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On June 9, 2010, the Internal Revenue Service’s Advisory Committee on Tax Exempt and Government Entities (ACT) recommended that the IRS provide additional assistance to charities in setting executive compensation through their Report of Recommendations, Exempt Organizations: Getting It Right – An Online Guide to Setting Executive Compensation for Charities.

ACT describes their creation as an online instructional tool in the form of a webinar or tutorial to provide “step-by-step, plain language advice for managers, boards and advisors of charities to assist them in a wide range of areas, including: developing internal procedures and compensation comparables, reporting salary information in their IRS Form 990 filings, and maintaining appropriate records necessary to meet the rebuttable presumption of reasonableness and comply with the regulations promulgated pursuant to Section 4958.”

IRS, legislators and the public have shown a great deal of interest in recent years in compensation of executives for all types of entities, including exempt organizations. Newspapers often herald the outrageous news of the latest charity that appears to have excessive compensation and the new Form 990’s expanded disclosures of compensation are expected to lead to even more scrutiny. Since Congress has granted the IRS tools to police the reasonableness of compensation through intermediate sanctions allowing application of excise taxes and the authority to invoke the private benefit or private inurement doctrines to revoke a charity’s tax-exempt status, the Section 4958 sanctions address situations where compensation is deemed excessive and provide a structure for corrective action. They also provide procedures that taxpayers may follow to establish reasonable processes around compensation-setting practices. ACT’s new tool is intended to better explain the rules and help organizations put into place appropriate measures to manage compensation.

It should be noted that recent IRS compliance studies on executive compensation, colleges and universities, and hospitals have provided IRS insight into the application of Section 4958. While in many instances the rules appear to have been followed, IRS wonders if the resulting compensation is truly appropriate as many organizations place compensation in the 90th percentile. Additionally, legislators have raised questions about the existing rules and have had such suggestions as to eliminate the safe harbor of the rebuttable presumption of reasonableness standard or to require detailed internal procedures and require compensation comparables to be disclosed as part of the Form 990 that is available for public inspection. No action has gone forward in these areas, but it is a subject that may see further attention. In the interim, IRS and the exempt organization community are working together to educate and improve communication in this area.

The June ACT report indicates the areas covered by this tool include the intermediate sanctions, revocation of tax-exemption, taxation of fringe benefits, and compensation-related disclosures required by the Form 990.

Other areas addressed are compensation and audit issues relevant to churches and compensatory, below-market rate loans. With regard to the intermediate sanctions, it addresses the basic rules, the rebuttable presumption and automatic excess benefits. Because state law requirements for setting executive compensation have significant overlap with the federal tax law rules (particularly the requirements for satisfying the rebuttable presumption under the intermediate sanctions), the tool addresses the process for setting compensation from the governing board’s standpoint and specific state law requirements. Also discussed are ten common pitfalls that organizations often encounter when setting executive compensation. This tool is designed to offer some best or preferred practices drawn from experts who regularly advise organizations on setting compensation.

ACT’s tool uses an informal voice with an effort towards education and humor to encourage reception to this new application. IRS has not announced yet if it will implement this suggested tool. The report, along with screen samples from the tool, is available on the IRS website: http://www.irs.gov/charities/. Because the report of 13 pages is part of a much larger document, we would be happy to provide you a copy of the report by email (as PDF) or by postal mail. Just email us at molive@smith-howard.com and request that a hard copy of "Getting It Right" be mailed to you.