,
Morgen Cheshire ,
Jonathan R. Flora 
,
Marla K. Conley ,
Christine F. Cushman and
Amy Newnam
It is well known that Congress, the IRS and state attorneys general have become increasingly focused in recent years on the level of compensation nonprofit organizations provide to their executives. One has only to look at the newly revised IRS Form 990 to see that the reasonableness of executive compensation is under scrutiny in the nonprofit sector. But there are other signs as well. Some examples include: increased penalties for intermediate sanctions; compliance projects, audits and questionnaires designed to gather data on compensation; and compensation initiatives developed by state attorneys general to encourage boards of directors to be more deliberate about setting compensation.
As enforcement and data collection efforts have stepped up, the IRS Advisory Committee on Tax-Exempt and Government Entities (ACT) recognizes that many exempt organizations lack sufficient resources to hire compensation specialists or other professionals that can help establish reasonable compensation figures for executives. In an effort to assist, ACT recommended, in its latest Report of Recommendations, that the IRS provide the sector with some guidance for understanding the proper procedures for setting reasonable compensation.
Observing that the sector is receptive to information provided by the IRS on its website, ACT has developed a prototype online instructional guide for setting reasonable compensation. The guide is designed to offer best practices drawn from experts who regularly advise organizations on setting compensation. Although these best practices are not mandatory, ACT has made clear its belief that most boards should at least consider the guidance when setting compensation. The tutorial covers tax considerations and business practices believed to make tax compliance more likely.
Setting an appropriate level of compensation is an important step in improving tax compliance, though the procedures used in setting and documenting compensation are also very important. If proper procedures for setting and approving compensation are followed, organizations can take advantage of a safe harbor that presumes that the approved compensation is reasonable. By following these procedures, organizations are also more likely to properly address conflicts of interest issues as they arise. Moreover, through arm's length negotiations, organizations are often able to better leverage and preserve their resources.
ACT's prototype instructional program is a step-by-step guide, which is meant to provide plain language advice for managers, boards and advisors of nonprofits. Among other things, it provides details about how to:
- develop internal procedures and compensation comparables;
- report salary information on the IRS Form 990; and
- maintain appropriate records.
An Invaluable Resource
IRS officials have not yet made any commitment to follow this recommendation, but it is foreseeable that the IRS will implement additional guidance on this issue in some form.
The ACT report makes clear that review of the IRS website is becoming common practice among exempt organizations, and in this area of enforcement and compliance, it is best to "follow the flock" by implementing best practices. The report also highlights that the IRS already makes accessible a lot of useful information on its website. The website contains instructional materials and other resources that are specific to charities and other exempt organizations: http://www.irs.gov/charities/index.html. In addition, if your organization does not currently receive the IRS Exempt Organization Update with alerts and announcements, you may want to subscribe at http://www.irs.gov/charities/article/0,,id=154837,00.html. Taking advantage of these resources can help improve an organization's compliance with IRS rules and regulations.
How Can Legal Counsel Help?
The background provided on the IRS website is a great starting point for organizations interested in understanding basic compliance requirements and potential compliance issues they may face. However, legal counsel can provide additional details and guidance specific to your organization's needs. Legal counsel can also help by reviewing your contracts, compensation arrangements, and reimbursement and allowance policies, as well as assisting your organization with potential IRS audit or collection proceedings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.