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As the year winds down, many nonprofits want to recognize the hard work their staff put in over the past twelve months. Holiday bonuses, gift cards, and small appreciation gifts may seem harmless, but the rules for nonprofit compensation are more restrictive than many leaders realize.

Because nonprofits must avoid private benefit and excess compensation, even well-intentioned gifts can trigger IRS concerns or require additional documentation.

Why Year-End Bonuses and Gifts Raise Special Issues for Nonprofits

Unlike private companies, nonprofits must ensure that all compensation, including salary, bonuses, and non-cash gifts, is reasonable and tied to legitimate employment value. Year-end generosity often happens quickly, especially when the organization wants to express appreciation before the holiday break. Without planning, that spontaneity can result in undocumented payments, gifts that count as taxable wages, or bonuses that look arbitrary rather than tied to performance. These are the types of issues that draw the attention of regulators.

Reasonable-Compensation Requirements Under IRS Rules

The IRS requires that total compensation for employees of 501(c)(3) and 501(c)(4) organizations be “reasonable,” meaning it must be comparable to what similar organizations pay for similar work. Bonuses are part of that total compensation package, which means they must be justified with objective criteria.

For highly compensated employees or officers, the stakes are even higher. An excessive bonus can be considered an excess benefit transaction, exposing the employee to a 25% tax penalty and the board members who approved it to their own penalties. Tying bonuses to clear metrics such as performance goals, organizational benchmarks, or comparable market data helps establish that the payment is appropriate and aligned with the nonprofit’s mission.

Board Approval and Proper Procedures

Internal approval processes matter. Larger or performance-based bonuses typically require board or compensation-committee approval. When a bonus involves an executive or someone closely connected to a board member, recusals are essential.

Proper documentation protects the organization. Minutes should reflect who was present, who recused, the criteria used to determine the bonus amount, and any comparability data or evaluations reviewed. Even modest bonuses can appear improper if they lack a clearly documented basis.

Foundations should be especially careful when board members or family members are involved in staff compensation decisions, as those relationships heighten the risk of perceived influence.

Distinguishing Bonuses From Gifts

Nonprofits often want to give small holiday gifts as a gesture of appreciation. But under IRS rules, many “gifts” are legally treated as wages:

• Gift cards are almost always taxable compensation, regardless of amount.
• Cash equivalents, including prepaid cards, are also taxable.
• Small items such as mugs, shirts, or food baskets may fall under the de minimis fringe-benefit exception if they are low in value and given infrequently.

A common mistake is assuming that a holiday gift is simply a personal gesture when, in reality, it must be processed through payroll. Gifts funded personally by a board member can also raise concerns if they create preferential treatment or blur governance boundaries.

Payroll, Tax, and Reporting Obligations

If a bonus or gift counts as compensation, it must be included on the employee’s W-2 and subject to standard payroll withholding. This applies whether the payment is made by check, added to a paycheck, or delivered as a gift card. Failing to treat taxable gifts properly can result in payroll errors and potential IRS penalties.

Foundations and other nonprofits with family employees should take additional care. Payments to insiders are closely scrutinized, and even modest errors can be interpreted as governance or compliance failures. Coordinating early with the finance team ensures that all reporting is handled correctly before year-end.

Avoiding Common Pitfalls

Well-meaning board members and nonprofit leaders often unknowingly cross a line when distributing bonuses or holiday gifts:

• Providing surprise bonuses with no written criteria or performance documentation.
• Awarding large executive bonuses without market-based comparison data.
• Using restricted or grant-designated funds to pay for staff bonuses.
• Allowing board members to personally fund staff bonuses in ways that create conflicts of interest.

Performing internal review or consulting with nonprofit general counsel before bonuses are announced can prevent most of these problems.

Policy Best Practices for Future Years

Establishing clear written policies makes year-end compensation far easier and safer to manage. Nonprofits should consider:

• Creating a formal bonus policy tied to defined performance measures or organizational milestones.
• Setting internal limits on de minimis gifts and clarifying the rules for awarding gift cards.
• Reviewing compensation processes periodically to ensure they align with IRS expectations and fiduciary duties.

A consistently applied policy not only protects the organization but also ensures fairness and transparency for all employees.

Work With an Atlanta Nonprofit Attorney to Ensure Year-End Bonuses Are Compliant

End-of-year appreciation is important for staff morale, but nonprofits must navigate compensation rules carefully. The Law Office of Cameron Hawkins advises Georgia nonprofits on reasonable-compensation standards, board-approval procedures, and IRS reporting requirements.

To review your year-end bonus or gift policies, call (678) 921-4225 or contact us online to schedule a consultation.