Abstract
The concept is simple enough: organizations that provide charitable services are exempt from paying taxes if “none of [their] earnings may inure to the benefit of a private shareholder or individual, [and they] do not attempt to influence legislation as a substantial part of [their] activity [nor] participate in any campaign activity for or against political candidates 1 .”
It’s that if, of course, that’s the problem – the tiny conjunction that creates complexity writ large, given the cadre of lawyers, accountants and consultants who advise tax-exempt organizations. Nowhere is this more crucial than in issues involving today’s equally complex tax-exempt compensation strategies.
As Doug Mancino, attorney at Seyfarth Shaw says, “While the rules affecting charitable organizations appear relatively straightforward, they contain many traps for the inexperienced advisor, who often has a propensity for saying ‘no’ rather than test the boundaries. This is especially true when innovative or non-traditional forms of executive compensation and benefits are involved.”
Background
The purpose of this new column is to address some of these potential traps and the often complex challenges faced by compensation and benefits professionals in tax-exempt organizations today.
The best place to begin this ongoing discussion is with some basics.
Let’s begin with who’s responsible for what. Most tax-exempt organizations are governed by volunteer boards, which are charged with ensuring that the compensation paid to disqualified persons – typically those employed by the organization – is reasonable and complies with criteria set forth in the tax code and state law. Failure to meet this criteria often puts executives and board members at risk of substantial financial penalties.
The role of the organization’s compensation and benefits professional is to help ensure the board’s decisions on compensation comply with these legal requirements while supporting and driving the organization’s mission and purpose.
Compliance
This appears fairly straightforward, until one understands that compliance must be addressed at both federal and state levels. And then the “fun” begins. Just because Uncle Sam says you’re tax exempt doesn’t mean you’re good to go.
Consider a federally tax-exempt New Jersey hospital that was denied a state exemption, based in part on the methodology used to determine executive compensation. The court ruled that the hospital failed to convince the court that the tax-exempt standard under federal tax law (enforceable by the IRS) should be adopted in New Jersey. 2
Other states pose other issues when it comes to tax-exempt compensation. In California and a few other states, executive compensation in not-for-profit healthcare organizations has become the subject of ballot initiatives. Often promoted by labor unions as a bargaining chip, these initiatives call for limiting the level of compensation to that paid to the President of the United States – $450,000.
Compliance, while critical, is not the only challenge that boards and compensation professionals face in the tax-exempt arena. Other issues that must be addressed include:
Creating compensation programs that are aligned with the mission and values of the organization;
Using performance-based compensation strategies to drive the organization’s sustainability and growth;
Incorporating strategies that help attract, develop, and retain top talent;
Developing compensation plans that support work-life issues, address generational differences, and eliminate gender bias.
The list is nearly endless.
While many of these issues equally important in both the tax-exempt and for-profit sectors, differences in the legal and regulatory requirements often call for subtle – and at times not-so-subtle – differences in how they are approached and addressed.
Other concerns
In addition to compliance, tax-exempt organizations must also consider the philosophy and vision of their sponsors, their mission and values, and even the type of organization they are, be it a foundation, a trade association, a health-care system, an institution of higher education, etc.
We will be covering many of these topics in future columns. In the meantime, let’s start a dialogue. Let me know what challenges you’re facing, what issues you’d like to learn more about, and what observations you have on this complex but important subject. Send your comments and questions to
I look forward to hearing from you.