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Compensation for Services in a Family Foundation
by Janice E. Rodgers, Partner, Wilson & McIlvaine, Chicago, Illinois
From the Association of Small Foundations, (for foundations with few or no staff)
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"I am on the board of my family foundation and we want to hire my daughter as executive director. Can we? How much can or should we pay her?"
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Variations of these questions are among the most common legal questions to the ASF office asked by family foundation board members. The answers from a legal standpoint are easy; applying them to a particular situation is more difficult. The key in both instances is the word "reasonable."
The first legal issue to consider: do your foundation's governing documents permit the payment of compensation to a child? As a board member, you should first read these documents (articles of incorporation, bylaws, trust agreement or declaration of trust). It is also possible that the state law governing your foudation will address this issue.
Assuming there is no prohibition under state law of the governing documents, the next concern is self-dealing under the federal tax rules. If you are a board member, you are disqualified person with respect to the foundation. As a descendant of a board member, your daughter would also be a disqualified person. A disqualified person is prohibited from engaging in any act of "Self-dealing" with the foundation. Generally, self-dealing includes any transaction between a private foundation and disqualified person.
There are, however, several exceptions. One is a special rule that says, except in the case of a government official, compensation (and reimbursement of expenses) must be paid by a private foundation to a disqualified person for personal services which are reasonable and necessary to carrying out the tax-exempt purpose of the private foundation, so long as the compensation (or reimbursement) is not excessive. This boils down to two key parts: 1) reasonable and necessary services, and 2) reasonable compensation.
The first portion of the test requires that the services be reasonable and necessary to carrying out the tax-exempt purposes of the foundation. Under this test, the work must further the foundation's charitable purposes; the daughter must be qualified to perform these services; and the extent of services must be reasonablefor this particular foundation. Does your foundation require an executive director to continue to extend its work? Is your daughter the best candidate for the job? Would the executive director position be more appropriate as a part-time position?
The amount paid must also be reasonable. The IRS says that reasonable compensation "is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances." In assessing the reasonableness of foundation director compensation in connection with a 1989 audit, the IRS looked primarily to the Foundation Management Report published by the Council on Foundations. (The Council also publishes a Grantmakers Salary Report). The IRS also reviewed a publication concerning corporate directors'compensation, and it is reasonably clear that compensation for similar services in the for-profit world may be considered. In addition, ASF's annual Member Survey took a detailed analysis of salaries for small foundations and is available to all members.
There is no formula that yeilds the "right" number for compensation. As you assess the appropriate comparisons to compensation paid to others for similar work, you should consider: asset size of the foundation, dollar amount of annual grants, methods of grantmaking, services provided, time spent, qualifications of the service provider, and compensation she has been offered or receives for other comparable services. The IRS will give more deference to decisions made by an independent compensation committee than to those made by a board consisting only of family members of the person being paid. The IRS is also more impressed with compensation decisions that are documented in detail at the time they are made rather than justified at the time they are challenged years later.
How much should the foundation pay your daughter? No more than the amount determined by a board of directors acting prudently and considering the factors described above. Finally, remember that the amount of compensation paid to a director or officer is disclosed on the foundation's annual tax return, which must be made available for inspection by anyone who asks to see it.
(Permission is given to copy this article in full, with attribution, per the Association of Small Foundations).
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