Recently there has been a great deal of focus on the Internal Revenue Service’s Exempt Organizations group (EO Group). Many of our clients and friends are directors of tax-exempt organizations. We would like to remind them that the EO also is continuing to focus on executive compensation of tax exempt organizations. In fact, in the EO’s 2013 Work Plan they called out a focus on the transparency of total executive compensation and the disclosures in Form 990. So let’s briefly review the key steps Directors should follow to establish and maintain appropriate executive pay and avoid the imposition of excise taxes under the IRS intermediate sanctions rules under Section 4958.
The intermediate sanctions regulations make it clear that independent directors of tax-exempt organizations can protect their organization and themselves by establishing and maintaining defensible rationales for their compensation programs and following good governance practices. The key concern that tax-exempt organizations should address is establishing a “rebuttable presumption” of reasonableness of compensation. To do so, the regulations require the following three key criteria:
- Approval of executive compensation must be done by an Independent Board or a designated committee (the Committee).
- The Committee should review comparable and appropriate compensation data as part of the decision-making process.
- The final decision and the rationale for such must be documented by the Committee.
As a Director, here are the 4 key topics that you need to be concerned with regarding executive compensation:
A. Define and document your executive compensation strategy, including:
- Your pay for performance philosophy
- Market definition (targeted market position, peer group, appropriate data sources)
- Executive benefits and perquisites approach
B. Define and document the role of the Committee
- Comprised of Independent Directors
- Elements of pay to be reviewed – “total compensation”
- Timing of compensation reviews
- Outside advice to be considered
C. Thoroughly document the Committee’s decision process and outcomes, including:
- Date of the decision
- Members present / voting results
- Terms of the compensation / benefits decided
- Outside advice and details of market / comparable data used
- Rationale for decisions made
D. Total compensation – your process should include:
- Review and understand existing and proposed employment contracts
- Cash compensation – base salary and bonus
- Executive perquisites and benefits
- Severance arrangements
To summarize, given what’s at stake, it is important that tax exempt organizations establish and follow a thorough and transparent governance process for executive compensation decisions. Compensation Committees frequently engage an independent compensation consultant with the expertise to synthesize complex data into simple, actionable advice for Committee members’ use.