More than ever, nonprofit organizations face an immense amount of internal and external pressure regarding compensation—and it’s not limited to just the executive leadership team. To satisfy the public, governmental agencies and charitable employees, nonprofit organizations must decide on compensation that’s market competitive and reasonable through all organization levels.
Today, nonprofit organizations face more questions than they have time to answer. They may find they need outside guidance when it comes to compensation. Here are three common reasons nonprofits engage firms to complete compensation studies:
- Help ensuring compliance with IRS requirements
- Understand potential tax consequences
- Attract and retain talent
These three challenges are summarized below.
Help Ensuring Compliance with IRS Requirements
In 2002, new IRS regulations set standards and procedures for justifying compensation levels in nonprofit organizations. The IRS states that crucial employees who work for nonprofit organizations be paid a reasonable amount, and any amount above the reasonable threshold is an excess benefit that can result in certain IRS sanctions, including fines to revocation of an organization’s tax-exempt status.
A nonprofit’s board is accountable for protecting its members and executives from these possible sanctions or, worse, revocation of their tax-exempt status. To shield its members and executives, the board should establish a rebuttable presumption of reasonableness—a multistep process performed by the organization. Per IRS guidelines, the three requirements for establishing a rebuttable presumption are:
- The compensation arrangement must be approved in advance by an authorized body of the applicable tax-exempt organization, which comprises individuals who don’t have a conflict of interest concerning the transaction.
- Prior to making its determination, the authorized body obtained and relied on appropriate data as to comparability.
- The authorized body adequately and timely documented the basis for its determination concurrently with making that determination.
Organizations must understand that directly engaging a firm to complete a compensation study doesn’t establish a rebuttable presumption of reasonableness or shield them from IRS scrutiny. While completing a compensation study doesn’t automatically establish a rebuttable presumption of reasonableness, a firm can guide a company through the process and help make available appropriate data for comparability to help an organization achieve such requirements.
Understand Potential Tax Consequences
Aside from potential sanctions imposed by the IRS, tax-exempt organizations are further subject to excise taxes if specific remuneration exceeds identified thresholds.
Internal Revenue Code Section 4960, enacted as part of the Tax Cuts and Jobs Act, imposes a 21 percent excise tax on tax-exempt organizations that pay their highest-paid employees a certain dollar amount above specific thresholds. This excise tax differs from the sanctions, as mentioned earlier, applied to executives, board members and possibly the organization. Under §4960, this excise tax is imposed if it’s determined that organizations paid 1) excess remuneration (greater than $1 million) or 2) excess parachute payments to covered employees.
If organizations are concerned about paying an executive more than $1 million or an excess parachute payment, they also may be subject to the sanctions noted above if the remuneration doesn’t pass the rebuttable presumption test.
There’s a sense of complexity regarding which tax-exempt organizations, and how those within the organizations, would trigger the potential excise tax. A more robust explanation of the who, what, when, where and why can be further explained by a tax or compensation professional.
Attract & Retain Talent
Aside from compliance concerns and the potential tax consequences of unreasonable or excess remuneration, competition for personnel is as strong as it’s ever been. To stay pertinent in the industry, organizations must be aware of benefits and salary trends. Competitive compensation aligns with a nonprofit organization’s strength and practicality, as well as its mission’s impact.
Engaging firms regularly with access to available data, documenting compensation determination practices and aligning compensation with organizational values are effective ways to maintain a happy workforce.
It’s no secret that nonprofit compensation is a sensitive topic. More frequently, local and national news outlets are covering stories of outrage at the salaries nonprofit CEOs receive. It’s especially true if these nonprofits rely on public donations.
To avoid problems with the IRS and the public, nonprofit organizations must be conscientious when making compensation decisions. Finding a healthy balance of competitive and reasonable compensation is essential. Overpaying executives may lead to bad press, reduced donations, high employee turnover and an organization possibly losing its nonprofit status.
Aside from helping organizations comply with the IRS requirements and address the potential excise tax, a compensation study can assist tax-exempt organizations with recruiting, retaining and promoting talented employees and executives alike. For more information, reach out to your BKD trusted advisor or use the Contact Us form below.