BP - Health Care Compliance Association

Executive compensation in troubled times – Part 1 ...continued from page 35
as far as the federal tax-exemption rules are concerned, it is all about
process, process, process.
Rebuttable presumption
Despite recent criticism of the rebuttable presumption process as
potentially protecting compensation levels that the public would not
be satisfied with, the law remains clear. If an organization successfully
establishes a rebuttable presumption of reasonableness, the burden
shifts to the IRS to prove that compensation of disqualified persons
(including many senior executives) is unreasonable. As noted above,
by the admission of a senior IRS official, that is often a difficult task.
In addition, establishing the presumption ordinarily protects organization
managers against imposition of the 10% excise tax that applies to
anyone approving an excess benefit transaction. 22 Given the increased
scrutiny of executive compensation decisions in nonprofit health care,
it is more important than ever for hospitals to take steps to establish a
rebuttable presumption of reasonableness for executive compensation
packages.
To establish a rebuttable presumption, the compensation package
must be reviewed and approved in advance by an independent board
or committee as being consistent with fair market value based on
appropriate market data for comparable compensation arrangements.
The decision also must be documented on a timely basis (within 60
days or prior to the next meeting) in the board or committee records
(e.g., minutes), and the minutes or other records of the board or
committee must note the terms of the compensation package that was
approved, the members who were present for the debate and voted
on the arrangement, the comparability data relied on and how it was
obtained, and any actions taken with regard to the arrangement by
any member with a conflict of interest in relation to the transaction. 23
The presumption is available for all fixed compensation (i.e., specific
dollar amounts, fixed formulas that are not subject to discretion such
as certain percentage formulas or payments conditioned on achieving
specific goals, or approval of a maximum payment as reasonable). 24 To
avoid disagreements over whether a particular compensation methodology
is a “fixed formula,” organizations may wish to include a cap on
total compensation at a reasonable level.
If the board or committee approves compensation that exceeds the
range of comparable data reviewed, the rebuttable presumption can
still be established if the reasons for exceeding the range are recorded
in the minutes. 25 Acceptable reasons for exceeding the range may
include some combination of a prior history of below-market compensation,
specific increased duties or time commitment, truly exceptional
performance that far exceeds expectations (which may be easier to
demonstrate with reasonable performance goals clearly defined in
advance), bona fide competing offers from unrelated entities, and
demonstrated difficulty in recruiting or retaining executives. 26 Failure
to follow the rebuttable presumption procedure does not necessarily
mean that compensation is excessive, 27 but the IRS reports on the
Executive Compensation Initiative and the Hospital Project suggest
that following this procedure is a best practice.
Conflicts of interest
In recent years the IRS also has shown an increasing interest in good
governance practices in general, issuing and revising both a model
conflicts of interest policy (available in the Instructions to Form 1023)
and good governance guidelines. 28 The model conflict of interest policy
is a starting point for many health care organizations in developing
their own conflict of interest policy, which can be helpful in minimizing
the excess benefit, inurement, and tax risks of executive compensation
and other insider transactions. The IRS also included specific safe
harbors in the regulations to determine when a board or committee
will be sufficiently independent to be able to meet the requirements
for establishing the rebuttable presumption of reasonableness.
Specifically, a member of the reviewing body will be deemed to be
independent for that purpose if he or she:
n Is not a disqualified person (insider) or family member of a
disqualified person who participates in or benefits economically
from the transaction (For this purpose, “family members” include
spouses, ancestors, brothers and sisters (whether whole or half
blood), children (whether natural or adopted), grandchildren, great
grandchildren, and spouses of brothers, sisters, children, grandchildren,
and great grandchildren);
n Is not an employee of or supervised by a disqualified person who
participates in or benefits economically from the transaction;
n Does not receive compensation or other payments subject to
approval by a disqualified person who participates in or benefits
economically from the transaction;
n Has no material financial interest affected by the transaction; and
n Does not engage in vote swapping (i.e., trading his/her vote
for approval of another transaction that benefits the member
economically). 29
Board independence is also relevant for disclosure purposes on Form
990, and the degree of independence of the board may affect how the
IRS, the media and the public perceive an organization and its compensation
practices. The Instructions for the new Form 990 define
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