Do’s and Don’ts of Executive Compensation
Executive compensation is a critical area of governance for all nonprofits. Compensation and benefits are expected to be reasonable in order to avoid excess compensation for any one individual but what does that mean and how does a nonprofit know whether their compensation package would be considered reasonable in the event of an IRS audit or the press?
The presenter was Rob Butler, who serves as Grant Thornton’s Managing Director/Tax Services Leader, serving New England not-for-profit clients. He assists clients with financial statements, tax questions, Form 990s, and federal and state income tax returns. Prior to joining Grant Thornton in 2013, Rob worked for Brandeis University as the Controller responsible for financial accounting, endowment accounting, as well as ensuring that the University was compliant with all regulatory requirements.
During his presentation, Rob reviewed executive compensation “to-do’s” including contract review, approval, comparison, and Form 990 Schedule J, and talked about developments with the Massachusetts State Attorney General and pending legislation proposals from Congressman Dave Camp.
Even though most of the agencies which belong to the Nonprofit Financials Manager group are small to intermediate size and do not necessarily have a lot of issues with executive compensation, it is good to learn about the rules which affect larger organizations the most, because they still apply to smaller organizations. In order to avoid government sanctions for excess compensation, you have to establish that the executive compensation in question is reasonable. Previously, if sanctions were levied, they would be levied against the charity itself. Now, the sanctions are levied against the executive in question, those who might benefit from the compensation arrangement, and those who approved the compensation in the first place. In order protect your executives and the agency against sanctions, you need to build a case for the reasonableness of the compensation in question. You do this by: 1) having an independent Board of Directors who approved it before anything is paid; 2) the compensation is based on a survey of similar organizations in your geographic location conducted by an external 3rd party; and 3) the vote or decision on the compensation is recorded in the Board Minutes. Once you have built a presumption of reasonable, the burden of proof for unreasonableness shifts to the IRS. Although this shifting of the burden of proof has been law since 1996, a proposal by Congressman Camp from Michigan would change this provision. Congressman Camp’s proposal is to go back to punishing the organization for any infraction and to eliminate the rebuttable presumption of reasonableness, shifting the burden of proof back to the individual organization. This proposal would emphasize the need for organizations to tighten up their procedures for determining executive compensation and to be prepared to defend their actions.
When determining the reasonableness of executive compensation, the following factors should be considered: the prevailing rates at comparable positions; there needs to be a job description and scope of work and you should be in possession of the executive’s resume; and there should be a compensation policy for all employees. Also, you need to take into consideration prior year’s compensation history, general economic conditions, the employer’s financial health; and any agreement and negotiation should be at “arm’s length”. All forms of compensation need to be included when evaluating total compensation for reasonableness: the employment contract, deferred compensation agreements, severance provisions, bonuses/tuition, housing, personal vehicles, expense accounts, credit cards, etc. You should pay particular attention to the Governance section of the 990: part IV, checklist about excess benefits; part VI – have you established a rebuttable presumption; and schedule J, detailed compensation. The Massachusetts Attorney General is traditionally a country-wide leader in regulating compensation issues and recently audited 25 non-profit organizations for compensation compliance. There will be changes in the Mass. Form PC, which are intended to increase the transparency of executive compensation. Your Board of Directors should be educated about the issues and rules and regulations around executive compensation.