A couple of weeks ago, the board of the Tampa General Hospital voted to take compensation for their board service, between $15,000 and $30,000 per year. Because nonprofit board positions are frequently unpaid, this raised a number of eyebrows and got a number of people talking and thinking about the issue (this article, by Monica Oss, was among my favorites). One board member resigned over the decision, and the board has since rescinded their decision.
But I think it’s still a question worth answering. There is some case to be made for compensation: as Ms. Oss points out, for-profit board members are compensated, often quite handsomely. And there’s certainly a time commitment involved with being a board member–in the Tampa General Hospital example, 6 meetings per year, plus committee meetings and retreats with hospital staff. Further, board members are expected to give their expertise, and as you can imagine, hospitals require a lot of specialized knowledge. If that knowledge has value (it does), isn’t it worth paying for?
Even with those arguments in mind, I’d still say that generally speaking, compensating board members is probably a bad idea.
First, compensating board members is a drain on resources. Not to pick on Tampa General Hospital, but to use them as an example, there are 15 board members, and each could have taken somewhere between $15,000 and $30,000. There were some board members who planned to decline the compensation, but assuming each board member took $15,000, that’s $225,000 being paid out in board compensation each year. I don’t know the hospital’s budget (it’s probably pretty big), but that’s quite a bit of money that could go to other projects in the organization.
Second, it may damage your relationship with the public. As a 501(c)(3) organization, your financials are available to the public through your tax returns. The public is generally wary and suspicious of nonprofits–if they’re going to give, they want to know that it’s going to help somebody. It doesn’t seem to please the media either; look at the first Tampa Bay Times article I linked above–in those first few paragraphs, it’s pretty clear the reporter does not approve. When you’re paying the board, that increases overhead and that can damage your relationship with the public.
Third, because paying directors is unusual, board members generally aren’t expecting, much less demanding, to be paid. Most directors understand that board service is a volunteer arrangement–and in some organizations, even an arrangement that requires the board member to give to the organization. In the Tampa example, one board member quit over the compensation arrangement, and others declined to take any compensation. Making board service more like a part-time job rather than a volunteer service opportunity might even turn some people off from the position.
And then there’s the legal stuff. Paying your board runs the risk of creating “inurement” to the directors. As it’s said in the regulations, the net earnings of the organization may not “inure in whole or in part to the benefit of private individuals.” By the way, don’t get too hung up on “net earnings,” as the Tax Court has said, any “unjust enrichment” counts (even a really small amount), whether its from the gross earnings or net earnings or whatever. If there is inurement, the organization’s tax-exemption can be revoked. Additionally, an insider that receives such a benefit gets hit with a 25% tax, and if the organization is not made whole, the insider gets hit with another 200% tax on the transaction. Additionally, any board member that approves such a transaction gets hit with a 10% tax. To sum up, this is a big deal.
Of course, often organizations will provide private benefits to individuals, and it’s not a problem. For instance, a food pantry provides food to people. A library lets people check out its books and CDs and whatnot. That’s not an unjust benefit, that’s just serving your charitable class as part of your exempt purpose. Using Tampa General Hospital as an example, a board member could be admitted to the hospital just like anyone else.
So what’s actually a problem? When you’re dealing with insiders of the organization (and board members are definitely insiders), those insiders cannot get the better of a transaction with the organization. It’s perfectly okay for an organization to do business with its insiders, but the terms have to be fair–if anyone is to be favored, it’s the organization. Also, any transactions between the organization and an insider are best done “at arm’s length,” meaning that the insider doesn’t have any special influence over the organization. Often, nonprofits have conflict of interest policies that require board members who stand to benefit from a transaction to disclose their interest and possibly recuse themselves from the discussion and decision. By the way, conflict of interest policies are a good idea.
Would this be private inurement? It’s hard to say (this is all very case-by-case), but here are the questions we need to ask:
First, is the compensation fair and reasonable? What are the skills the board members are providing? How much time do the board members spend on their duties? I’d suggest that an organization that compensated its directors get crystal clear on the time spent and the value provided by the directors. Also, the fact that other boards are usually uncompensated is a problem, although in the Tampa case, the board suggested a growing trend of paying directors a stipend. Again, this is all going to be largely determined by the facts of a particular case.
Second, is the compensation negotiated at arm’s length? Probably not. The problem is that there’s going to be a conflict of interest–the board members are voting on their own compensation. That’s a real problem with board compensation. One way to deal with that might be a “27th Amendment” solution–the 27th Amendment to the U.S. Constitution requires that no law changing the pay for a representative or a senator can take effect until the next Congress, so all the representatives and one-third of the senators have to survive an election to experience the change in pay. Perhaps something like that–where no board compensation changes could take effect until after the next board election–would make board compensation more palatable from a conflict-of-interest perspective. To my knowledge, that theory is untested.
Because paying directors is an unusual practice, an organization that decides to do it can expect to be scrutinized thoroughly–from the IRS, the media, and the public. Between the risks of the IRS finding inurement, the potential for public relations damage, and the possible better uses for the funds, I’d generally advise against paying board members.