May 25, 2020

Executive Compensation is Biggest Area of Noncompliance for Exempt Organizations, Says IRS

The area of establishing and overseeing executive compensation is the biggest area of noncompliance—and IRS audit concentration—for tax-exempt organizations, according to the Internal Revenue Service (“IRS”) director of exempt organizations.  Generally, a tax-exempt organization’s net profits may not inure to the benefit of any private shareholder or individual.  However, an individual who provides services for an exempt organization may receive compensation for his or her efforts as long as the compensation is both reasonable and not excessive.  Problems with excessive compensation commonly arise in the area of executive compensation.  If an executive receives excessive compensation, the IRS may assess intermediate sanctions against the exempt organization, the executive and the board members who improperly set the executive’s compensation.  Board members could face personal liability, jointly and severally, up to $10,000 for each excess compensation transaction.

Executive Compensation

Whether an executive’s compensation is reasonable depends on the particular employment situation, including the executive’s duties, training, and position.  The exempt organization’s board of directors is responsible for setting an executive’s compensation and ensuring that he or she does not receive excess compensation.  If the board of directors creates a committee to set and review executive compensation, the committee should present compensation packages to the board for review and the board should analyze the compensation package carefully.  An IRS representative has noted that if a board of directors makes an uninformed decision regarding executive compensation and the executive compensation is unreasonable, such board members may also face adverse tax consequences.

Fringe Benefits

In calculating whether executive compensation is reasonable, the board of directors must take into account all compensation, including fringe benefits.  Peter Lorenzetti, the IRS tax-exempt manager for the Northeast, recently stated that fringe benefits are the most common area in which exempt organizations receive intermediate sanctions because such organizations often fail to include fringe benefits in the calculation of the executive’s total compensation.  According to Lorenzetti, if an exempt organization fails to treat fringe benefits as compensation to an executive, such failure will be considered an automatic excess benefit, which triggers an automatic imposition of taxes.

In addition, the IRS is currently engaged in the National Research Program, a comprehensive audit of 6,000 U.S. companies, including tax-exempt organizations, that focuses on uncollected employment taxes.  Such audits are specifically focused on fringe benefits, according to the chief of employment tax operations at the IRS.  The IRS Fringe Benefits Audit Techniques Guide lists the following as a few of the most common fringe benefits provided to executives:

  • Qualified Employee Discounts
  • Spousal/Dependent Life Insurance
  • Transportation (including Chauffeurs, Employer-paid Parking and Non-commercial Air Travel)
  • Relocation Expenses
  • Wealth Management (including Qualified Retirement Planning)
  • Payment of the Employee’s Share of Employment Taxes
  • Athletic Skyboxes/Cultural Entertainment Suites

To ensure compliance with executive compensation rules, the board of directors of an exempt organization should regularly review executive compensation packages. The board should also maintain active involvement in and oversight of all executive compensation.

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About this Author

Timothy C. McDonald, von Briesen Roper Law Firm, Milwaukee, HealthCare Law Attorney

Timothy McDonald is a Shareholder in the Compensation & Benefits/ERISA Section. His practice focuses on health and welfare, corporate pension, 401(k), profit sharing, 403(b), executive compensation, nonqualified deferred compensation, employee stock ownership (including S corporation ESOPs), cafeteria, voluntary employees’ beneficiary association (VEBA), and flexible benefit programs. He works with publicly-traded and private for-profit businesses, tax-exempt entities, municipalities and school districts, and religiously affiliated institutions. The best endorsement...