Upper Saddle River, N.J. - August 23, 2006 - Not-for-Profits (NFPs) continue to receive the brunt of the government’s attention as the Internal Revenue Service attempts to identify executive compensation excesses and put limitations on the amount that is paid to senior management. Post-Enron, there has been an unprecedented amount of media and public attention placed on excesses in executive compensation, focusing not only on public companies, but not-for-profit organizations as well. Much of the criticism is justifiable, particularly when there is little or no linkage between the amount of compensation paid to an executive and the organization’s performance. Many of these excesses can be attributed to pay determination arrangements that are self-serving.
For publicly traded companies, the government’s reaction to excessive compensation has resulted in legislation such as Sarbanes-Oxley (SOX), the FASB requirement affecting the expensing of stock options, and the SEC’s tightening of executive compensation disclosure rules. Although aimed at public companies, in reality they also impact all companies, including NFPs.
In a recent article in The CPA Journal , the authors indicated, “The IRS intends to aggressively enforce section 4958, and the related regulations.” Further it indicated, “…the IRS was 'seeing issues' in the reporting of loans, deferred compensation, and other perks.” The recent changes to section 457(f), which requires that at retirement, all deferred compensation arrangements, including annuitized supplemental executive retirement plans (SERPs), become fully taxable, further exacerbates the issue. Under the new rules, the amount of the deferred compensation shows up as part of the annual Total Compensation Package (TCP), but is again shown as part of total compensation in the year of retirement.
It is the organization's responsibility to prove that the TCP is appropriate through a “rebuttable presumption” that the compensation arrangements were reasonable, in which case, the burden of proof rests with the IRS. This requires that three (3) conditions be met by the NFP:
1) the compensation decisions were made at arm's length by an independent body (committee or Board)
2) the Board relied upon competitive information provided by a qualified and independent third party
3) the transactions and basis for their determination were appropriately documented.
In addition to the three items noted above, we strongly recommend that the Boards of NFPs take a hard look at how executive compensation is determined within their respective organization, and that it is consistent with a written and well thought-out compensation philosophy. Furthermore, the executive compensation program must reflect compensation levels within the appropriate competitive marketplace, and correlate with the financial viability and performance of the organization.
Compensation Resources, Inc provides consulting in Executive & Sales Compensation, Salary Administration, Stock Option & Performance Management Plans.
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