Following up on the 400 questionnaires sent out to colleges and universities under its College and Universities Compliance Project, the IRS has announced that it will conduct audits of 40 of those schools, with a particular emphasis on executive compensation.  As noted in our earlier posts on this subject, this activity by the IRS follows on the heels of a similar project examining nonprofit hospitals.

Lawrence Associates will present a two-part program “Will Your Nonprofit’s Executive Compensation Withstand Scrutiny by the IRS, Public and Media?” including an overview, strategies and responses.  We will be joined by Richard Lucash of the law firm McCarter & English.  The webinars will be run on January 27 and February 24, 2010 at 1pm EST.  Registration is free using the comp code at our web site.

Wednesday Webinars is a series of free one-hour educational offerings by experts in nonprofit management.   Most presentations have been offered at nonprofit conferences, and all are aimed at providing professional development opportunities for senior staff and trustees of nonprofit organizations

The blog FierceHealthcare (www.fiercehealthcare.com) reports that “More than 100 executives at Kettering Health Network, named by Thomson Reuters as one of the top 10 U.S. health systems, had their pay frozen.”

An article in the Charlotte Observer has been spreading virally across websites and blogs since it was posted on December 20.  While it repeats the mistake of articles from other sources by noting the Charity Navigator survey that reported an overall increase in nonprofit CEO salaries, while neglecting the fact that the survey covered 990′s from before the economic downturn, it’s nevertheless a likely indication of the direction of the political winds – or headwinds, so to speak - regarding nonprofit salaries.  It appears that the unfavorable publicity about for-profit salaries is spilling over to the nonprofit side.  The article describes a number of what appear to be egregious cases, but then seems to slide over to the common position that a high salary for a nonprofit CEO is automatically suspect.  Another item in the article that we’ve seen picked up by many other websites is a discussion of the small number of IRS personnel assigned to monitor nonprofits.  Watch for action from Congress on this next year.

Forbes Magazine – usually, in our estimation, a pretty good business journal – recently published an article that’s one of the more extreme examples of the mindset that “people who work for nonprofits should be paid less that those who work for for-profits” or perhaps “it’s inherently wrong for a nonprofit CEO to make a significant income.”   The article lists some nonprofit CEOs and their incomes, as if the dollar amounts were sufficient to establish the incomes as “unreasonable.”   We could point out all the problems with the article but the comments on the on-line posting do that pretty thoroughly.  The real question is not whether this article and others like it are well written or not, but rather whether the attention that CEO salaries have attracted since the recession began last year will ultimately manifest itself in new regulations on nonprofit compensation.  For that, it’s more important to pay attention to pronouncments from Congress and from key people at the IRS, as reported in many of our earlier posts.  We will, as always, monitor those closely and report regularly to our readers.

As promised by the IRS’ Sarah Hall Ingram, Commissioner, Tax Exempt and Governance Agencies, at her talk at Georgetown University this summer, the IRS has issued a Governance Check Sheet for nonprofit organizations for use by its agents.  The check sheet essentially runs through the issues of nonprofit organization governance covered by the new IRS Form 990.  In her talk, Ingram said that the purpose of the data collection was to seek information to support the IRS’ view that good governance fostered compliance with the applicable tax laws and regulations.  Nonprofit organizations should take advantage of this check sheet as a useful tool to audit and monitor their governance practices.

Note items 13 and 14 which focus on compensation – essentially asking if the organization is taking the steps necessary to establish the “rebuttable presumption of reasonableness” under the IRS regulations on Intermediate Sanctions.

National Public Radio’s All Things Considered (November 23, 2009) highlighted the impact of business wage cuts, and the importance of having a vision for the future. The story featured Lawrence Associates’ client Michael Casper, founder and CEO of UltraSource, a ceramic microchip manufacturer in Hollis, N.H. Recognizing that every crisis contains an opportunity, Michael asked Lawrence Associates to help design and communicate a plan that would increase compensation based on profitability. By markedly reducing breakage during the company’s sensitive production process, these engaged employees are earning back even more than the 10% pay cut, and they are committed to the company’s success. Read or listen to the story here.

The Freedom From Religion Foundation has filed a lawsuit in Federal court in California, challenging the Internal Revenue Code and corresponding California law provisions which exempt ministers from tax on the rental value of a home provided as part of compensation, and on amounts paid as a rental allowance.  The challenged sections also allow the minister to deduct mortgage interest and taxes paid with a rental allowance.  The FFRF suit is found here.

We attended a presentation last Friday at the 2009 MNN/AGM Fall Conference, by David Spackman, Chief of the Non-Profit Organizations/Public Charities Division of the Massachusetts Office of the Attorney General.  Mr. Spackman expressed some views that should be noted by nonprofits.  In line with positions taken by some key IRS figures recently (see our earlier posts on this subject), he said he was convinced that the Intermediate Sanctions rules are causing escalation of executive compensation in nonprofits.  Essentially, everyone knows what everyone else is being paid, and most boards consider their executives to be above average; thus the average continually rises and actual compensation with it.  Saying this another way, he said the IRS rebuttable presumption process has set a floor.  Spackman went on to say that for some organizations, meeting the requirements for the IRS Rebuttable Presumption won’t be enough to demonstrate that compensation is reasonable.

 Spackman seemed to indicate that the AG would be affirmatively seeking out and examining only the largest nonprofits in the state, starting with the recently-announced review of some major healthcare organizations.  But boards that want to be well-positioned in case of a review by the AG, which can occur even for smaller organizations in particular circumstances, should take note of his statement that his office wants to see boards and compensation committees get more deeply into decision-making about compensation; in particular, not simply sign off on survey-based numbers, but consider, for example, why an executive’s performance is “above average” and why numbers submitted by a compensation consultant are comparable to the executive’s position.

 See our earlier posts in this blog for a series of discussions on the operation of the IRS Rebuttable Presumption rules and the examination of large Massachusetts healthcare organizations by the Attorney General.

In our previous posts, we’ve discussed the basics of the IRS Intermediate Sanctions rules governing compensation for senior management of nonprofits – the key definitions and the applicable penalties.  Now it’s time to consider how to stay out of trouble.

The essence of the IRS rules is that any money, property or services provided to an individual by a nonprofit must be compensation, of a reasonable amount, and documented as such.  While the regulations are extensive, the IRS sets out steps by which an organization can create a “rebuttable presumption” (that is, a presumption in favor of the organization) that the compensation for the person in question is reasonable. 

To establish the presumption requires what the IRS lists as 3 steps, although the “steps” have multiple pieces:

1.  The compensation arrangement, or the terms of the property transfer, must be approved in advance by an authorized body of the organization.  The members of the authorized body must not have any conflicts of interest with respect to the arrangement being approved.

Note: Many organizations miss the “in advance” requirement because the compensation committee doesn’t approve the compensation package until after the time period (usually a year, but longer in the case of multi-year employment contracts) has started.  We are frequently involved with providing our clients with model timetables so that all the steps for setting and reviewing compensation can be scheduled to conform to the regulations.

2.  The authorized body obtains and relies on appropriate data for comparability before making its determination.  This requires a determination that the compensation is reasonable.  Organizations frequently utilize the services of compensation consultants to provide analyses utilizing underlying data from compensation surveys.  The consultants in turn are generally looking at compensation paid by similarly-situated organizations for functionally comparable jobs.  Many factors enter into this analysis; among other things, there are significant compensation differences for similar jobs among geographic regions of the US and even between relatively nearby locations (such as a city center and outlying suburbs). 

3.  The authorized body adequately documents the basis for its determination concurrently with making that determination.

“Adequate documentation” is defined in the IRS regulations and includes, among other things the terms of the transaction approved, and, if a decision is made to pay outside the range established by the comparable data, the basis for that determination.

Note:  Many organizations miss the timing requirements for the documentation.  The IRS spells out that to meet the “concurrently” requirement, records must be prepared by the next meeting or 60 days after final action by the authorized body is taken, whichever occurs later.  Then, there’s a second step – the records must be reviewed and approved by the authorized body as “reasonable, accurate and complete.”

While failing to meet every element of establishing the rebuttable presumption is not necessarily fatal and does not, by itself, mean that the compensation will be subject to penalties, the difference between “mostly” complying and actually meeting the rebuttable presumption requirements is often one of planning.  By setting a schedule in advance, the organization can help ensure that it will gather the necessary data, obtain the necessary advice from its attorneys, accountants and compensation consultants, and take the necessary actions in a timely manner.