Can Nonprofits Give Bonuses? Section 4958 and Form 990 Rules

Yes, nonprofits can give bonuses. A 501(c)(3) organization is allowed to pay its employees — including executives — bonuses on top of salary, as long as the total compensation package is reasonable for the work performed and the payment is not a disguised distribution of the organization’s earnings. The IRS treats a bonus as part of an employee’s overall pay, not as a gift or a share of profits, and reviews it alongside salary and benefits when deciding whether the compensation is appropriate.

Getting the bonus wrong carries real consequences. An unreasonable payment can trigger excise taxes on the person who received it and on the managers who approved it, and in serious cases can put the organization’s tax-exempt status at risk.

What “Reasonable” Means

A 501(c)(3)’s exemption depends on the rule that no part of its net earnings may benefit any private shareholder or individual. Every dollar paid out, including a bonus, must be compensation for services rather than a share of surplus revenue.

The IRS measures reasonableness by looking at the employee’s entire package: salary, bonus, deferred pay, fringe benefits, insurance premiums, and any other economic benefit the organization provides. The total has to reflect what a similar organization would pay someone doing comparable work under comparable circumstances.¹

What counts as “comparable” depends on the nonprofit’s budget size, the complexity of the role, the geographic cost of living, and what peer organizations actually pay. If an executive earns a $150,000 salary and receives a $20,000 bonus, the board needs evidence that $170,000 in total pay aligns with market data for similar positions. Pay that significantly exceeds that market risks being classified as an excess benefit.

The process matters too. The comparison should be arm’s length, meaning the person receiving the bonus did not control or unduly influence the decision. Objective salary surveys and a recipient with no vote in the matter make the compensation far easier to defend.

Fixed Versus Discretionary Bonuses

The IRS draws a line between two kinds of bonus structures, and the difference affects how closely a payment will be scrutinized.

A fixed bonus is one whose amount is set by a formula written into the employment contract before services are performed, with no one exercising discretion over whether the payment is made or how much it will be. Fixed bonuses tied to measurable, pre-set performance targets receive more favorable treatment under the excess benefit rules.

A discretionary bonus is one where a board or committee decides after the fact whether to award it and how much to pay. Because someone is making a judgment call about the payout, discretionary bonuses face closer scrutiny. They are still allowed, but they need stronger documentation to defend.

A separate concern arises when a bonus formula is tied purely to the organization’s financial performance. If a plan effectively shares profits with insiders based on the nonprofit’s bottom line, the IRS can treat those payments as violating the prohibition on private inurement.

When a Bonus Goes Wrong: Excise Taxes Under Section 4958

When a bonus pushes an insider’s total compensation above fair market value, the IRS can impose excise taxes called intermediate sanctions instead of revoking the organization’s exemption. These penalties fall on the individuals involved, not on the nonprofit itself.

The disqualified person who received the excess benefit owes a first-tier tax equal to 25 percent of the excess amount.²
If the excess is not corrected within the taxable period, the tax jumps to 200 percent of the excess amount.²
Any organization manager who knowingly approved the excess benefit owes a tax equal to 10 percent of the excess amount, capped at $20,000 per transaction.²

A “disqualified person” is anyone who was in a position to exercise substantial influence over the organization’s affairs at any time during the five years before the transaction. That generally covers officers, directors, founders, major donors, and their family members.²

To avoid the 200 percent second-tier tax, the recipient must correct the excess benefit by repaying the excess and taking any further steps needed to put the organization back where it would have been if the transaction had been at arm’s length.²

How to Protect a Bonus Decision: The Rebuttable Presumption

The strongest protection a nonprofit can build around a bonus is the rebuttable presumption of reasonableness. When it applies, the IRS carries the burden of proving the pay was excessive, rather than the organization having to prove it was fair. Three conditions have to be met:

The bonus must be approved in advance by the board or an authorized committee made up entirely of individuals with no conflict of interest. A member has a conflict if they are the recipient, a family member of the recipient, someone whose own pay is controlled by the recipient, or anyone with a material financial interest in the outcome.³
Before voting, the approval body must obtain and rely on appropriate comparability data: salary surveys, compensation studies from similar organizations, or written offers from competing employers.⁴
The approval body must document the basis for its decision at the time the decision is made. The written record should identify the comparability data reviewed, the members who voted, and the reasoning behind the final number.⁴

Meeting all three conditions does not make the bonus immune from challenge, but it shifts the burden to the IRS and provides significant practical protection during an audit.

Bonuses for Non-Executive Staff

Section 4958’s excise taxes reach only disqualified persons — people with substantial influence over the organization. Rank-and-file employees who do not hold leadership positions or exert control over operations are generally not disqualified persons, so those specific penalties would not apply to their bonuses.

The broader private benefit doctrine still applies to all compensation. If a nonprofit pays bonuses to staff at levels far above market rates, those payments can be treated as serving private interests rather than the charitable mission. The IRS evaluates whether private benefit is merely incidental, both in amount and in relation to the public benefit the organization provides. Excessive pay to any employee, regardless of rank, can count against the organization’s exempt purpose.

Payroll Tax Withholding on Bonuses

A nonprofit employer has to run bonuses through payroll like any other employer. The IRS classifies bonuses as supplemental wages, which carry their own withholding rules.

Federal income tax on bonuses under $1 million in a calendar year is withheld at a flat 22 percent. Supplemental wages exceeding $1 million are withheld at 37 percent.⁵
Social Security tax applies at 6.2 percent for both employer and employee, up to the 2026 wage base of $184,500 in combined earnings for the year. Once total wages pass that threshold, no additional Social Security tax applies.⁶
Medicare tax applies at 1.45 percent on the full bonus for both employer and employee, with no wage cap. Employees earning over $200,000 also owe an additional 0.9 percent Medicare surtax on amounts above that threshold, which the employer withholds but does not match.⁷

Reporting Bonuses on Form 990

Nonprofits that file Form 990 must disclose the compensation of their officers, directors, trustees, key employees, and their five highest-compensated employees earning more than $100,000 from the organization. Key employees — those with certain responsibilities and reportable compensation above $150,000 — must also be listed.⁸

Schedule J of Form 990 breaks each listed person’s compensation into categories, with a separate column for bonus and incentive pay. The schedule also asks whether the organization paid any compensation tied to its net earnings, and whether any non-fixed payments, including discretionary bonuses, were made. Organizations that used the rebuttable presumption procedure for payments under an initial contract report that as well.⁹

Form 990 is publicly available, so these disclosures are visible to donors, journalists, and watchdog organizations. Board minutes should also record any bonus approval, including the date, the comparability data reviewed, and the vote, and the organization should keep those records for as long as they remain relevant to its tax-exempt status.¹⁰

1
Internal Revenue Service. Intermediate Sanctions – Compensation
2
Office of the Law Revision Counsel. 26 U.S. Code 4958 – Taxes on Excess Benefit Transactions
3
eCFR. 26 CFR 53.4958-6 – Rebuttable Presumption That a Transaction Is Not an Excess Benefit Transaction
4
Internal Revenue Service. Rebuttable Presumption – Intermediate Sanctions
5
Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
6
Social Security Administration. Contribution and Benefit Base
7
IRS.gov. 2026 Publication 15-A Employer’s Supplemental Tax Guide
8
Internal Revenue Service. Exempt Organizations Annual Reporting Requirements – Form 990, Part VII and Schedule J: Whose Compensation Must Be Reported in Part VII, Form 990
9
IRS.gov. Instructions for Schedule J (Form 990)
10
IRS.gov. Good Governance Practices – 501(c)(3) Organizations