Some of the rules governing compensation at Not For Profit (NFP) organizations differ from those covering For Profit organizations, mostly in the area of how managers and executives can get compensated. Each year we work with about a dozen Not For Profit organizations on a variety of compensation plans, covering the three main areas that apply to Not For Profit compensation. These are areas that we understand fully:
This section allows the IRS to impose an excise tax on any executive and the board members of a NFP [specifically a 501(c)(3) or (4)] in any case where it deems the executive is paid "in excess." Unfortunately, the words "in excess" are not defined.
The good news, however, is that there is something called the Rebuttable Presumption which can protect the board and the executives from penalties if the right process is followed.
We are very familiar with the provisions under 4958 and with the procedural requirements of the Rebuttable Presumption.
Section 457 was added in the 1986 Tax Act. It governs deferred compensation in tax-exempt organizations. Long story short, there are two types of plans, "eligible" and "ineligible." The ineligible plans are covered in IRC section 457(f) and they are the most likely kinds of plans of interest to NFPs because the benefit limits for the "eligible" plans are quite modest while there is no limit on benefits under 457(f). Unfortunately, there are some extra hurdles that must be jumped to take advantage of the tax deferral benefits usually available to deferred compensation plans. One of these hurdles is a requirement to provide "substantial future service."
BTW, the combination of Intermediate Sanctions and Section 457 can make providing a last minute retirement plan for a NFP executive challenging but it can be done!
This Code section applies to For Profits as well as NFPs. It is too extensive to go into detail here but it defines various rules on when and how deferral elections must be made, and when and under what circumstances deferred funds can or must be paid out.
IRC Sections 4941 and 4945 have similar requirements so it is also important for Foundations to exercise care when deciding on pay for executives.
California has its own rules under the California Nonprofit Integrity Act (SB 1262), signed into law September 29, 2004. It requires that all NFPs covered by the law establish a specific review procedure for considering the pay of the CEO and CFO. In brief, for any entity meeting a $2 million threshold, the Act requires that compensation, including benefits, of the two officers shall be reviewed and approved by the Board of Directors or an authorized committee of a charitable corporation or an unincorporated association or the trustee or trustees of a charitable trust. The standard for review is to determine whether the compensation is "just and reasonable."
The review must occur when the officer is hired, when the term of employment of the officer is renewed or extended, and when the compensation is modified, unless the modification applies to substantially all employees.
Although some aspects of Not For Profit compensation are the same as at a For Profit (e.g., exempt/nonexempt, employee vs. contractor determinations), the rules governing Not For Profit executive compensation are different. The IRS has stated that it intends to be more rigorous in monitoring Not For Profit compensation practices and levels. It is important that Not For Profits and executives be very familiar with the rules and to work with someone like Lipis Consulting to ensure compliance.
Over the years we've seen certain problems crop up on a regular basis. Though common, the following short list of pitfalls often have innovative and even bold solutions that turn blunders into opportunities. In some cases they can be avoided entirely.