Internal Revenue Service targets Excessive Salaries at Nonprofits.

In late July, 1996, President Clinton signed a new law giving the Internal Revenue Service (“IRS”) an additional and more practical weapon to deal with not only executives of nonprofit organizations who receive excessive salaries and/or benefits, but also those at the nonprofit corporation who approve such arrangements.

Prior to the enactment of this law, the only recourse the IRS had was to revoke the tax exempt status of the organization, known by some as the “death penalty.” Now the IRS has more flexibility in addressing these issues. These laws were prompted in part because of recent well-publicized abuses such as the bilking of United Way of America of more than $1 million dollars by its former President, and the continued and significant growth of organizations in the nonprofit sector. Under the new law, a nonprofit organization may obtain a presumption that the compensation to its executives is reasonable. To obtain this presumption, salaries must be approved by a board which is composed of individuals unrelated to, and who can substantiate that they are not under the influence of, the person receiving the compensation. Further, these compensation decisions must be based on a comparison of the pay and benefits of the organization in question with similar positions at similarly situated organizations. Finally, the comparison must be adequately documented.

The law provides sanctions for violations. The executives involved can be fined an amount equal to twenty-five (25%) percent of the compensation and benefits found to be excessive. If those fined fail to take corrective action or pay the fines, the law permits additional fines up to as much as two (2) times the amount of the excessive compensation and benefits. Managers and directors who approved the compensation knowing it to be improper could also be subject to an excise tax of ten (10%) percent of the amount of the excess compensation or benefits, to a maximum of $10,000.00.

Benefits given to executives are scrutinized by the new law, but in an obscure way that is difficult to apply. A nonprofit organization must carefully consider whether purchasing automobiles or giving automobile reimbursements, payment of club dues, providing for the use of apartments, providing travel expenses unrelated to the business of the organization, the use of credit cards not properly documented, interest-free loans, blanket expense accounts, and other fringe benefits may run afoul of this new law.

This law confirms the increasing interest and oversight which the IRS is giving to nonprofit organizations. We recommend each nonprofit agency consider including the provisions of the law within its decision-making process when establishing compensation and benefits for its executive managers. The use of an independent board or committee of the board to make compensation and benefits decisions based upon well documented competitive compensation and benefits information will go a long way to protect your nonprofit organization from the impact of this new law.

Members of our Nonprofit Group stand ready to respond to any questions you might have with respect to this law.