Are nonprofit CEOs overpaid?

Public Interest, Wntr, 2001 by Peter Frumkin

The IRS regulatory scheme announced in 1998 reflected these different motivations. The new regulations included provisions on unreasonable compensation, a procedure for rebuttal, an intermediate sanction, and disclosure requirements. The new regulations define the old notion of an "excess benefit transaction" as one in which an economic benefit provided by a tax-exempt organization to an employee or trustee "exceeds the value of the consideration (including the performance of services) received for providing such benefit." Compensation is excessive if it "exceeds what is reasonable under all the circumstances." Compensation is reasonable "if it is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances." These are, however, fairly loose and porous standards, for how does one interpret the words "like enterprise" and "like circumstances"?

Because there is little case law in the tax status of nonprofits, the reasonable-compensation definition by itself would not help organizations know what was required of them. In order to allow charities to exercise their best judgment with greater certainty, Congress placed a "rebuttable presumption" in its legislation, which the IRS adopted in its regulations. Charities may rely on a rebuttable presumption that their compensation decision was reasonable if it was approved by a board that is made up entirely of individuals unrelated to, and not subject to the control of, the disqualified person; if it obtains and relies oh appropriate comparability of compensation data; and if it adequately documents the basis for its salary decision.

A critical tool for strengthening managers' incentives for diligence and minimizing the effect of penalties on innocent parties is the creation of an intermediate sanction, a penalty designed to give the IRS an alternative to the ultimate sanction of revoking an organization's tax-exempt status. The intermediate-sanctions penalty is a two-tiered tax. Once the IRS determines that a charity has paid excess compensation, it imposes an initial 25 percent tax on the disqualified person who received the excess amount. This individual must not only pay the tax but also repay the amount of the excess compensation to the organization. If the individual does not repay the excess by the time the IRS mails a notice of deficiency or assesses the 25 percent tax, he is then liable for a 200 percent tax on the excess.

The new regulations will also make information disclosure fuller and easier to access. Form 990 is the annual reporting form required of all public charities except for churches and organizations whose annual receipts are $25,000 or less. Form 990 requires organizations to report the amount of their revenues, expenses, and assets and liabilities, with the expense category broken down by program, management, and fundraising. They must describe their major purpose and service accomplishments. Most relevant to reasonable compensation, they must disclose compensation for officers, trustees, and directors, as well as for their five other highest-paid employees; they must also report their five highest-paid independent contractors. Finally, they must disclose certain taxes and fines paid during the previous year, including intermediate-sanctions penalties. Although the law has long required charities to make their Form 990s available, organizations must now not merely make their 990s available for in-person inspec tion but photocopy and mail out the forms upon request or post the information on the Internet. To increase incentives for disclosure, the IRS can now impose stiff penalties for noncompliance.