Many Community Action Agencies (CAAs) routinely review the perks they provide to help retain experienced staff and hire new talent. One way which CAAs may choose to reward productive employees is by adopting and implementing an incentive compensation plan. Incentive compensation is a one-time payment to employees above and beyond their regular salary as a reward for good performance.

Federal tax and grant rules permit nonprofit CAAs to pay incentive compensation. While CAAs must pay careful attention to avoid federal grant disallowances and IRS penalties, the need for new approaches to recruit and retain quality staff is motivating some funding sources to take a more favorable view of incentive compensation. This article reviews the incentive compensation rules applicable to CAAs, discusses issues to consider when drafting an incentive compensation policy, and describes how to implement a policy to mitigate the risk of disallowance.