Nonprofit Variable Pay

Penalties

There are two sets of penalties that may be levied: one against the disqualified person and the other against the organization managers. These penalties are potentially severe and can add up to a great deal of money.

Disqualified person

The penalties against the disqualified person fall into three categories:

1. Correction. An excess benefit is correctable only by the disqualified person making a payment in cash or cash equivalents equal to the correction amount. The amount to be repaid is the sum of the excess benefit, plus interest on the excess benefit at a rate that equals or exceeds the applicable federal rate, compounded annually. The time period is from the date the excess benefit transaction occurred to the date of correction.
2. Excise tax. The disqualified person who has been found to receive an excess benefit must pay a tax of 25% of the excess benefit.
3. Additional tax. The excise tax is payable within a taxable period. The taxable period is the period beginning on the date the excess benefit transaction occurs and ending on the earlier of either the date the notice of deficiency is mailed, or the excise tax is assessed, at which time the tax must be paid. If unpaid, an additional tax of 200% of the excess benefit will be imposed.

Organization managers

An organization manager is typically an officer, director or trustee of a tax-exempt organization or any individual having powers or responsibilities similar to officers, directors, or trustees of the organization, regardless of title. When a tax is imposed upon a disqualified person, a second tax is imposed upon any and all organization managers who knowingly participated in the excess benefit transaction, unless the participation was not willful and was due to reasonable cause. The IRS has the burden of proof to establish that the organization manager(s) participated knowingly, and that participation was willful and not due to reasonable cause.

The tax is 10% of the excess benefit charged against the disqualified person, up to a maximum of $20,000 per incident. This maximum is for all organization managers, not each one. So, if there were 4 managers, the maximum for each one would be $5,000. If the disqualified person is also one of the organization managers, he/she can be penalized in both categories. Technically then, a disqualified person could be fined 25%, 200%, and their portion of 10% of the excess benefit tax, plus be required to pay back the amount of the excess benefit with interest.

It is crucial to keep these requirements and penalties in mind when designing a variable pay plan and make sure it is both reasonable and effective.