The Legal, Ethical and Practical Pitfalls of Incentive Compensation for Fundraising Professionals

Business-minded board members, particularly those with backgrounds in sales and marketing, often propose incentive-based compensation plans for development officers. Individuals soliciting charitable contributions for nonprofit organizations, however, should not be compensated based on fundraising results. This prohibition includes finder’s fees for new donors, commissions based on a percentage of contributions raised, and many other incentive-based arrangements. There are many legal, ethical and practical reasons for this restriction on the compensation of fundraising professionals, the most important of which are described below.

Legal – Intermediate Sanctions Rules

The federal intermediate sanctions rules impose excise taxes and other penalties on certain individuals who receive and in many instances those who approve excessive compensation paid by charitable organizations. Incentive compensation is difficult to manage in the context of the intermediate sanctions rules, particularly when there is no outside limit placed on the total compensation that may be paid under the arrangement. The intermediate sanctions rules apply to any “disqualified person” who benefits from, and organization managers who participate in, an excess benefit transaction.

Disqualified Persons. A disqualified person is any person who is in the position to exercise substantial influence over the affairs of the corporation. This generally includes executive directors, officers, directors, substantial contributors, highly compensated employees, treasurers, and chief financial officers, as well as the family of disqualified persons.

Organization Managers. Anyone in a position of control who participates knowingly and willingly in the transaction, including board members voting to approve the compensation.

An excess benefit exists when a disqualified person receives an economic benefit that exceeds the value of consideration that the organization receives for the services performed by such person, regardless of intent or motive. If the consideration paid is equal to or less than the value of the work to the organization, no violation of the rules has occurred, even if a disqualified person is involved. Disqualified persons violating the rules are subject to a tax of 25% of the excess benefit. If payment is not made in full by the specified date, an additional tax of 200% of the excess benefit is imposed. Organization managers in violation of the rules are subject to a tax of 10% of the excess benefit that may not exceed $20,000 total for each transaction

Ethical – AFP’s Code of Ethical Principals and Standards

The Association of Fundraising Professionals (the "AFP"), which is widely regarded as the most important trade organization in the sector, opposes most incentive-based compensation arrangements in its Code of Ethical Principles and Standards (the “CEPS”). The CEPS specifically prohibits its members from accepting compensation that is based directly on contributions raised. Specifically, the CEPS states: “(21) Members shall not accept compensation or enter into a contract that is based on a percentage of contributions; nor shall members accept finder’s fees or contingent fees.”

The CEPS does allow for certain incentive-based arrangements as follows: “(22) Members may accept performance-based compensation, such as bonuses, provided such bonuses are in accord with prevailing practices within the member's own organization and are not based on a percentage of contributions.” Typically these arrangements are based on performance metrics related to effort exerted to complete specific tasks that may or may not result in fundraising success such as proposals submitted, events executed, and/or social media campaigns launched.

The following guidelines apply:

1. the member's organization has a policy and practice that awards performance-based compensation; and 
2. the policy has the approval of the organization's governing body; and 
3. the policy and practice include, but are not limited to, the member's area of responsibility (e.g., are a norm within the organization); and 
4. the criteria are restricted to mutually agreed-upon, pre-established overall goals; and
5. the criteria for determining the eligibility for, and amount of, such compensation shall exclude any consideration of a percentage of contributions. This should be interpreted as an absolute prohibition of any reference to, or use of, a percentage of income to determine compensation, either in effect or actuality.
   

Practical – Transparency and Donor Trust

Incentive compensation arrangements, in many instances, must be disclosed in federal tax filings that are available to the general public online and upon request. A charitable organization that intends to pay performance-based incentive compensation must disclose those arrangements on its Form 1023, which is the initial application for tax-exempt status. An organization that later decides to pay incentive compensation is not required to amend its Form 1023 but in many instances must disclose the incentive compensation paid on Schedule J to its annual Form 990. Some exceptions, however, permit aggregation on the Form 990 of compensation paid for current employees with total compensation of less than $150,000. Additional disclosures may be required on state charitable solicitation license applications and renewals.

If disclosure of these performance-based compensation arrangements is required, the organization risks diminished trust by its current and prospective donors. Many donors are reluctant to support organizations that pay a percentage of contributions to professional fundraisers because they perceive that their contributions’ impact on the organization’s charitable goals is diluted. In addition, donors may question whether the fundraising professional is motivated by the organization’s charitable mission or the fundraiser’s own personal gain in requesting the donation.