The following is an excerpt from Nonprofit Executive Compensation: Planning, Performance, and Pay, Second Edition By Brian Vogel and Charles W. Quatt, Ph.D:

All nonprofit organizations are subject to what is called the “private inurement” doctrine.

Simply put, private inurement is income or other financial gain from a nonprofit to an individual [or entity] for which the nonprofit does not receive a comparable benefit in return (in other words, the value of the financial gain the individual receives from the organization exceeds the value of the services he or she provides to the organization). Persons engaging in private inurement are usually “insiders’ who are in a position to divert nonprofit assets or income to their own benefit.

The private inurement doctrine does not forbid financial relationships between nonprofit organizations and insiders. Instead, it requires that the organization receive in return a benefit more or less equal to the financial gain to the insider.

The private inurement doctrine has three main implications for chief executive compensation at all tax-exempt organizations:

1. Compensation should be clearly tied to the chief executive’s performance in leading the organization toward achievement of its mission (“accomplishing exempt purposes”).
2. Compensation should be reasonable and not excessive
3. Because there is no equity available in a nonprofit organization, compensation committees should be wary of any compensation arrangement that looks like the distribution of profits.

Nonprofits should collect data such as salary surveys to use when setting executive compensation.  The use of such data should be documented in board meeting minutes.

Click here for an IRS report on executive compensation by tax-exempt organizations.

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