An executive compensation package that the IRS determines to be in excess of the fair market value of service provided is an excess benefit transaction, subject to intermediate sanction penalties. The initial tax levied against the employee is 25 percent of the portion of compensation deemed to be unreasonable and the tax increases to 200 percent if the excess compensation is not repaid promptly. An intermediate sanction tax equal to 10 percent of the excess benefit can also be imposed against the governing board members who participated in establishing the compensation, if such participation is considered willful and is not due to reasonable cause. The term "intermediate sanction" is used to identify this penalty because it is less severe than complete revocation of the not-for-profit organization’s exempt status, an option that remains available to the IRS.
What can the governing board do to avoid sanctions on compensation paid to executives?
Recognize the governing board members’ responsibility.
- Does your governing board have ultimate responsibility for setting compensation?
- Do you have a compensation committee comprised of members of the board?
- Can you identify which of your employees are covered by the intermediate sanction regulations?
- Is your governing board able to determine exactly how much compensation is reasonable?
- Is the methodology you utilize to establish salary and benefits reasonable?
- Do you review reports from salary surveys or similar studies?
- Does the governing board have conflict of interest policies in place?
- Do board members understand the dollar amount of intermediate sanction penalties?
- Has your board communicated with covered employees so they understand the consequences of having some of their compensation identified as "excess" by the IRS?
Be sure you can you identify all items of compensation and know the value of each benefit included in your compensation package.
- What process do you use to identify total compensation?
- Are you sure all fringe benefits you provide to your executives have been included in your compensation calculations?
- Do you know how to value the non-taxable benefits included in your compensation package?
- Is your governing board aware of the impact your geographic location has on the calculation of reasonable compensation for your executives?
- Have you considered cost of living differences in your evaluation of reasonable pay?
Document the rebuttable presumption of reasonableness.
- Do you understand the "rebuttable presumption of reasonableness" and why it is so important to your organization?
- Can you identify the information necessary to adequately document the rebuttable presumption?
- Do you know how often the rebuttable presumption should be established for an employee?
- Do you use a salary consultant to assist in meeting your responsibilities as you analyze salary amounts and compare benefit packages?
- Do you understand the benefits of requesting a "letter of reasonableness" that states whether or not your compensation package is in line with other similar sized organizations’ packages?