Nonprofit Law/compensation for musicians when revenue fluctuates from event to event
I am the Executive Director of a string quartet that is in the midst of filing for 501(c)(3) status, and we're nearly done with the application. In preparing the application, questions about compensation structure have arisen.
In our business, organizations (such as Universities or Concert Series) hire the quartet to give performances, workshops, and public demonstrations. The contracts for these services have a wide range of variance in terms of the fees paid to our organization, based on the budgets of our clients, and our willingness to accept the "gig" for the fee offered. Our musicians are highly skilled and are performing at a professional level, but the organization is young and not yet well known, so the fees we can obtain are still far below the market rate for such services. Thus, so far the musicians are "underpaid" for their services, but our organization is growing, our reputation is growing, and therefore our fees are gradually growing.
My question is about the way we compensate the musicians. Until now, they have been paid as independent contractors, and when we have landed a better-paying gig, the musicians have been paid better, and when we have a lower-paying gig, the musicians are paid less. (Even the higher-paying gigs are still below market rate.) If I understand the requirements for being tax-exempt, however, we should be paying some kind of fixed rate that doesn't fluctuate with revenue.
Is it possible to set up some kind of fee structure that accounts for the variance in revenue, but that still remains in line with IRS requirements? Is a tiered system of per-service compensation allowed, or must we come up with some average number for every type of service (e.g. performance pays X, workshop pays Y), and stick to that, even if our revenue is much greater or much less for a particular service?
thank you in advance for your advice!
The first principle of the IRS for 501(c)(3) organizations is that compensation to workers may not be more that what is reasonable in the circumstances. Starting on pdf page 10 of http://www.irs.gov/pub/irs-tege/eotopici93.pdf
the IRS discusses many of the factors it would look at to decide whether a salary is reasonable.
Rev. Rul. 69-383, 1969-2 C.B. 113, provides that a fixed percentage
compensation plan of an exempt hospital does not result in
prohibited private inurement if: (1) the compensation
plan is not merely a device to distribute profits to persons in
control or to transform the organization's principal activity into
a joint venture; (2) the compensation plan is the result of
arm's-length bargaining; and (3) the compensation plan results in
reasonable compensation by comparing the amounts paid to amounts
received by physicians at similar hospitals having comparable
responsibilities and patient volume. Whether these criteria are
met, depends upon the facts and circumstances of each case.
Cited on page 3 of
"Physician Incentive Compensation"
a IRS publication from 2000 in which they show the factors involved
in determining excess compensation. That ruling would apply, in
principle, to all 501(c)(3) organizations
Later, in 2004, the IRS wrote, "If compensation is based on
revenues, the potential for unreasonable compensation warrants a
close review of the compensation arrangement."
www.irs.gov/pub/irs-tege/eotopicc04.pdf on page 18
You did not ask but you may want to review your determination that the musicians are independent contractors. There are many factors that the IRS uses to conclude whether
someone is an employee or an independent contractor and the
nonprofit corporation's treatment of someone as an independent
contractor instead as an employee for tax purposes may be
incorrect and subject the nonprofit organization to taxes and
penalties. For the factors the IRS considers, see
Harvey Mechanic, Attorney at Law -
P.S. This response is intended to be a general statement of law, should not be relied upon as legal advice and does not create an attorney/client relationship.