingly simple question of whether their organization can compensate board members as a tool to reduce barriers to board participation.

If you are wondering whether your organization can compensate board directors, the answer is yes, you canSection 407 of the Maine Nonprofit Corporation Act (the “Act”) provides that a nonprofit organization “may pay compensation in a reasonable amount to its members, directors, or officers for services rendered.”

Simple, right?

Not so fast! Now that we’ve established that board compensation is possible, let’s go down the rabbit hole of additional considerations and implications that your organization should thoughtfully consider when making its decision.

Board Compensation Must Be Reasonable

As a corporate entity operating in Maine, your organization is subject to the Act. However, you may also be a 501(c)(3) organization and, therefore, exempt from federal taxes. If you are a tax-exempt nonprofit organization, this means that you are also required to meet applicable sections of the federal Internal Revenue Code (IRC), administered by the Internal Revenue Service (IRS).

You may be asking, why does this even matter?

It matters because organizations that are exempt from taxes under Section 501(c)(3) of the IRC exist for a public benefit. When your organization submits its annual 990 report, it provides the IRS with information necessary to determine whether your organization continues to provide a public benefit, a characteristic key to maintaining your tax-exempt status. In fact, many of the rules and regulations governing tax-exempt nonprofit organizations are to guard against inadvertent – or intentional – use of the organization’s assets for private benefit or inurement, a fancy term that means the inappropriate use of an organization’s assets by organizational insiders.

In the case of board compensation, inurement is a particular concern. That is one reason why nonprofit compensation, including nonprofit board compensation, must be “reasonable.” The IRS has established a safe harbor protocol that creates a presumption of reasonableness when followed.

Under these IRS guidelines, an organization’s board compensation is presumed reasonable if the compensation:

  1. is approved in advance and in accordance with conflict-of-interest guidelines;
  2. uses data to make an informed decision; and
  3. documents its decision-making process and its final determination in a timely manner.

If your organization does not yet have a conflict-of-interest policy in place, consider using these resources and templates to develop one.

Board Compensation is Distinct from Compensation for Non-Board Services

Compensation to a director for board service under Section 407 of the Act is distinct from compensation that may be paid to the same person for direct services provided as a “full-time or part-time employee, independent contractor, consultant or otherwise.” Compensation for direct services provided to the organization is governed by Section 713-A of the Act and explicitly excludes “reasonable payments made to directors for serving as directors.”

Any person, including a director, who is compensated for the services described in Section 713-A is considered a “financially interested person.” No more than 49% of the board may be comprised of financially interested persons.

A simple check of your board roster in light of Section 713-A should help you determine if any action is necessary to remain compliant with the Act.

Board Compensation May Remove Directors’ Statutory Immunity

Under Section 158-A of Title 17 of the Maine Revised Statutes, any person acting within the scope of their responsibilities and serving “without compensation” as a director, officer, or volunteer of your organization is “immune from civil liability for personal injury, death or property damage, including any monetary loss”. On the surface, it seems that board compensation would remove the statutory immunity; however, there are insufficient court decisions interpreting this Maine statute to be certain.

In neighboring states where statutory immunity was invoked in response to a lawsuit, the matters were decided based on issues other than immunity. So, unfortunately, we are left with an inconclusive understanding of how a court might interpret and apply the phrase “without compensation” in light of situational and other legal factors. This judicial ambiguity does present a certain amount of risk to nonprofit organizations, particularly those organizations providing direct services where liability protections are a concern.

This risk does not prevent your organization from considering or implementing board compensation practices, but it should be understood and actively managed. A discussion with your organization’s attorney about organizationally-specific needs and concerns will be particularly helpful when considering this matter. Another thing to consider is whether your organization has directors and officers (D&O) insurance. Depending on the level of coverage and policy exclusions, D&O insurance may be the only risk mitigation tool your board needs. A discussion with your insurance provider about the amount of and exclusions included in your insurance policy may shed some light on your actual risk exposure.

Board Compensation Requires Structured and Transparent Discussions

You now know that board compensation is permissible, you also have an IRS-recommended process to set "reasonable" compensation, and you have a few specific areas of risk to consider. Now is the time to pull together a working group to create a structured process by which your board can more fully consider the merits of implementing board compensation. At a minimum, this group should consist of the Board Chair, the Executive Director, the Governance Chair, and the Treasurer.

Until next time.

Take our poll to find out where your organization stands on the topic of board compensation relative to other Maine-based nonprofit organizations! [UPDATE: The poll is now closed.]

About the Author

Krystal is the Founder and Manager of Providentia Group and Founder of The Alpha Legal Foundation.

All information and statutory and regulatory references are for general informational purposes only and do not constitute legal advice.