The increased scrutiny of nonprofit organizations by the Internal Revenue Service (IRS) and the public at large has forced nonprofit organizations to take a closer look at their executive compensation packages. Now more than ever, this review has become increasingly important since the enactment of I.R.C. Code Sec. 4958.
Sec. 4958 applies to 501(c)(3) and 501(c)(4) organizations and imposes penalties or excise taxes for receipt of excess benefits by officers or directors from a nonprofit organization. The provisions of 4958 could also penalize those officers and directors who approved or failed to disapprove the excess benefit.
An excess benefit is one that exceeds fair market value for the benefit received by the organization or is not comparable to similar benefits paid by similar tax-exempt organizations. Executive compensation has long been an issue of focus for nonprofits. Most nonprofit organizations already benchmark their officers’ salaries to ensure that the compensation is not excessive.
What organizations have not been addressing, however, are the additional perks that may or may not show up on an executive’s W-2. One area of compensation that is often overlooked is the personal use of listed property such as cars, computers and cell phones. Although it may appear to be a small issue, tax-exempt organizations should review their executive compensation packages with the inclusion of such perks in order to avoid “automatic” excess benefits.
A benefit could be deemed an automatic excess benefit if it was not appropriately reported, even if the inclusion of the benefit would not make the entire compensation package excessive. Automatic excess benefits are meant to punish those organizations that withhold information regarding all compensation and benefits given to their executives.
Penalties related to excess benefits are severe. There is three-tiered excise tax system consisting of a 25% excise tax on the individual who received the benefit (plus return of the excess benefit), a 200% excise tax on the individual (if the benefit is not returned in a timely manner) and a 10% excise tax on the board members who approved the benefit.
As such, it is important for non-profit organizations to analyze and substantiate benefits given. In addition, it would be advisable to amend or write a policy that addresses the personal use of listed property specifically. The policy should address established personal-use percentages and how these amounts would be includable in compensation. Policy should also address contemporaneous substantiation requirements for reimbursements of expenses.
Most nonprofit organizations work diligently to ensure that their compensation practices are fair. But organizations should analyze their total executive compensation packages to uncover any inadvertent benefits prior to IRS review. Documentation is one of the keys to avoiding both IRS penalties and public embarrassment for the nonprofit organization, its management and Board of Directors.
