Good Company

Charity May Begin at Home, but Tax Exempt Status and Executive Compensation Guidance Come From the IRS

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After more than two years of examinations and analysis, on March 2nd, the IRS issued its long-awaited Report on Exempt Organizations Executive Compensation Compliance Project -- Parts I and II.  The findings and lessons reported are certainly illustrative of areas of concern and opportunities for improvement, but offer little direct guidance. It is clear, however, that exempt organizations and executive compensation will remain areas of intense IRS scrutiny.

The 10 page report, available via link at http://www.irs.gov/pub/irs-tege/exec._comp._final.pdf, addresses the objectives and breadth of the IRS's study to date. A cross-section of exempt organizations was contacted and examined, covering a broad range in size and mission/purpose with only religious organizations and other Form 990-exempt organizations immune from study. While the project's emphasis was executive compensation, a number of related compliance failures were brought to light. 

This IRS initiative grew out of the 1996 legislation that imposes intermediate sanctions in connection with excess benefit transactions (IRC Section 4958) and the related final regulations promulgated in 2002. The concept motivating the intermediate sanctions was - rather than threaten the revocation of exempt status, seemingly reserved only for the most egregious of cases, focus on the offending insiders, namely officers, directors, key employees and other controlling persons - so called "disqualified persons." The recently issued report is the first step in examining the impact of the "intermediate sanctions" legislation on the conduct of exempt organizations and their insiders. 

The most notable highlights of the report include:

• Form 990 reporting needs to be improved with complete and clear information. Expect form revisions to enhance clarity and transparency, particularly in the areas of executive compensation and insider loans.
• 15% of the examinations resulted in written advisories suggesting modification of future conduct and mandating on-going IRS review and interaction.
• In connection with excess benefit transactions examined as part of the initiative to date, excise taxes of $21 Million were imposed on 40 insiders from 25 organizations - an average of nearly $1 Million per organization and over $500,000 per insider. 
• Failings which led to these significant excise tax impositions include: excessive salary and incentive compensation; unreported payments for vacation homes, personal legal fees and personal automobiles; unreported payments for meals and gifts to others; and payment for services to an insider's for profit enterprise in excess of fair value. This list should not be construed as exclusive as other risk areas abound.
• 10% of the public charities reported loans in excess of $100,000 to officers, directors, trustees and key employees. The IRS requested follow-up from 92% of these organizations and 37% were referred for examination. Clearly, loans from exempt organizations to insiders are fraught with risk.
• The IRS continues to recognize the "rebuttable presumption" which, if met, shifts to the IRS the burden of proving the unreasonableness of compensation and benefits afforded disqualified persons. Requirements to satisfy the rebuttable presumption include the independence of the compensation-setting body, reliance on appropriate compensation/benefits comparability surveys and data, and appropriate documentation of the compensation-setting process and approvals. 
• The report notes that the IRS intends to focus on initiatives to enhance the understanding and satisfaction of the rebuttable presumption requirements. That being said, there are IRS recommendations as part of an unrelated work plan floating to Congress that suggest the rebuttable presumption is not a justified burden for the IRS to bear as it has only created better documentation and not necessarily better behavior by exempt organizations. More to follow down the road on the rebuttable presumption.

With both altruistic and economic motives, the IRS will continue to scrutinize exempt organizations and promote compliance through enforcement, education and transparency. Informed, conscientious and diligent management and boards must safeguard against shortcomings and abuses; otherwise these individuals and their exempt organizations may learn first-hand about the intermediate sanctions. 

This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.