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Executive compensation in troubled times – Part 1 ...continued from page 33
authority or control over determinations of 10% or more of the expanded questions regarding board independence, conflicts of interest
organization’s capital expenditures, operating budget or employee procedures, disclosure of financial statements, governance policies,
compensation);
and compensation review procedures. These questions are consistent
n Who exactly approves the compensation,
with the IRS’s view that a well governed exempt organization is also a
n What comparability data is relied on in the process,
compliant one. Now the IRS intends to prove that theory.
n Whether the compensation was within the range of that data, and
n Whether the comparables included compensation levels at other In its FY2009 work plan released in late November, the IRS Exempt
tax-exempt hospitals. 16
Organizations Division (EO) announced a new three-part initiative
aimed at nonprofit governance issues. EO will continue its work in the
The IRS has also instructed agents to focus on the effectiveness of nonprofit governance area by focusing on three areas:
internal financial controls when auditing exempt organizations to help
shape the course and scope of the audit – consistent with the IRS view First, EO will develop a checklist to be used by agents in examinations
of exempt organizations to determine whether the organization’s
(and a theme of the new Form 990) that organizations following good
governance practices are more likely to be in compliance with the tax governance practices impacted the tax compliance issues identified in
laws. 17 As part of the opening document requests in hospital audits, the examination and to educate organizations about possible governance
considerations.
IRS agents are now asking for compensation committee minutes as
well as internal audit reports.
Second, EO will commence a training program to educate its employees
about nonprofit governance implications in the determinations,
Fiduciary duties
Setting appropriate parameters for executive compensation is not only rulings and agreements, and education and outreach areas.
likely to be viewed by the public as the right thing to do in tough
economic times, it is also good business and in the best interest of Third, EO will begin identifying Form 990 governance questions
the organization. In that regard, directors and officers of nonprofit that could be used in conjunction with other Form 990 information
corporations owe fiduciary duties of care, loyalty, and obedience to the in possible compliance initiatives, such as those involving executive
corporation. Those fiduciary duties require directors and officers to act compensation, transactions with interested persons, solicitations of
in good faith and in a manner they believe to be in the best interests noncash contributions, or diversion or misuse of exempt assets. 21
of the corporation as opposed to their own personal interests. 18 In
fulfilling those duties in the area of executive compensation, directors Given the emphasis on compensation matters in recent IRS compliance
initiatives, it is likely that these new governance initiatives also
and officers may rely on:
will include close scrutiny of executive compensation processes. Failure
“information, opinions, reports, or statements, including financial to provide proper oversight of the executive compensation process,
statements and other financial data, if prepared or presented by … including an appropriate conflict of interest policy and ensuring that
legal counsel, public accountants or other persons as to matters the compensation levels and plan design are reasonable, also may lead to
director reasonably believes are within the person’s professional or state law allegations of a breach of fiduciary duty. Compensation decisions,
however, are more than a pure numbers game, whether for state
expert competence.” 19
law or federal tax purposes. Simply limiting total compensation does
When the process breaks down, directors and officers are at risk for not necessarily better serve the organization, if it is done at the expense
state attorneys general seeking to recoup excessive payments, including of recruiting and retaining qualified executives or compromising job
bonuses and other insider deals. 20
performance (by providing little or no incentive for improving the
organization’s performance in financial and non-financial areas).
Although fiduciary duties for nonprofits arise under state law, they
also can lead to federal tax compliance concerns including imposition Emphasis on process
of excise taxes at rates up to 225% for excess benefits under Section Real estate experts are fond of saying that the value of property is all
4958 if executive compensation exceeds fair market value. In the about location, location, location. For executive compensation, at least
redesigned Form 990, the IRS will be asking a number of new and
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35
March 2009