Compensation practices have been an area of focus by the IRS during examinations of tax-exempt organizations, especially of board members and foundation managers earning over $100,000. This is of greater concern for private foundations, which have rules around self-dealing transactions.
It’s important to have well-defined and documented compensation setting practices at your organization to reduce exposure. Here are some recommended practices to maintain compliance in this area.
Establish Written Compensation Arrangements
These need to be approved by an independent, authorized body of the organization in advance of any payments. “Payments made under a compensation arrangement are presumed to be reasonable,” according to IRS regulations.
Use Comparability Data That’s Appropriate
When determining the amount of compensation, comparability data should be appropriate for the position, type of organization, and geographical location. It’s important to use comparability data from other exempt organizations and not focus on for-profit organizations, although the regulations don’t prohibit use of comparability data from for-profit organizations.
There are many resources available for this information, including GuideStar, compensation studies, and other informal surveys.
Keep Adequate Documentation
This documentation is related to the determination of the compensation and the approval of the compensation arrangement. It’s a common recommended practice to have the compensation arrangement approved at an authorized governing body meeting where a written or electronic record of the decision is kept.
In this record, the following should be recorded:
- Terms of the approved arrangement and the date it was approved
- Authorized governing body members present at the meeting and a record of their votes
- Comparability data used to decide the compensation amount
- Conflicts of interest with the arrangement and any action taken
What's Considered Compensation?
Beyond salary and wages, the IRS defines compensation as:
- Contributions to pension and profit-sharing plans
- Unpaid deferred compensation
- Payments for personal expenses, rents, royalties, and fees
- Personal use of the organization’s property or facilities
When ensuring that wages or salary are reasonable based on comparability data, payments for other items should also be considered for economic benefit provided. Imagine this scenario: A foundation was paying compensation for services rendered to a paid board member that was high for the area or services being provided. The compensation amount could be considered not economically beneficial to the foundation and therefore an excess benefit transaction.
To avoid these types of transactions, follow the recommended processes to maintain compliance to ensure the value of the amount paid for services or other benefits are reasonable. Alternatively, if the amount of compensation paid in the above example is reasonable but pushes the board member’s overall compensation above the threshold of reasonable for his or her job, then the transaction could still be an excess benefit.
An organization’s compensation policies as well as compensation for officers, directors, trustees, foundation managers, and the highest paid employees are reported in detail on Form 990, which is available for public inspection.
Disclosures related to policies and procedures in place for compensation setting can be found on Form 990, Part VI, lines 15a and 15b, and on Schedule J. Compensation amounts are disclosed in three places: Part VII and Schedule J on Form 990 and Part VIII on Form 990-PF. A private foundation would have to provide a response on Form 990-PF, Part VII-B as to whether compensation paid to a disqualified person fails to qualify for an exception from self-dealing.
Compensation can be a complex issue depending on the transactions occurring within an exempt organization. Adequate planning and documentation are the key to staying transparent with compensation policies and remaining compliant.
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To better understand if your compensation practices are in line with IRS expectations, contact your Moss Adams professional.