Setting Pay the Right Way: Why Your Nonprofit Needs a Clear Compensation Policy
January 14, 2026
I. INTRODUCTION
Setting compensation for employees and contractors is a core task for any nonprofit. These decisions affect people, finances, and public trust, which is why they should be guided by a clear and consistent Compensation Policy. Because compensation decisions are closely tied to a nonprofit’s tax-exempt status and governance obligations, they are also subject to regulatory scrutiny. The IRS underscores this importance by addressing compensation and compensation practices in multiple sections of Form 990.
A well-designed Compensation Policy helps organizations approach these decisions deliberately and with appropriate oversight, setting the stage for the standards discussed below.
II. WHY HAVE A COMPENSATION POLICY?
A. Employee Care and Morale
Every organization, regardless of size or success, is built on the individuals who carry out its mission. Fair and competitive compensation plays a critical role in employee satisfaction, retention, and morale. Competitive wages allow a nonprofit to attract qualified candidates and build a team that aligns with the organization’s values and goals.
B. Donor Confidence
Donors care not only about a nonprofit’s mission, but also about how that mission is carried out. Compensation practices are one area where donors may look for signs of ethical management and responsible stewardship of resources. A clear and organized Compensation Policy helps demonstrate that the organization takes its obligations seriously, including in how employees are compensated and supported.
C. Consistency
A written Compensation Policy promotes consistency by establishing guidelines, pay standards, and the use of comparability data. This structure reduces the need for ad hoc decision-making and helps save time and administrative resources. The policy can also serve as a helpful reference when responding to questions from donors, employees, or prospective hires, keeping the nonprofit’s messaging consistent.
D. Budget Targeting
Nonprofits operate within defined budgets, which may include restricted funds such as government or corporate grants. A well-drafted Compensation Policy helps ensure that compensation decisions align with budgetary constraints while still supporting recruitment and retention goals.
E. Legal Compliance and Reduced Risks of Lawsuit
A Compensation Policy also supports compliance with state and federal employment laws and plays a role in maintaining tax-exempt status. IRS Form 990 requests compensation-related information in multiple sections, including Part I, Part VI, Part VII, Part IX, and Schedule J. Without a structured policy, nonprofits may face increased risk of disputes or claims of unfair treatment. Having an attorney assist with drafting and periodically reviewing a Compensation Policy can significantly reduce legal and operational risks.
III. WHAT A COMPENSATION POLICY SHOULD INCLUDE
A. Purpose and Scope
A Compensation Policy, like most policies, should explain its own purpose and scope. It should state which forms of compensation it covers and should declare those forms of compensation to be reasonable, fair, and supported by appropriate data. It should also tie compensation back to the organization’s mission and public-charity status.
B. Assignment of Responsibility
A Compensation Policy should clearly identify who is responsible for reviewing and approving compensation decisions. Many organizations delegate this responsibility to a finance committee or similar body, with ultimate oversight resting with the board of directors.
C. Use of Comparability Data
An equitable Compensation Policy relies on comparability data to establish reasonable compensation levels. Comparability data should include, but not be limited to, the following:
1. Salary and benefit studies from independent sources;
2. Written job offers for similar positions at similar organizations (similar in ways like asset
size, geographic location, mission, staff, and services);
3. Documented discussions with similar nonprofit or for-profit organizations; and
4. Information obtained from IRS Form 990 filings of comparable organizations.
All compensation decisions, including the data relied upon and any deviations from it, should be documented and retained in the organization’s records.
D. Conflicts Of Interest
Any board member or member of a finance or similar committee with the power to make compensation-related decisions should, of course, recuse themselves from doing so when they stand to make a personal benefit, such as deciding their own salary, or the salary of a spouse or close family member. While these situations should be majorly addressed in a separate Conflict of Interest Policy, reiterating this requirement in the Compensation Policy helps avoid even the appearance of impropriety.
E. Documentation and Transparency
All compensation decisions should be documented in a timely and consistent manner. A Compensation Policy should promote this by defining documentation practices and standards. Clear records support accountability and compliance with reporting obligations.
F. Periodic Review
As with other key governance policies, a Compensation Policy should be reviewed and approved initially by the board of directors. However, it’s incredibly important that the board is not only involved in the creation of the policy, but also in the maintenance of it. Because it will undoubtedly need updating at some point, the Compensation Policy should address its own amenability, including the specifics of who and under what circumstances it can be reviewed or updated.
IV. CONCLUSION
Nonprofits of all sizes benefit from a clear, equitable Compensation Policy. It provides guidance for leadership, reassurance for employees, transparency for donors, and support for compliance and reporting obligations.
If you’d like guidance on drafting, updating, or reviewing your Compensation Policy, I’m happy to help. Reach out anytime at gordon@gordonfischerlawfirm.com to start the conversation. I offer a free consultation!