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7 tips for Churches and Not-for-Profit Organizations to Avoid Unreasonable Compensation

Written by Sorin Leahu on May 27, 2021 Category: Nonprofits, Religious Institutions

One of the key requirements for churches and other 501(c)(3) organizations to maintain their tax-exempt status is to avoid “private inurement.” Private inurement occurs when an insider of an organization receives from the organization greater benefits than he or she provides to the organization. Likewise, private inurement can also occur whenever the organization’s assets are transferred to an individual solely because of that person’s relationship to the organization. However, it is important to remember that churches and not-for-profit organizations may provide “reasonable compensation” for services performed. But when compensation becomes unreasonable, the organization may jeopardize its tax-exempt status and the IRS may also impose sanctions on the recipient.

To avoid unreasonable compensation, churches and other not-for-profits should heed the following tips:

  1. Remember that compensation is not limited to salary and can also include: bonuses, retirement gifts, personal use of church assets like a vehicle, debt forgiveness, severance pay, housing allowance, payments of personal expenses, insurance, and other benefits. When determining whether compensation is reasonable, all forms of compensation should be included.
  2. Establish fair value of any property sold or transferred to an insider. Selling or transferring property to an insider for less than market value may lead to consequences.
  3. Establish the fair value of services provided to the organization. It is important to set compensation in accordance with value received. In particular, consideration should be given to an employee’s experience and the number of hours worked on behalf of the organization.
  4. Do not establish compensation based on a percentage of revenue the organization receives. Again, the standard should be the fair market value of the services provided. Basing compensation on percentage of income could lead to unreasonable compensation.
  5. Consider forming a compensation committee. It may be of great benefit to an organization to establish a committee of disinterested persons to determine what amount of compensation is reasonable.
  6. Set compensation based on objective criteria. The best way to set compensation is by employing objective standards. These may include (i) reviewing compensation paid by similar organizations; (ii) obtaining compensation surveys by independent firms; or (iii) reviewing offers from similar organizations.
  7. Have a clear reimbursement policy. Any church or not-for-profit organization should maintain a reimbursement policy that clarifies what sort of expenses qualify for reimbursement, what substantiation is required, how to request reimbursement, and when requests for reimbursement should be made.

By following these 7 tips, your organization can reduce the risk associated with unreasonable compensation.

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