Q:  Our board has identified a new CEO. The topic of a bonus came up in the initial stages of negotiation. The board is willing to consider a bonus as part of this person’s compensation package, but this is new territory for us. The directors need guidance on how to structure it. What should we consider?

 

A: Bonuses are becoming more popular within the sector. They allow an organization to show appreciation to employees for a job well done, without permanently impacting the budget’s bottom line. This is especially important in an environment where donors regularly express the desire for their gifts to go directly to programs rather than operations and you don’t want to show a high salary, yet you are competing for strong talent.

The key to any bonus program is to ensure that the bonus is tied to the achievement of specific, pre-determined goals that are considered sufficiently above and beyond the expectations of the job for which the individual was hired. The ability of the person to reach these goals should be under his/her control and not solely reliant on the work of others. Also, given today’s emphasis on impact, consider crafting the goals around the differences made to benefit the community, versus merely increased numbers or satisfaction levels.

Several other considerations should be taken into account. First, bonuses should never be “a given” – otherwise, you might as well just offer the higher salary from the beginning. Second, remember that bonuses must be taxed, which means the cost of offering a bonus is higher than just the dollars being paid to the CEO. Third, do some research to determine what is a “fair” amount to offer. Compare your proposed bonus to bonuses extended to other CEOs running similar organizations, as defined by mission category, budget size and geographic area. Such information is relatively easy to find. GuideStar, the Nonprofit Times, and the Chronicle of Philanthropy produce annual compensation studies with both national and local data. Their samples are large, making them reliable resources. But, there are also local studies to which you can refer. You might start by looking to see if your state arm of the National Council of Nonprofits produces one. This comparison is important. Besides ensuring that you are adequately compensating the work you value while demonstrating that you are responsibly stewarding your organization’s money, you are protecting all parties. If the amount you offer is too high, you open yourselves to an excess benefit penalty. In this situation, the CEO, individual board directors, and the organization would all be liable for paying an excise tax that could be as high as 200% of the amount above the threshold of what is considered “reasonable.” How would the subject of excess benefit even come up? You must report bonuses on your Form 990, and the IRS does pay attention! Fourth, to ensure you don’t exceed the threshold, in addition to doing your due diligence, consider setting a cap on how much money can be earned in the form of a bonus.

To help you look at this issue from all angles, consider turning the job of setting the entire compensation package, including the bonus, over to a compensation committee. Such a committee is typically made up of board directors with, perhaps, outside experts like human resources professionals, compliance officers, or attorneys who specialize in compensation. A great resource for the committee is found at www.irs.gov. It is IRS Private Letter Ruling 200601030, which spells out the process to be used for approving and awarding bonuses. While on the site, dig deep into the IRS’s treasure trove of other relevant materials. Of course, you could also use a benefits consultant.

Hopefully, this brief response will get you started. But, remember,I am neither an attorney or tax advisor, nor do I know your organization, so this should not be taken as professional advice. I suggest you speak with a labor or tax attorney and/or your own tax advisorbefore finalizing the bonus.