In public comments made earlier this week, senior Internal Revenue Service (IRS) officials shared a series of significant observations arising from the IRS' current focus on exempt organization executive compensation arrangements. This focus has involved more than 1,200 “compliance check letters” sent to exempt organizations and more than 600 examinations. These observations (and our related analysis) include the following:
- Delegation of compensation decisions to a dedicated executive compensation committee will not absolve the entire board of directors from its responsibility for oversight of compensation decisions. This position is consistent with the recommendation made this summer by the Panel on the Nonprofit Sector in its final report to Congress and emphasizes the need for transparency in reporting committee decisions to the full board.
- Compensation decisions should only be made by disinterested board members. The IRS continues to express concern regarding the presence on a board-level compensation committee of directors having a significant business relationship with the organization. This confirms the importance of establishing the independence of compensation committee members.
- Satisfaction of the criteria for establishing the rebuttable presumption of reasonableness is recommended. There is increasing evidence that it is rapidly becoming a governance "best practice" for exempt organizations. In fact, the IRS officials stated that qualifying for the rebuttable presumption likely will minimize the chances of IRS scrutiny.
- There is substantial risk in relying solely on compensation data from comparable for-profit organizations. Rather, the exempt organization may apply comparability data from similarly situated nonprofit organizations or a combination of for-profit and nonprofit organizations.
- The compensation analysis should assure that all forms of compensation and benefits are aggregated and assessed, regardless of whether such amounts are actually treated as income. Items that should normally be included within the compensation analysis are the personal component of reimbursed travel expenses, personal use of employer-owned property (e.g., cell phones), gifts and gift certificates, spousal travel and club memberships.
- All economic benefits provided to officers, directors and key employees must be reported on the Form 990, or else are subject to risk of treatment as an automatic excess benefit transaction. Items frequently not reported, or underreported, on the Form 990 include the amount of deferred compensation provided to executives, executive perquisites and fringe benefits, such as personal use of a company-provided automobile.
These observations from IRS officials should be given close consideration by exempt organizations, their general counsel and compensation committees. In response, exempt organizations should consider taking all of the following actions:
- Assess the process used to establish compensation and benefits, paying particular attention to the board’s role in that process, and the extent of communication between the decision-making body (e.g., compensation committee) and the board.
- Assure that any board member who is participating in the process is disinterested and, to the extent that they are not, take appropriate corrective action.
- Analyze the process used to establish compensation and benefits and assure the process incorporates appropriate comparability data, evaluates all forms of compensation (whether or not included in income) and allows the organization to meet the standards for the rebuttable presumption of reasonableness.
- Assure that Form 990 reporting adequately reflects all the economic benefits provided to each officer, director and key employee and that all taxable items are properly reported.