In this recurring Q&A, longtime executive pastor and XPastor.org founder David Fletcher takes on readers’ questions about finances, staffing, communications, and more. Submit your questions using the subject line "Hey, Fletch" to firstname.lastname@example.org.
I had someone tell me that the personnel percentage of our overall budget is too high and could be considered unreasonable compensation. Is excessive or unreasonable compensation something to monitor on a per-employee basis or an overall budget basis?
When a church has more than 65 percent or 75 percent of its budget going to salaries and benefits, it may be in a poor financial posture for unexpected expenses. It may be difficult or impossible for that church to get a bank loan. The bank will ask, “How are you going to pay it back? Where is the money going to come from?” Three-fourths of a budget going for compensation could be considered poor stewardship and a disproportionate allocation of resources, but it is not what is meant by “unreasonable compensation.”
Excessive or unreasonable compensation is what is paid to an individual. GuideStar, an information service for nonprofits, has an article titled “What You Need to Know About Nonprofit Executive Compensation.” It offers these pertinent insights:
The IRS permits tax-exempt organizations to pay executives “fair and reasonable” compensation. However, there is no universal standard defining fair and reasonable. What’s fair and reasonable at one nonprofit may be a gross under- or overpayment at another.
In another article titled “The Private Inurement Prohibition, Excess Compensation, Intermediate Sanctions, and the IRS’s Rebuttable Presumption,” GuideStar offers general information about IRS regulations for 501(c)(3) public charities. These public nonprofits file IRS Form 990, which churches are not required to file. This means that salaries for nonprofit executives are in the public record with Form 990, while church salaries are not. That fact aside, church boards would be wise to pay attention to what GuideStar has to say in this article. Of particular interest would be these factors that nonprofits should use to evaluate the reasonableness of compensation (developed by nonprofit law expert Bruce R. Hopkins):
- Compensation paid by similar organizations, both exempt and taxable, for equivalent positions in the same community or geographic area
- The need for the particular services of the person in question
- The uniqueness of the person’s background, education, training, experience, and responsibilities
- Whether the compensation was approved by an independent board of directors
- The size and complexity of the income and assets and the number of employees
- The person’s prior compensation arrangements
- The person’s job performance
- The relationship of the person’s compensation to the compensation paid to the other employees.
- The number of hours the person spends performing his or her job
Churches would be wise to consider using these factors—modified, of course, to reflect their own policies, style of governance, and state guidelines.
Along with the expert insights from GuideStar, Church Law & Tax has great materials on what constitutes unreasonable or excessive compensation for churches. Here are a few:
- “Setting Reasonable Compensation” by Elaine L. Sommerville
- The “Reasonable Compensation” chapter in Church Compensation: From Strategic Plan to Compliance by Elaine L. Sommerville
- “Tax Law and Compensation Planning” by Richard R. Hammar
- “The Tax Code's ‘No Inurement’ Limitation” by Richard R. Hammar
- The “Income” and “Church Reporting Requirement” chapters in the Church & Clergy Tax Guide by Richard R. Hammar
For help with planning the budget for staff and other areas of ministry, see these Church Law & Tax resources (to name just a few):