IRS Reasonable Executive Compensation

INTERMEDIATE SANCTIONS FOR TAX-EXEMPT ORGANIZATIONS

As a part of a law passed by Congress commonly referred to as intermediate sanctions and codified in IRC Section 4958, the IRS has introduced a new set of regulations penalizing disqualified persons, mainly executives of tax-exempt organizations, for receiving excess benefits from these organizations. Excess benefits are very similar to overpayments as discussed in this course.

These penalties are called intermediate sanctions as they fall short of taking away the tax-exempt status of the organization. The penalties that can be applied consist of repayment of the excess amount of compensation in full with interest, and a 25% excise tax on the excess payment. In addition, a 200% excise tax on the excess payment may be applied if it is not repaid within the taxable period, and a 10% tax on the excess payment, up to $20,000, may be levied on any of the organization's managers responsible for the decision to provide the excess benefit to the disqualified person.

Compensation to these "disqualified persons" must meet the same standards of reasonable compensation as has already been discussed here. It is likely that the same criteria that suffice in corporate cases will also apply here.

The regulation provides for a Rebuttable Presumption of Reasonableness that if met shifts the burden of proof to the IRS in proving the reasonableness of the person's compensation.

The criteria for shifting the burden of proof to the IRS include:

• the compensation package was set in advance by the authorized personnel
• the decision makers obtained and relied upon appropriate data as to comparability in making the determination. This in often in the form of outside professional/expert advice or executive compensation survey data, such as that provided by ERI Economic Research Institute.
• documented rationales were prepared at the time of the decision

The regulations allow for abatement of the penalties provided that:

• the correction is made promptly
• it can be established that the excess benefit transaction was due to reasonable cause and not to willful neglect

To learn more about how to protect nonprofits from overcompensation penalties, see DLC Course 18: Intermediate Sanctions.