A Hot Button Issue
When it comes to executive compensation and benefits, the public expects charities to be transparent and accountable. The idea that organizations that receive public support would provide executives with exorbitant compensation packages does not sit well.
Appropriately documenting the process for determining executive compensation is crucial to satisfying public and regulatory concerns regarding excessive compensation. Here are some steps to help minimize risk and avoid the potential problems associated with awarding excessive executive compensation packages:
- A compensation arrangement should be approved in advance by the board of directors or other governing body composed entirely of individuals who do not have a conflict of interest,
- The board should use data from similar organizations when setting compensation, and
- Discussions, proposals, and the board’s decisions should be adequately documented. Include the terms and approval date of each transaction, the members present when each transaction was debated, and the members who cast a vote.
In addition to setting the salaries of the CEO and other executives, the organization’s compensation committee or board is responsible for reviewing any and all other benefit arrangements (qualified and nonqualified retirement plans and severance, if provided) and perks to ensure they are compatible with the organization’s compensation philosophy and its charitable mission.
What’s going on in the world of nonprofit executive compensation?
The 2014 GuideStar Nonprofit Compensation Report sheds some light on how executives are faring post-recession. The report, based on data for 2012, shows that chief executive officers (CEOs) of large charities received median pay increases of about 4% in 2012. Median pay increases for top executives of small charities (those with annual budgets of less than $250,000) were around 1%. Overall, the median increase for incumbent CEOs was 2.2%.
Benchmarking Compensation IRS regulations allow small organizations (those with annual gross receipts of under $1 million) to use compensation data from three comparable organizations in the same or similar communities as benchmarks. Larger organizations often use surveys or consultants.
IRC Section 4958
IRC Section 4958 applies to public charities defined in IRC section 501(c)(3). This section imposes an excise tax on compensation that constitutes an excess benefit transaction, which occurs when a disqualified person receives more than reasonable compensation for his/her services. Disqualified persons are those that are able to exercise significant influence over the affairs of the exempt organization (i.e. officers, directors, trustees and key employees.) Reasonable compensation is understood to be the amount that ordinarily would be paid for like services by a like organization in like circumstances.
If the organization follows the three steps defined in the Section 4958 regulations under the “rebuttable presumption” rules, the burden of proof of determining whether compensation was not reasonable is on the IRS.
- An independent body must review and approve the amount of compensation (salary & benefits.)
- Reliance should be placed on appropriate comparability data when setting the compensation amount, and
- Contemporaneous documentation relating to the compensation setting process must be kept.
IRS Form 990 Part VI, Line 15 currently requests information relating to these three steps of the rebuttable presumption process.
If you have any questions about your nonprofit organization, please contact Warady & Davis LLP at (847) 267-9600.
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