Executive Compensation and Nonprofit Tax Risk: A 2026 Planning Reminder
Executive compensation is an important governance issue for nonprofit organizations. Competitive pay helps attract and retain effective leaders, but compensation decisions also carry tax, reporting, and reputational considerations. As organizations look ahead to 2026 planning, boards and leadership teams may benefit from revisiting how executive pay is reviewed, approved, documented, and reported.
For tax-exempt organizations, the IRS focuses on whether compensation is reasonable for the services provided. IRS guidance explains that reasonable compensation is generally the value that would ordinarily be paid for similar services by a similar organization under similar circumstances.
Understand the Excess Benefit Risk
One area of concern is the excess benefit transaction rules under Internal Revenue Code Section 4958. These rules can apply when certain tax-exempt organizations provide an economic benefit to a disqualified person, such as an executive or other person with substantial influence, and the value provided is more than the value received by the organization. The IRS notes that excess benefit transactions can involve compensation, fringe benefits, contract payments, or property transactions.
The issue is not whether a nonprofit can pay its executives. It can. The issue is whether the total compensation package is reasonable, properly approved, and supported by appropriate information. Salary, bonuses, deferred compensation, severance arrangements, taxable fringe benefits, and other economic benefits may all need attention as part of the overall review.
Documentation Matters
The IRS provides a rebuttable presumption process that can help support compensation decisions when three key steps are met: advance approval by an authorized body without conflicts of interest, reliance on appropriate comparability data, and timely documentation of the decision.
For boards, this means the process is just as important as the final number. Meeting minutes, compensation studies, peer comparisons, conflict-of-interest disclosures, and clear approval records can help show that the organization followed a thoughtful governance process. Without that support, even well-intended compensation decisions may be harder to explain later.
Form 990 Tells the Story
Executive compensation is also visible through Form 990 reporting. The IRS requires organizations to report certain officers, directors, trustees, key employees, highest compensated employees, and independent contractors in Part VII, with additional compensation reporting in Schedule J when applicable.
Because Form 990 is publicly available, compensation reporting is not only a compliance matter. It is part of how donors, grantors, regulators, and the public understand the organization’s governance and stewardship.
Make Compensation Review Part of 2026 Planning
As nonprofit leaders prepare for 2026, executive compensation should be reviewed before decisions are finalized, not after Form 990 preparation begins. A consistent process can help boards connect compensation to role responsibilities, organizational size, financial capacity, and market data.
Brady Martz works with nonprofit organizations to support financial reporting, audit readiness, and governance-related conversations. A proactive compensation review can help leadership strengthen transparency, reduce tax risk, and maintain confidence in the organization’s stewardship.
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