Yes, A Nonprofit Board of Directors Can Be Paid! Part 1: California Law and the 49% Rule
I often hear people say that those serving on the board of directors of a nonprofit organization cannot be paid for their service, however, this is not an accurate depiction of the law of nonprofit corporations, as this and the subsequent blog post will discuss.
Important note: This and the following blog post refer to laws that are specific to California nonprofit benefit corporations. Laws applicable to other types of nonprofit corporations, such as religious corporations, are not discussed here.
First of all, why pay Members of the Board of Directors?
I have increasingly encountered veterans of the nonprofit sector complain to me about the all-volunteer or predominantly-volunteer board of directors structure. It’s a legit complaint. To be an effective member of the board of directors of an organization requires considerable time and energy over an extended period of time. Doing this as a volunteer may be sustainable and rewarding for those with sufficient resources to support their costs of living from other sources, or in other words: having the time and energy to volunteer for board service is a privilege that not everyone can easily enjoy. Many leaders of nonprofit organizations that serve low-income, under-resourced, or marginalized populations feel it's important for their board to include representatives from those marginalized populations. I couldn’t agree more. And, I strongly believe that those representatives should be compensated for their service, whenever feasible, to facilitate their effective participation.
*We use the term “director” and “board member” interchangeably in this blog post as they mean the same thing. In the law, an individual member of a board of directors is called a “director” but in my experience, the term “board member” seems to be most commonly used colloquially to refer to a single director or a small group of directors. In this blog post, reference to a director is referring to someone who serves on the board of directors, and not necessarily someone who has the word “director” in their job title but who does not serve on the board of directors (e.g. an Executive Director who is not also a member of the board of directors).
Further, I would even argue that some nonprofits with sufficient resources may want to consider compensating even those directors who are not necessarily from a marginalized group; all directors should be offered compensation (and perhaps be encouraged to decline the compensation only if they are in a position to do so), because compensation can act as an incentive for directors to put more time into their role. I know of many volunteer boards of directors of nonprofits that struggle to get a quorum at their meetings due to frequent absences, which stalls important decision-making. Additionally, some nonprofit directors* struggle to make time for important tasks in between formal meetings, like reading emails and reports, networking, fundraising, developing proposals to make the organization work better, etc., etc. In such cases, offering a modest amount of compensation to directors (which of course should be withheld for lack of participation) might incentivize participation and thus foster a more engaged and effective board of directors.
Every organization has its unique culture, participants, budget priorities, and other factors to consider, so I don’t necessarily recommend paying all board members in all organizations, but compensating board members for their service is something I find myself increasingly urging clients to seriously consider doing.
California Law and the 49% Rule
According to California Corporations Code Section 5227, a director who is compensated by an organization for services rendered to it within the previous 12 months for anything other than reasonable compensation for being a director is an “interested person” along with their family members. “Interested persons” include employees and independent contractors who provide services to the organization. “Interested persons” also includes individuals who might have other business dealings with the organization, for example, a director who leases office space to the organization or a director who owns a business that provides goods or services to the organization would count as “interested.” Not more than 49% of the board of an organization can be made up of “interested persons,” per that statute. This means that a director can be compensated for being a director and not be classified as an “interested person” if the only compensation they receive from the organization is for their service as a director.
A director who is also compensated through other arrangements with the organization, like holding a paid staff position, being paid as a contractor, etc. is an “interested person” and the organization should ensure that these “interested persons” do not make up more than 49% of the Board. As long as your organization abides by the 49% limitations on “interested persons,” it is permissible to pay someone for both serving on the board and for other roles.
**Corporation Code Section 5227 specifies the 49% rule and defines exactly what an “interested person” is according to California law.
The 49% “interested persons” limitation is a fact of California nonprofit public benefit corporation law** so California nonprofit corporations must abide by it, but nonprofit organizations in other states may be subject to similar or different restrictions. Many of my nonprofit organization clients also have 501(c)(3) tax-exempt status as determined by the IRS, so additional federal laws regarding compensation apply to such organizations. A high level summary of the IRS requirements for 501(c)(3) nonprofits is that any compensation paid to anyone must be “reasonable.” This rule applies to anyone who is compensated by the organization, whether for service on the board of directors or other roles. There are more nuanced guidelines and rules about compensation provided by the IRS, which will be elaborated on in the next post.
Disclaimer: Please also remember that the law is complicated and it changes. So this blog post is intended as an informational resource but it might not cover all the relevant points for your specific situation and it should not be relied upon as legal advice. Before making radical changes to your organization’s policies on compensation please contact me to set up a consultation or speak with another attorney who is familiar with laws applicable to nonprofit organizations in your state. An attorney can help your organization navigate governance and compensation practices among other legal issues.