The executive director works full-time for the non-profit, but can the other two board members be paid on a contract basis for their knowledge and skills, since that is why we wanted them to join with us in the first place? OR is that a conflict of interest to the IRS?
Of course they can be employees of the organization and in fact in most instances they will be. There is no problem with that and the people that operate the non-profit are not expected to do so for free. I mean, the Director of the Red Cross makes millions per year and the President of my NFP undergrad college made over 500K.
You just need to make sure that the salaries that are paid are reasonable for the position.
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Mr. Natoli is absolutely correct. As he stated, their compensation needs to be reasonable for whatever they are providing to the company.
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Yes, it is okay for nonprofit organizations to pay its directors who work for the organization.
Usually nonprofits should not pay board members for "knowledge and skills" solely in their capacity as directors. But if the individuals are using their knowledge and skills in actually providing services to the organization, they may be compensated reasonably. The IRS would want the nonprofit to determine what is reasonable compensation based on what others are paid in similar situations (i.e., doing similar work for similarly situated nonprofits).
There is a potential for a conflict of interest or an "excess benefit transaction" whenever the activities of a tax exempt organization benefit the private interest (compensation) of an officer or director of the organization. The nonprofit organization should adopt a conflict of interest policy and should follow the policy diligently. The IRS publishes a sample conflict of interest policy.
Finally, be sure to consider carefully whether the contracted workers are independent contractors or employees. See IRS guidance on this issue, as well.
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While I agree with the other answers given (compensation needs to be reasonable, services need to be necessary, etc.), one problem inherent with this type of situation is setting appropriate compensation. Certainly the individual should not vote on his or her own compensation; however, where the entire board is "interested" (i.e. receiving compensation), I suggest the board take care to document how it arrived at the compensation amounts (comparable salaries paid by similarly situated charities for example).