Monitoring Executive Compensation in Tax Exempt Organizations
posted Nov 16, 2017 by Patrick Martin, CPA in the Mission Matters Blog
Any nonprofit board needs to have an extensive discussion regarding executive salaries in order to comply with Internal Revenue Code Section 4958, which deals with taxes on excess benefit transactions.
When top officials within tax exempt organizations receive excess compensation, Internal Revenue Code Section 4958 provides for the assessment of penalties called intermediate sanctions.
Excess compensation occurs when an individual receives compensation from a tax exempt organization, directly or indirectly, and the value of the economic benefit provided by the organization exceeds the value of the consideration received by the organization. Examples of an excess benefit can occur in an exchange of compensation, and other compensatory benefits, and exchange of property with the applicable tax-exempt organization.
Intermediate sanctions are payable by the insiders who benefit from the excess benefit transaction and by the organization's officers, directors and other influential people who knowingly participate in these transactions. It is a term used in regulations enacted by the United States Internal Revenue Service that is applied to tax exempt organizations who engage in transactions that benefit a disqualified person within the organization.
Intermediate sanctions include:
- An initial amount of 25% of the amount that the IRS determines to be the excess benefit imposed on the person receiving the benefit
- A possible additional 10% imposed on any member of management involved in the transaction, not to exceed $10,000 per transaction, and
- An additional excise tax equal to 200% of the excess amount imposed on the person receiving the benefit if the excess benefit is not corrected within the taxable period.
It’s important to keep in mind that there are special rules providing for possible abatement of some of these penalties if a timely correction is made.
5 Duties of the Board
Regulations implementing intermediate sanctions contain a fairly straight forward procedure for making sure that top executive compensation fully complies with the law. To ensure that your nonprofit is in compliance with these regulations, the board must:
- Gather compensation comparability data for the position. (This can be based on industry surveys, expert compensation studies, or documented compensation of similar positions held in comparable organizations which may be derived from Form 990s open to public inspection.)
- NOT have personal interest in the compensation arrangement.
- Approve the compensation, without discussion or voting participation by the person whose compensation is being approved (or any other member with a conflict of interest).
Provide documentation showing the basis for the board’s determination along with the approval. The documentation must cover:
- The terms of the approved transaction
- The date the transaction was approved
- A list of those present during the debate and who voted on it
- Any comparability data used by the board in the decision making process and information on how that data was obtained
- Any information about actions of a member of the decision making body with a conflict of interest
- Carefully read Form 990 and compensation and salary details publicly disclosed there.
Why compliance is necessary
In order to avoid intermediate sanctions, full compliance with IRC §4958 is vital. The IRS refers to these penalties as “intermediate sanctions” because they are considered an intermediate step on the path to loss of tax-exempt status. The loss of your organization’s tax exempt status is essentially the worst outcome.
Reports have shown that the median pay increase for nonprofit top executives is starting to approach a normal level. Though it has not been widely discussed in RI, placing more limits on compensation for nonprofit leaders is becoming more and more important for nonprofit boards across the U.S.
For more information on nonprofit compensation, contact any member of our Not-for-profit Services Team.