Recently the IRS has turned its sights on benefits given by nonprofit organizations using as its weapon the intermediate sanctions provisions under IRC Sec. 4958. In brief, intermediate sanctions allow the IRS to penalize a nonprofit entity and the disqualified person (meaning, in part, a person in a position to exercise substantial influence over the affairs of the nonprofit organization) receiving the excess benefits through taxes, penalties and other remedies.
This is part of a larger initiative by the IRS to recoup the lost revenue from uncollected employment taxes. The IRS is taking the position that the failure to properly tax or include fringe benefits in the compensation of the nonprofit’s executives results in an automatic excess benefit subjecting it to the intermediate sanctions. It is common for a nonprofit to overlook the obligation to report in the W-2 for its executives the value of the benefits paid or provided when determining total compensation paid to them. If the taxable fringe benefits are not included in the W-2, the IRS may find your nonprofit to be engaged in an excess benefit transaction.
Some examples of benefits and perks that are being targeted are unsubstantiated business expenses, discretionary spending allowances, first class travel, companion travel, club memberships, personal use of cell phones, and the like.
What can a nonprofit entity do? Form 990 points the way. It highlights the importance of the nonprofit entity to review its internal compensation decisions, the policies and practices used in making those decisions and the governance policies and controls associated with fringe benefits. The bottom line is (1) develop a structure within which compensation decisions are made and insure that structure is transparent and independent; (2) establish sound policies and procedures with respect to the compensation process, including where appropriate finding out what other similarly situated nonprofits are paying; (3) establish an independent group of individuals to make the compensation decisions, whether it be independent members of the Board of Directors or a duly organized and authorized compensation committee or similar group; and (4) be sure the independent group adheres at all times to the policies and procedures you have establish. If you take these steps, your efforts to ward off the IRS should be successful.