Federal tax rules describe three steps a board can take before it votes on an executive's pay. The people approving it have no personal interest in it, they look at what similar organizations pay for similar work, and they write down what they looked at and how they decided, at the time they decide. When a board takes all three steps, the IRS presumes the pay is reasonable. When it doesn't, the IRS looks at the facts and circumstances without that presumption in place.
What the tax rules ask of your board
If your board is approving next year's budget this month, the salaries of your executive director and other senior officers are among the items you'll be voting on. Federal tax rules describe three things a board can do before that vote to protect its decision: the people approving an executive's pay have no personal interest in it, they look at what similar organizations pay, and they write down what they looked at and how they reached their decision, at the time they decide.
When a board takes all three steps, the IRS presumes the pay is reasonable. When it doesn't, the IRS looks at the facts and circumstances of the compensation without that presumption in place. If your organization files the full Form 990, the form also asks about this process, and the board's answer is part of the public record.
Josh Green, writing in Blue Avocado, observes that many small nonprofits don't know this process exists. At budget time, it's natural to focus on the salary amount. The rules add a second question alongside that one, which is how the board will document the basis for its decision. The review also covers the whole compensation package, including bonuses, retirement contributions and other benefits, along with base salary.
This article focuses on 501(c)(3) public charities. The same rules also apply to 501(c)(4) social welfare organizations, while private foundations follow a different set of rules. Throughout the article, "executive" refers mainly to the executive director or CEO, the treasurer or CFO, and anyone with final responsibility for carrying out the board's decisions or supervising management, such as a COO. Other people with substantial influence over the organization can also fall under these rules.
Three steps the IRS looks for
The three steps come from Treasury Regulation 53.4958-6, which sets up what tax professionals call the "rebuttable presumption of reasonableness." When a board follows the steps, the burden shifts to the IRS: to challenge the compensation, the IRS would need evidence strong enough to outweigh the comparison data the board relied on. The steps are optional, and the regulation notes that skipping them doesn't, by itself, suggest the pay was too high.
People with no conflict approve it, in advance. This can be the full board or a committee that's allowed to act for it, as long as everyone taking part in the discussion and the vote is free of a conflict of interest. At smaller nonprofits an executive sometimes sits on the board. In that case, the regulation allows that executive to stay long enough to answer questions and then leave before the discussion and the vote. The executive's family members are also excluded, as is anyone who works under that executive or whose pay that executive approves. The same goes for any member with a financial interest in the decision, or a member who approves benefits for the executive while the executive approves benefits for them.
They look at comparison data first. The goal is to understand what similar organizations, of similar size and in similar communities, pay for similar work. A single national figure with no breakdown usually isn't enough for this. One of the regulation's own examples describes a university board that relied only on a national survey of university presidents, with no breakdown by size, revenue or location, and it concludes that the survey wasn't appropriate comparison data.
They write it down at the time. "At the time" has a specific meaning here: the record has to exist before the later of the next meeting of the board or committee, or 60 days after its final vote. The board or committee then approves the record as reasonable, accurate and complete within a reasonable time afterward.
The rules behind these steps use the term "disqualified person." Along with the executives named above, it includes voting board members and certain family members of anyone covered, regardless of title. The regulation spells out which relatives count, and it looks back five years, so a person can remain covered for a time after leaving a role. If your board approves pay for more than one of these positions, you can use the same three steps for each one.
If the IRS ever decides an executive was overpaid, the excise taxes under Section 4958 are imposed on individuals, and the organization itself owes no tax under that section. The executive would generally owe a tax of 25% of the excess. If the excess isn't corrected in time, which generally means repaying it with interest, an additional tax of 200% can apply. Board members and other managers who took part knowing it was an excess benefit can owe a tax of 10% of the excess, with a combined limit of $20,000 per transaction for all of them together. That tax doesn't apply when a manager's participation was not willful and was due to reasonable cause.
Jan Masaoka, writing in Blue Avocado, observed that community boards more often worry about the opposite situation, paying their executives too little, and that many EDs feel the same way. The same comparison data can help a board think through whether a raise is due.
When does the IRS look at executive pay?
IRS examinations of nonprofits are uncommon. In fiscal 2023, the IRS examined about 1,020 returns in the main Form 990 series. Examinations of Forms 990, 990-EZ and 990-N fell by about 35% in fiscal 2024 and then rose by about 33% in fiscal 2025.
When the IRS does select an organization, the reason may be a pattern in its Form 990 data, a complaint or referral (including a whistleblower tip), media coverage, or a compliance check that raised questions. Excess compensation to insiders is one of the issues the IRS names as a reason for an audit.
Even when the IRS doesn't examine an organization, executive pay can still draw attention, because much of it is reported publicly. A few details are worth knowing:
An organization generally must complete Schedule J if anyone listed in Part VII of its Form 990 receives more than $150,000 in total compensation from the organization and its related organizations. Schedule J reports that pay in more detail, and a few other situations can also require it.
Your answers on Line 15 and the pay figures in Part VII are public, so donors, funders, reporters and your state attorney general's office can read them.
Section 4960 generally imposes a 21% excise tax on the organization for pay above $1 million to a covered employee, with some exclusions, such as pay for medical or veterinary services. For tax years beginning after December 31, 2025, coverage extends to employees broadly. Under the earlier rules, it covered the five highest-paid employees each year, plus anyone who had been covered in an earlier year. This tax is separate from the excess benefit rules, so it can apply even when the pay is reasonable.
For the excess benefit rules, the minutes and comparison data from the three steps show how the board arrived at an executive's compensation if an examiner, a funder or a reporter asks. They don't change whether the Section 4960 tax applies.
What to capture in the minutes
Josh Green, writing in Blue Avocado this fall, describes two patterns he sees repeatedly. Some boards compare themselves to organizations three to five times their size. Others set the salary in a board meeting, discuss it for perhaps ten minutes, and move to the next item, with nothing in the minutes to show what data they reviewed.
I find it useful to think about this in accounting terms. The compensation decision is like a journal entry, and the minutes are its supporting documentation. Even when the compensation itself is reasonable, it's much easier to explain later if the support is on file.
The regulation lists what the record should include:
The terms the board approved, and the date
Who was present for the discussion, and who voted
The comparison data the board relied on, and how it got that data
What any conflicted member did (stayed to answer questions, then left, for example)
If the board landed above or below the range in the data, the reason why
If you file the full Form 990, this is also something the IRS asks about each year (organizations filing the 990-EZ or 990-N don't see this question). Part VI, Section B, Line 15a asks whether the process for setting the top executive's pay included review and approval by independent persons, comparability data, and contemporaneous documentation of the deliberation and decision, and Line 15b asks the same question about other officers and key employees. Answering "yes" means describing the process in Schedule O, and because the 990 is a public document, donors, funders and others can read the board's answer.
It also isn't necessary to commission a new study every year. One of the regulation's examples describes a hospital board that reused the prior year's custom compensation survey because market conditions hadn't changed in any meaningful way, and that survey still counted as appropriate data. A hospital is a different setting from most community nonprofits, though the same idea applies: if you reuse last year's comparison data, it's worth noting in the minutes that you did and why it still holds.
How the ED's salary shapes the rest of the pay scale
This section applies to the executive director specifically, because the top salary on staff has an effect beyond that one position. Masaoka points out that it typically acts as a ceiling for everyone else on staff. If the ED makes $75,000, for example, it becomes difficult to offer a program director $78,000, so a low ED salary tends to hold down the salaries below it.
Masaoka illustrates the effect with a hypothetical. If a $10,000 raise for the ED leads to $50,000 in raises across the other positions, the organization would need to raise $60,000 more the next year. The actual ratio at any organization would depend on its headcount and how compressed its pay scale is. She offers this as one reason so many EDs are reluctant to ask for raises at all.
She also tells a story about an ED who went into her salary conversation braced to ask for 10%, only to have the board surprise her with 25%. She was thrilled until the drive home, when she realized she would now have to raise every dollar of it.
Two other points from her piece may be useful at budget time:
Board members tend to judge the ED's salary against their own, so a member earning $40,000 and a member earning $300,000 can look at the same number and see two very different things. Comparison data gives every board member the same reference point.
She suggests setting next year's salary based on what the board expects the ED to contribute in the coming year, using last year's performance as the best evidence of that. Framed that way, the salary becomes a forward-looking budget decision, made alongside the rest of next year's plan.
A checklist for your next board meeting
If you're the board chair or treasurer, you may find this short list helpful ahead of the meeting:
Decide who takes part. The executive whose pay is being set can stay to answer questions and then step out for the discussion and the vote, and it's worth noting anyone else on the board who has a conflict.
Gather comparison data. Look for organizations close to yours in budget size, mission area and region. Outside the special rule for small organizations, the regulation doesn't set a minimum number of comparables. Green's advice is a peer group of 8 to 12, each within about 25% of your revenue, and organizations under $1 million in revenue may rely on data from three comparable organizations.
Put the data in the board packet. This gives members time to review it before the meeting.
Consider a separate motion for each executive's pay. The regulation doesn't require one, and it can happen at the same meeting as the budget. I suggest it because it makes the minutes much easier to write.
Write the minutes within the window. Cover the five items above before the later of the next meeting of the board or committee, or 60 days after its final vote. Then have the board or committee approve them as reasonable, accurate and complete within a reasonable time.
Check the 990. If you file the full Form 990, make sure the answers on Part VI, Lines 15a and 15b match what the board actually did.
If your organization brings in less than $1 million a year, step two has a simpler standard. The regulation says data from three comparable organizations in the same or similar communities is enough, and you can average your gross receipts over the three prior years to see whether you qualify. If your organization controls, or is controlled by, another organization, the regulation requires you to combine your receipts with that organization's when you check. Its example is a small theater with receipts between $400,000 and $800,000, whose board relied on a telephone survey of three similar-sized performing arts groups, with one board member writing up a brief summary of the results.
Sources
Jan Masaoka, How Much to Pay the Executive Director?, Blue Avocado (first published August 13, 2010; updated June 13, 2025)
Josh Green, What Most Boards Get Wrong About Executive Compensation (and What the IRS Actually Requires), Blue Avocado (November 3, 2026)
26 CFR § 53.4958-6, Rebuttable presumption, Legal Information Institute
26 U.S.C. § 4958, Taxes on excess benefit transactions, Legal Information Institute
Minnesota Council of Nonprofits, Executive compensation best practices (Form 990, Part VI, Line 15 wording)
ICNL, IRS Investigations of Nonprofits: An Explainer (August 2026)
MinistryWatch, Takeaways from the IRS's Latest Data Book
Fox Rothschild, Audits of Tax-Exempt Organizations in FY25 (June 2026)
Journal of Accountancy, Not-for-Profit Pay Faces Broader Tax Risk (November 2026)
26 U.S.C. § 4960, Tax on excess tax-exempt organization executive compensation, Legal Information Institute
26 CFR § 53.4958-3, Definition of disqualified person, Legal Information Institute