Compensation for Business Leaders

Nonprofit Executive Compensation

In addition to maximum reasonable compensation that applies to both nonprofit and for-profit organizations, there are specific regulations pertaining to executive compensation in nonprofit, tax-exempt organizations.

Intermediate Sanctions

For nonprofit organizations, employee compensation, which may exceed the standard of what is considered maximum reasonable compensation, is one area that can be subject to IRC 4958 Intermediate Sanctions. Intermediate sanctions are the penalty excise taxes imposed by the Internal Revenue Service when individuals associated with a tax-exempt organization are potentially overpaid. Intermediate sanctions may be applied to "disqualified persons" who receive excess benefits and to the organization managers who approve the transaction. A disqualified person is someone who is "in a position to exercise substantial influence over the affairs of the organization." This definition includes a nonprofit's board members, substantial contributors, and executive officers. It also includes the family members of disqualified persons.

To protect parties involved in setting compensation levels, there are Safe Harbor provisions. The Safe Harbor provision protects the organization decision makers who are involved in the design and administration of these plans by excusing liability if an attempt to comply in good faith can be demonstrated. For example, safe harbor provisions would protect the decision makers from liability under Securities and Exchange Commission rules for financial projections made in good faith.

Rebuttable Presumption

Rebuttable presumption is a legal term used in a variety of ways. Under IRC 4958, generally, it means that if certain steps are taken, then it will be presumed that the person taking those steps acted in a certain way (fairly, reasonably, without negligence, etc.). It is an assumption considered true until proven false.

The advantage of a rebuttable presumption in compensation cases is that the burden of proof shifts to the IRS. Having a presumption in your favor can often be a major advantage in a dispute or in litigation. If the rebuttable presumption steps are followed, there is a presumption that the compensation is reasonable. However, the IRS may rebut the presumption of reasonableness if it finds the comparable compensation data that was relied on to determine the reasonable compensation to be of questionable validity.

Under most circumstances, when the IRS challenges the reasonableness of compensation, a facts and circumstances approach will be followed with the burden on the organization and the person being compensated to prove the amount is reasonable.