Can a 501(c)(3) Pay Its Founder, Officers & Directors?

A question I hear from founders of Arizona nonprofit corporations almost every week is some version of this: “I’m on the board. I also do most of the work. Can the nonprofit pay me?” The founder may be the person who runs the programs, keeps the books, designs the website, or is a lawyer, CPA, contractor or consultant whose services the nonprofit needs. Sometimes the question is about a director’s spouse, child or company rather than the director personally.

The good news is that Arizona law does not prohibit a nonprofit corporation from paying a member of its board of directors. The bad news is that paying a director is one of the most heavily regulated things a nonprofit can do. Arizona corporate law, the Internal Revenue Code, IRS regulations, the IRS annual information return, the payroll tax rules and Arizona’s volunteer immunity statute all come into play. If the board gets it wrong, the consequences range from personal excise taxes on the director and the board members who approved the payment, to personal liability under Arizona law, to revocation of the organization’s 501(c)(3) tax exemption.

This article explains when an Arizona nonprofit corporation may legally pay a director, the steps the board must take to do it correctly, and every significant legal issue that arises when money flows from the corporation to someone who sits on its board.

Two Bodies of Law Control Director Pay

Every payment by an Arizona nonprofit corporation to one of its directors must pass two separate tests. Passing one does not mean you pass the other.

• Arizona corporate law. The Arizona Nonprofit Corporation Act, found in Title 10, chapters 24 through 40 of the Arizona Revised Statutes, decides whether the corporation has the power to make the payment, who must approve it, what the directors must disclose, and when a director can be held personally liable. These rules apply to every Arizona nonprofit corporation, whether or not it is tax exempt.
• Federal tax law. If the corporation is (or wants to be) exempt under section 501(c)(3) of the Internal Revenue Code, federal law adds the private inurement prohibition, the excess benefit transaction excise taxes, the private foundation self-dealing rules, information-return reporting and public disclosure on Form 990. Similar rules apply to 501(c)(4) social welfare organizations.

Arizona law is relatively forgiving. Federal tax law is not. The safest approach is to design every director compensation arrangement to satisfy the stricter federal rules, which almost always satisfies Arizona law at the same time.

What Arizona Nonprofit Law Says About Paying Directors

The board may set director compensation unless the articles or bylaws say otherwise

A.R.S. § 10-3812 is short and direct: unless the articles of incorporation or bylaws provide otherwise, the board of directors may fix the compensation of directors. That statute covers pay for serving as a director — attending meetings, serving on committees, and performing the governance work of the board. Arizona does not cap the amount, require member approval, or require that directors serve for free.

Pay for other services a director provides — working as executive director, doing the bookkeeping, providing legal or accounting services, or doing construction work — is not a “director fee.” It is a contract between the corporation and the director, and it is governed by the conflicting interest transaction rules discussed below.

Read your articles of incorporation and bylaws first

Before the board approves any payment to a director, read the corporation’s articles of incorporation and bylaws. Three things commonly appear in them:

• A private inurement clause. Articles for organizations that intend to qualify under 501(c)(3) usually say that no part of the net earnings may inure to the benefit of any director, officer or private person, except that the corporation may pay reasonable compensation for services rendered. That clause permits reasonable pay for services and prohibits anything more.
• An unpaid-director clause. Some bylaws say directors serve without compensation, or allow only reimbursement of expenses. If yours do, the board cannot pay director fees until the bylaws are amended. Read the clause carefully — many prohibit pay for serving as a director but still allow a director to be paid for separate services.
• A required approval procedure. Some bylaws require a supermajority, a vote of the members, or approval by a compensation committee. The board must follow whatever procedure the documents require.

If the documents do not permit what the board wants to do, amend them first. Amending bylaws is usually a simple board action. Amending articles of incorporation requires filing articles of amendment with the Arizona Corporation Commission.

A nonprofit corporation cannot distribute profits to anyone

A.R.S. § 10-11301 prohibits an Arizona nonprofit corporation from making any distributions except the narrow categories allowed by A.R.S. § 10-11302 (purchasing memberships, distributions on dissolution and certain distributions to member nonprofit corporations). A.R.S. § 10-3140 defines a “distribution” as a direct or indirect transfer of money or property to or for the benefit of members in respect of their membership interests.

Reasonable pay for real services is not a distribution — it is an exchange of value. But a payment labeled “compensation” that is really a way to pass the nonprofit’s surplus to insiders can be attacked as a disguised distribution. Under A.R.S. § 10-3833, a director who votes for or assents to an unlawful distribution can be personally liable to the corporation for the amount, and the person who received it can be required to give it back. A director who is present at the meeting is presumed to have assented unless the director’s dissent is recorded in the minutes or delivered in writing as the statute requires.

Every director owes fiduciary duties when approving pay for another director

A.R.S. § 10-3830 requires each director to act in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director reasonably believes to be in the best interests of the corporation. A director may rely on information from officers, lawyers, accountants and committees the director reasonably believes are competent.

Approving an above-market salary for a friend on the board, without asking what similar organizations pay, is the kind of decision that fails that standard. The statute presumes directors acted properly, and a challenger must prove otherwise by clear and convincing evidence, but that presumption only helps directors who actually did their homework.

Who can sue if the board gets it wrong

A.R.S. § 10-11430 allows a court to dissolve an Arizona nonprofit corporation in a proceeding brought by the Arizona Attorney General if the corporation has continued to exceed or abuse its authority, and in a proceeding brought by a director, by a specified number of members, or by a person named in the articles if those in control have acted illegally, oppressively or fraudulently, or if corporate assets are being wasted, misapplied or diverted for noncorporate purposes. A pattern of overpaying insiders is exactly the kind of conduct those provisions are aimed at.

Arizona’s Director Conflicting Interest Transaction Rules

When an Arizona nonprofit corporation pays a director for services, buys from or sells to a director, leases from a director, or does business with a director’s family member or company, the transaction is almost always a “director’s conflicting interest transaction” under A.R.S. § 10-3860. These statutes do not prohibit the transaction. They tell the board how to approve it so a court will not later set it aside or award damages because the director had a personal interest.

When does a director have a conflicting interest?

A director has a conflicting interest in a transaction if, at the time the corporation commits to it, the director knows that the director or a related person is a party to the transaction, or has a financial interest in it significant enough that it would reasonably be expected to influence the director’s vote. A conflict also exists for certain transactions that would normally come before the board when the other party is a business where the director is a director, partner, agent or employee.

“Related person” is defined broadly in A.R.S. § 10-3860. It includes the director’s spouse, the spouse’s parents and siblings, the director’s children, grandchildren, siblings and parents and their spouses, anyone living in the director’s home, and trusts and estates in which any of those people is a substantial beneficiary. Paying a director’s daughter or hiring a director’s husband’s company is treated the same as paying the director.

The three safe harbors

Under A.R.S. § 10-3861, a director’s conflicting interest transaction cannot be enjoined, set aside, or give rise to damages because of the director’s interest if any one of the following is true:

• Qualified director approval. The transaction was approved under A.R.S. § 10-3862 by a majority — but at least two — of the qualified directors who voted, after the conflicted director made the “required disclosure.”
• Member approval. If the corporation has voting members, the transaction was approved under A.R.S. § 10-3863 by a majority of the votes entitled to be cast by members who are not under the director’s control, after notice and required disclosure.
• Fairness. The transaction, judged by the circumstances at the time the corporation committed to it, is established to have been fair to the corporation.

A person challenging the transaction must first prove by clear and convincing evidence that none of the three safe harbors applies. That is a powerful protection — but only for boards that follow the procedure.

What the conflicted director must disclose

The “required disclosure” defined in A.R.S. § 10-3860 has two parts: the existence and nature of the conflicting interest, and all facts known to the director about the transaction that an ordinarily prudent person would reasonably believe to be material to deciding whether to proceed. A director who wants to be paid must tell the board what the director will do, how many hours it will take, what the director charges others, and anything else a reasonable board member would want to know.

Who counts as a “qualified director”

A.R.S. § 10-3862 defines a qualified director as a director who has no conflicting interest in the transaction and no familial, financial, professional or employment relationship with the conflicted director that would reasonably be expected to influence the director’s vote. The spouse of the director being paid is not a qualified director. Neither is an employee who reports to that director, or a business partner of that director.

Arizona’s Conflict of Interest Policy Statute

A.R.S. § 10-3864 requires the board of an Arizona nonprofit corporation to adopt a policy covering transactions between the corporation and “interested persons” — officers, directors, and any entity in which an officer or director is a member, officer or director or has a financial interest. The policy must cover sales, leases and exchanges of property, loans to or from interested persons, and payment of compensation for services provided by interested persons.

The statute exempts a corporation whose book value of assets at the end of its last fiscal year was less than $10 million or whose gross receipts in its last fiscal year were less than $2 million, as well as membership-only organizations, most religious corporations, governmental corporations and certain licensed health service corporations. In practice, that means most small Arizona nonprofits are not required by state law to have the policy.

Every 501(c)(3) should adopt one anyway. IRS Form 1023 asks whether the organization has adopted a conflict of interest policy, and Form 990 asks the same question every year and whether the organization monitors and enforces it. A written policy that requires disclosure, recusal, comparability data and contemporaneous minutes is the single best tool a board has for paying a director safely.

Federal Tax Rules for 501(c)(3) Organizations

The private inurement prohibition

IRC § 501(c)(3) exempts an organization only if “no part of the net earnings” inures to the benefit of any private shareholder or individual. Directors are the classic insiders the rule is aimed at. Reasonable compensation for services actually rendered is not inurement. Unreasonable compensation, personal use of the organization’s property, below-market loans, and sweetheart deals are.

There is no “small amount” exception to the inurement rule. In a serious case, the IRS can revoke the organization’s exemption, which can make its income taxable and end the deductibility of donations made after revocation.

Intermediate sanctions: the excess benefit transaction excise taxes

Because revocation punishes the charity and its beneficiaries rather than the insider, Congress enacted IRC § 4958, commonly called the “intermediate sanctions” rules. They apply to public charities described in 501(c)(3), to 501(c)(4) social welfare organizations and to 501(c)(29) organizations. They tax the people involved instead of (or in addition to) the organization.

An excess benefit transaction is any transaction in which the organization provides an economic benefit to a disqualified person that exceeds the value of what the organization receives in return, including services. Under Treas. Reg. § 53.4958-3, every voting member of the board of directors is automatically a disqualified person, and so are the director’s family members (spouse, ancestors, children, grandchildren, great-grandchildren, siblings and the spouses of those people) and entities that disqualified persons own more than 35% of. A person stays a disqualified person for five years after leaving the board.

If more than one person is liable for the same tax, they are jointly and severally liable. In addition to the excise tax, the disqualified person must correct the transaction — generally by repaying the excess benefit plus interest so the organization is put back in the position it would have been in had the director dealt with it under the highest fiduciary standards. Notice that board members who vote for an excessive payment to a fellow director can owe the tax personally, even though they received nothing.

The “automatic” excess benefit trap

IRC § 4958 contains a rule that catches many small nonprofits: an economic benefit is not treated as payment for services unless the organization clearly indicated its intent to treat it that way at the time. Under Treas. Reg. § 53.4958-4, the organization shows that intent with written, contemporaneous evidence — a signed employment or services contract, board minutes approving the payment as compensation, or reporting the payment on a Form W-2 or Form 1099 filed before the IRS starts an examination.

If the organization pays a director’s personal expenses, lets the director use a nonprofit-owned car or vacation property, or makes “bonus” payments that are never documented or reported, the entire benefit can be an automatic excess benefit — even if the director’s total pay would have been reasonable had it been documented properly.

The rebuttable presumption of reasonableness

Treas. Reg. § 53.4958-6 gives boards a powerful shield. If the board follows three steps, the compensation is presumed reasonable, and the IRS can overcome the presumption only by developing contrary evidence that rebuts the comparability data the board relied on.

1. Approval by an independent authorized body. The arrangement must be approved in advance by the board (or a committee permitted under state law to act for it) made up entirely of individuals who have no conflict of interest. The director being paid, and that director’s family members, may answer questions but must leave the meeting during debate and the vote.
2. Reliance on appropriate comparability data. Before deciding, the board must obtain and rely on data showing what similarly situated organizations, taxable and tax-exempt, pay for comparable services. For an organization with annual gross receipts under $1 million (which may be averaged over the prior three years), data on compensation paid by three comparable organizations in the same or similar communities for similar services is enough.
3. Concurrent documentation. The minutes must record the terms approved and the date, the directors present during debate and who voted, the comparability data and how it was obtained, and how any conflicted director was handled. If the board approves pay above or below the range of the data, it must record why. The minutes must be prepared before the later of the next board meeting or 60 days after the final action, and then approved by the board within a reasonable time.

The presumption is optional. Failing to obtain it does not mean the compensation is excessive. But for any nonprofit paying a director, it is the cheapest insurance available, and it also satisfies Arizona’s fiduciary standard and conflicting interest procedure at the same time.

Private foundations: stricter self-dealing rules

If the Arizona nonprofit is classified as a private foundation rather than a public charity, IRC § 4958 does not apply. Instead, the far stricter self-dealing rules of IRC § 4941 apply. Almost any financial transaction between a private foundation and a disqualified person — a sale, lease, loan, or use of foundation property — is prohibited regardless of whether the terms are fair.

The main exception allows a private foundation to pay a disqualified person (including a director) compensation for personal services that are reasonable and necessary to carry out the foundation’s exempt purposes, as long as the compensation is not excessive. Self-dealing triggers a 10% tax on the self-dealer and a 5% tax on foundation managers who knowingly participate (capped at $20,000), with second-tier taxes of 200% and 50% if the act is not corrected.

The 21% excise tax on very high compensation

IRC § 4960 imposes a 21% excise tax on the organization when it pays a covered employee more than $1 million in a year. For tax years beginning after December 31, 2025, the One Big Beautiful Bill Act expanded “covered employee” from the five highest-paid employees to essentially all current employees of an applicable tax-exempt organization. Few Arizona nonprofits pay anyone $1 million, but large organizations with a highly paid director-employee need to plan for it.

What “Reasonable Compensation” Means

Under Arizona law and federal tax law, everything turns on whether the payment is reasonable. Reasonable compensation is the amount that would ordinarily be paid for like services by like organizations, taxable or tax-exempt, under like circumstances. Factors the board should consider include:

• What comparable organizations in Arizona or similar communities pay for the same job.
• The director’s qualifications, experience and track record.
• The actual duties, the number of hours, and whether the work is full-time or part-time.
• The size, budget and complexity of the organization.
• Whether the director could otherwise hire someone else to do the same work for less.
• Written offers from other organizations competing for the person’s services.
• The organization’s ability to pay without starving its charitable programs.

Reasonableness is measured by total compensation, not just salary. The IRS adds together cash pay, bonuses, deferred compensation, retirement contributions, health and other insurance, use of a car or property, housing, expense allowances that are not substantiated, and other fringe benefits. A $50,000 salary may be reasonable while a $50,000 salary plus a paid car lease, a family health plan and an unaccounted monthly expense allowance is not.

Every Type of Payment to a Director and the Issues It Raises

“Paying a director” takes many forms. Each one raises its own legal issues.

1. Fees for serving as a director

Meeting fees or an annual stipend for board service are permitted by A.R.S. § 10-3812 unless the articles or bylaws say otherwise. Most small Arizona 501(c)(3) organizations do not pay director fees, and donors and grant makers often expect an unpaid board. If you pay director fees, keep them modest, document them, and understand that they cost every paid director the volunteer immunity protections discussed below. Director fees are generally reported as nonemployee compensation, not wages.

2. Salary for a director who is also an employee

It is common for the founder to sit on the board and also serve as the paid executive director. That is legal. The director-employee should not vote on his or her own pay, should leave the room during the discussion, and should have a written employment agreement or offer letter approved by the independent directors. The organization must run payroll — withholding federal and Arizona income tax and Social Security and Medicare taxes and issuing a Form W-2 — and comply with Arizona’s minimum wage, paid sick time and workers’ compensation requirements like any other employer. Many governance experts recommend that a paid executive director serve as a non-voting, ex officio board member.

3. Paying a director for professional or contract services

A director who is a lawyer, CPA, web developer, contractor, consultant or other service provider can be paid for services to the nonprofit. These transactions are director’s conflicting interest transactions under Arizona law and disqualified person transactions under federal law. Use a written agreement that describes the services and the rate, get comparable quotes or rate data, have the qualified directors approve it, and pay only against invoices. Many nonprofits ask a professional director to provide services at a discount — which helps the reasonableness analysis — but a discount does not eliminate the need for proper approval.

4. Reimbursement of expenses

Reimbursing a director for actual, documented expenses incurred on the nonprofit’s business — mileage, travel to a conference, supplies the director bought for a program — is not compensation if the reimbursement is made under an accountable plan as described in Treas. Reg. § 1.62-2. That requires a business connection, substantiation with receipts within a reasonable time, and return of any excess advance. Flat monthly “expense allowances” with no receipts are taxable compensation, and if they are not reported as compensation they can be automatic excess benefits. Reimbursing a director’s spouse’s travel is compensation unless the spouse has a genuine business purpose for the trip.

5. Buying, selling or leasing property with a director

A nonprofit that rents office space from a director, buys a building from a director, or sells equipment to a director must pay or receive fair market value. Get an independent appraisal or broker opinion of value, have the qualified directors approve the deal after full disclosure, and document it. The same three-step rebuttable presumption in Treas. Reg. § 53.4958-6 applies to property transfers. A private foundation generally cannot buy, sell or lease property with a disqualified person at all, even at a fair price.

6. Loans to or from a director

Loans are specifically covered by Arizona’s conflict of interest policy statute, A.R.S. § 10-3864. A loan to a director is one of the most dangerous transactions a charity can enter into. The IRS views loans to insiders with great suspicion, they must be reported on Schedule L of Form 990, and a below-market interest rate or forgiven loan is an excess benefit. Do not make loans to directors. A loan from a director to the nonprofit is less risky, but the interest rate and terms must be reasonable and the loan should be documented with a promissory note approved by the qualified directors. Private foundations generally cannot borrow from or lend to disqualified persons, except that a disqualified person may make an interest-free loan to a private foundation used exclusively for charitable purposes.

7. Paying a director’s family member or company

Hiring the director’s child, paying the director’s spouse’s consulting firm, or buying from a company the director owns is treated as if the director were paid. Under Arizona law those people and businesses are related persons or create a conflicting interest. Under federal law, family members and 35%-controlled entities are disqualified persons. The same disclosure, independent approval, comparability data and documentation steps apply.

8. Charitable assistance or grants to a director

A charity that provides scholarships, financial assistance or other aid should generally not give that aid to its directors or their families, even if they otherwise qualify. Grants to interested persons must be reported on Schedule L of Form 990, and aid to an insider is a textbook inurement problem. If a director or family member genuinely needs help, the safest course is to disqualify them under the organization’s written selection procedures.

9. Perks, gifts and benefits

Holiday gifts, paid personal travel, use of the organization’s vehicles or vacation property, club memberships, free tickets to the gala for personal guests, and similar perks are all economic benefits. Small benefits that qualify as de minimis fringe benefits are disregarded under Treas. Reg. § 53.4958-4. Anything more must be included in the director’s compensation, approved and reported — or not provided at all.

10. Indemnification and directors and officers insurance

Paying the premiums on a directors and officers liability policy and indemnifying a director under A.R.S. § 10-3851 and the related statutes are generally not treated as compensation problems when they cover liabilities arising from good-faith service to the organization. Indemnification is limited by statute and requires a determination under A.R.S. § 10-3855 that the director met the required standard of conduct. Every Arizona nonprofit that pays any director should carry D&O insurance.

Summary table

Tax Reporting, Payroll and Form 990 Disclosure

Form W-2 or Form 1099-NEC

A director who is paid as an employee receives a Form W-2. A director who is paid director fees or is paid as an independent contractor receives a Form 1099-NEC if the payments for the year reach the reporting threshold. Under the One Big Beautiful Bill Act, that threshold rose from $600 to $2,000 for payments made after December 31, 2025, and it will be adjusted for inflation beginning in 2027. Payments below the threshold are still taxable income to the director.

Remember the automatic excess benefit rule: filing a W-2 or 1099 on time is one of the ways the organization shows it intended to treat a payment as compensation. Many small nonprofits issue the form even when the amount falls under the threshold, simply to create that record.

Form 990 public disclosure

Every 501(c)(3) that files the full Form 990 must list every current director in Part VII — including unpaid directors — along with the compensation each received from the organization and related organizations. Form 990 is a public document, and copies are widely available online, so donors, grant makers, reporters and other board members can see exactly what each director was paid.

• Schedule J requires additional detail for anyone whose reportable compensation from the organization and related organizations exceeds $150,000.
• Schedule L reports excess benefit transactions, loans to and from interested persons, grants to interested persons, and business transactions with interested persons. Business transactions are reportable when payments to an interested person during the year exceed the lesser of $100,000 or the greater of $10,000 or 1% of the organization’s total revenue, or when compensation paid to a family member of a listed director or officer exceeds $10,000.
• Part VI, line 1b asks how many voting board members are “independent.” A director who is paid as an officer or employee, who receives more than $10,000 as an independent contractor (other than reimbursed expenses), or who is involved in a Schedule L transaction is generally not independent. A board with few independent directors is a visible governance red flag.
• Part VI also asks whether the organization has a written conflict of interest policy, how it monitors compliance, and whether the process for setting the compensation of top management included independent review, comparability data and contemporaneous documentation.

Organizations eligible to file Form 990-EZ or the Form 990-N e-postcard have lighter reporting, but the substantive rules — private inurement, IRC § 4958 and Arizona’s conflicting interest statutes — apply to every organization regardless of size.

Form 1023 and Form 1023-EZ

If your nonprofit has not yet applied for recognition of exemption, know that Form 1023 asks detailed questions about compensation of officers, directors and highest-paid employees, whether directors are related to each other, how compensation is set, and whether the organization has adopted a conflict of interest policy. Planned director pay must be disclosed. See our articles IRS Form 1023 Preparation Services and IRS Form 1023-EZ: Eligibility, Instructions & Filing Guide.

Paid Directors Can Lose Volunteer Liability Protection

One consequence of paying a director is rarely discussed until a lawsuit is filed: the director may lose the special liability protections that state and federal law give to unpaid volunteers.

• Arizona volunteer immunity. A.R.S. § 12-982 makes a volunteer of a tax-exempt nonprofit immune from civil liability for acts or omissions in good faith within the scope of the volunteer’s official duties, unless the harm was caused by willful, wanton or grossly negligent misconduct. A.R.S. § 12-981 defines a volunteer as a person who serves without compensation other than reimbursement of actual expenses, and expressly includes directors, officers and trustees. A director who receives fees or salary is not a “volunteer” under that definition.
• Federal Volunteer Protection Act. 42 U.S.C. § 14503 provides similar federal protection, but 42 U.S.C. § 14505 defines a volunteer as someone who receives no compensation (other than reasonable reimbursement of expenses) and no other thing of value in lieu of compensation in excess of $500 per year.
• Limits on articles-based protection. A.R.S. § 10-3202(B)(1) allows the articles of incorporation to eliminate or limit a director’s personal liability to the corporation and its members for money damages, but never for the amount of a financial benefit the director received to which the director was not entitled, for intentional harm, for a violation of A.R.S. § 10-3833, or for an intentional violation of criminal law. Excessive pay to a director falls squarely within the first exception.

The practical lesson: if any director is paid, the corporation should carry directors and officers insurance and have strong indemnification provisions in its articles and bylaws.

Other Practical Risks of Paying a Director

• Donor and grant maker reaction. Many foundations and government funders ask whether board members are paid and expect a majority independent board. Some will not fund an organization whose board members are compensated.
• Loss of board independence. A board where the paid founder and the founder’s family hold a majority of the votes cannot objectively supervise the founder. The IRS, the Arizona Attorney General, donors and courts all notice.
• Quorum and voting problems. When several directors are conflicted, the board may not have enough qualified directors to approve the transaction under A.R.S. § 10-3862.
• Internal disputes. Pay for one director is the most common trigger of board fights in small nonprofits, and A.R.S. § 10-11430 lets an individual director ask a court to dissolve the corporation if assets are being wasted or diverted.
• Restricted funds. Grants and donations restricted to a particular program cannot be used to pay a director unless the director’s compensation is an allowable cost under the restriction.
• Personal income tax. Director fees and contractor pay are subject to income tax and self-employment tax. Directors who are paid should plan for estimated tax payments.

Step-by-Step: How to Legally Pay a Director

Follow these steps every time an Arizona nonprofit corporation pays, or increases the pay of, a director:

1. Check the governing documents. Confirm that the articles of incorporation and bylaws allow the payment and identify any special approval procedure. Amend them first if necessary.
2. Adopt a written conflict of interest policy if the corporation does not have one, and have every director sign an annual disclosure statement.
3. Put the services in writing. Prepare a job description, services agreement or employment agreement that describes the work, the hours and the pay.
4. Make the required disclosure. The director being paid discloses the conflicting interest and all material facts to the board, in writing if possible.
5. Gather comparability data. Collect salary surveys, compensation data from similar nonprofits (Form 990s are a good source), rate quotes from other providers, or appraisals for property deals. Organizations with gross receipts under $1 million may rely on data from three comparable organizations.
6. Confirm you have enough qualified directors. Make sure at least two directors with no conflict and no family, financial, professional or employment relationship with the director being paid will vote. Add independent directors first if you do not.
7. Recuse the conflicted director. The director being paid, and any related director, answers questions and then leaves the room for the discussion and the vote.
8. Vote and record the decision. The qualified directors approve the arrangement in advance of any payment.
9. Write contemporaneous minutes. Record the terms, the date, who was present and who voted, the comparability data and its source, how the conflict was handled, and the reason for any deviation from the data. Finish the minutes before the later of the next board meeting or 60 days, and have the board approve them.
10. Pay correctly. Run payroll for employees, pay contractors against invoices, reimburse expenses only under an accountable plan, and issue a W-2 or 1099-NEC.
11. Report on Form 990. Disclose the compensation in Part VII and complete Schedules J and L when required.
12. Review annually. Revisit the compensation, the comparability data and the conflict disclosures every year, and repeat the approval process for any increase.

Frequently Asked Questions

Is it illegal for a board member of an Arizona nonprofit corporation to be paid?

No. Arizona law expressly allows the board to fix the compensation of directors unless the articles or bylaws provide otherwise (A.R.S. § 10-3812), and a director may be paid reasonable compensation for services the director actually performs. What is illegal is paying more than reasonable compensation or paying a director without proper approval.

Can the founder of a 501(c)(3) be on the board and also be paid as executive director?

Yes. This is very common. The founder must not vote on his or her own compensation, the pay must be reasonable and supported by comparability data, the independent directors must approve it in advance, and the decision must be documented. A board made up only of the founder and the founder’s family cannot properly approve the founder’s pay, so add independent directors first.

Can directors vote on their own compensation?

They should not. Under A.R.S. § 10-3862, only qualified directors count toward approval, and under the IRS rebuttable presumption in Treas. Reg. § 53.4958-6, the authorized body must be made up entirely of individuals without a conflict of interest. A director who will be paid may answer the board’s questions but should leave the meeting during discussion and the vote.

How many independent directors does an Arizona nonprofit need to approve a director’s pay?

To use the board safe harbor in A.R.S. § 10-3861 and A.R.S. § 10-3862, the transaction must be approved by a majority, but at least two, of the qualified directors who vote. As a practical matter, a nonprofit that intends to pay one or more directors should have at least three independent directors so the board can still act if one is absent.

What happens if a nonprofit overpays a director?

Under IRC § 4958, the director owes a 25% excise tax on the excess and must repay it with interest. If it is not corrected, the director owes an additional 200% tax. Directors who knowingly approved it can owe a 10% tax, capped at $20,000 per transaction. In serious or repeated cases, the IRS can revoke the organization’s exemption. Under Arizona law, the directors can face claims for breach of fiduciary duty and, in some cases, personal liability for unlawful distributions.

Does the nonprofit need a compensation study to pay a director?

Not by law, but the board needs reliable comparability data to establish the rebuttable presumption of reasonableness and to satisfy its fiduciary duty. Small organizations with gross receipts under $1 million can rely on compensation data from three comparable organizations in similar communities. Larger organizations paying significant salaries often use an independent compensation survey.

Can an Arizona nonprofit reimburse a director for expenses without it counting as pay?

Yes, if the reimbursement is made under an accountable plan: the expense must be for the nonprofit’s business, the director must substantiate it with receipts within a reasonable time, and any excess advance must be returned (Treas. Reg. § 1.62-2). Reimbursement of actual expenses also does not cost a director volunteer status under A.R.S. § 12-981.

Can a nonprofit hire a director’s spouse, child or company?

Yes, but it is treated the same as paying the director. Those people and entities are related persons under Arizona’s conflicting interest statutes and disqualified persons under federal tax law. Use the same disclosure, recusal, comparability data and documentation process, and expect to report compensation to a director’s family member above $10,000 on Schedule L of Form 990.

Can an Arizona nonprofit corporation make a loan to a director?

Arizona’s nonprofit act does not contain a blanket prohibition, but loans to directors are covered by the conflict of interest policy statute (A.R.S. § 10-3864), must be reported on Schedule L of Form 990, and invite inurement and excess benefit problems. A private foundation generally cannot lend to a disqualified person at all. The safe answer is: do not lend money to directors.

Does paying a director affect the director’s personal liability?

It can. Arizona’s volunteer immunity statute, A.R.S. § 12-982, and the federal Volunteer Protection Act protect only people who serve without compensation other than reimbursement of expenses (with a $500-per-year allowance under the federal act). A paid director loses those protections and should be covered by directors and officers insurance and indemnification.

Does Arizona law require a nonprofit corporation to have a conflict of interest policy?

A.R.S. § 10-3864 requires one only for corporations with at least $10 million in assets and at least $2 million in gross receipts, subject to several other exemptions. However, the IRS asks about a conflict of interest policy on Form 1023 and every Form 990, and every 501(c)(3) that pays any insider should have one.

Can a director be paid a percentage of the money the director raises?

It is risky. Uncapped commission or percentage-of-revenue pay to an insider is a red flag for private inurement, and IRC § 4958 allows the IRS to treat certain revenue-based arrangements as excess benefit transactions. A fixed salary with a capped, documented incentive tied to mission goals is far safer.

How is a director’s pay reported to the IRS?

Employee wages go on Form W-2. Director fees and independent contractor pay go on Form 1099-NEC when the total for the year reaches the reporting threshold, which is $2,000 for payments made in 2026. All compensation of current directors is also disclosed publicly on Form 990, Part VII, with additional detail on Schedule J above $150,000 and on Schedule L for many transactions with interested persons.

Is a director who receives pay still considered independent?

For Form 990 purposes, a director is generally not independent if the director was paid as an officer or employee, received more than $10,000 as an independent contractor (other than reimbursed expenses), or was involved in a transaction reportable on Schedule L. The number of independent voting members is reported on Form 990, Part VI, line 1b.

Do these rules apply to Arizona nonprofits that are not 501(c)(3) organizations?

The Arizona rules — A.R.S. § 10-3812, the distribution prohibition, fiduciary duties and the conflicting interest statutes — apply to every Arizona nonprofit corporation. The excess benefit taxes apply to 501(c)(3) public charities and 501(c)(4) and 501(c)(29) organizations. The private foundation self-dealing rules apply to private foundations. Other exempt organizations, such as 501(c)(6) trade associations and 501(c)(7) social clubs, are subject to their own inurement rules.

What should a nonprofit do if it already paid a director without following these rules?

Stop the payments, gather the facts, and talk to a lawyer before the next Form 990 is filed. If the payments were reasonable, the board can often document its review, obtain comparability data and ratify the arrangement going forward. If the payments exceeded reasonable compensation, the director generally must correct the excess benefit by repaying it with interest, and the organization must evaluate its excise tax and reporting obligations.

Questions About Paying a Director of Your Arizona Nonprofit?

Arizona nonprofit attorneys Richard Keyt and his son, attorney and former CPA Richard C. Keyt, have formed 550+ Arizona nonprofit corporations that became 501(c)(3) tax-exempt organizations. We understand the Arizona Nonprofit Corporation Act and the IRS rules that apply when a nonprofit pays one of its own directors.

To learn about forming a new Arizona nonprofit corporation, read our step-by-step guide on how to form an Arizona nonprofit corporation and see the 28 services we provide when we form an Arizona nonprofit corporation. To hire us to form an Arizona nonprofit corporation, submit our online nonprofit incorporation questionnaire.

If you have questions about this article, book a free office, phone or Zoom video consultation, call Richard Keyt (Rick, the father) at 480-664-7478 & email rk@keytlaw.com or his son Richard C. Keyt (Ricky) at 480-664-7472 & rck@keytlaw.com.

This article provides general information about Arizona and federal law as of October 2026. It is not legal or tax advice for any specific situation. Reading it does not create an attorney-client relationship.