Nonprofit accountability

Over the past several months, the compensation practices, or lack thereof, of tax-exempt organizations has come under scrutiny by the public, the media, Congress and the IRS. The perception is that executives in nonprofit organizations are receiving unreasonable salaries. This negative attention may have caused the public to lose faith in nonprofit organizations and the laws that govern them.

For organizations that rely heavily on public support, this negative press could put their organizations at great risk. Nonprofit organizations must implement proper policies and procedures to ensure against unwarranted criticism.

In response to the seemingly inappropriate behavior, the IRS implemented The Tax Exempt Compensation Enforcement Project in the summer of 2004. The purpose is to identify and stop abuses by organizations that pay excessive compensation and benefits to their officers and other insiders.

The IRS plans to contact 2,000 charities and foundations to inquire about their compensation practices. A finding of excessive compensation could lead to the revocation of an organization∏s tax-exempt status. Exempt organizations should be aware of the IRS criteria for excessive compensation and the recent developments that are taking place in the industry.

On June 22, 2005, the Panel on the Nonprofit Sector issued its final report to Congress and the nonprofit sector on strengthening transparency, governance and accountability of charitable organizations. The report includes recommendations to impose penalties on charity board members and other charity managers who approve self-dealing or excess benefit transactions, including excessive compensation. The panel is comprised of respected leaders in charitable organizations across the country. Among its suggestions:

  • Impose penalties. Penalize board members and managers for failure to exercise due care if they should have known the transaction was improper and would result in disciplinary action.

  • Impose burden of proof on executives. Executives accused of receiving excessive compensation by the IRS would have to prove its reasonableness.

  • Revise Form 990 and 990-PF. These forms would be updated to more clearly display compensation arrangements. The different categories of compensation (salary, bonuses, social club memberships, health insurance and entertainment expenses) would be clearly segregated on the forms. These forms would continue to be available for public inspection at

  • Full board must approve compensation. The board must approve the compensation of executives annually unless there is no change in the compensation or there is a multiyear contract.

The emphasis is not on restricting executive compensation, but rather holding organizations and their boards accountable for determining a reasonable salary for executives. Nonprofits are permitted to pay reasonable compensation to their executives in the same way as for-profit organizations.

What is reasonable compensation? Treas. Reg. Sec. 53.4958-4(b)(1)(ii) defines reasonable compensation as the amount that would ordinarily be paid for like services by like enterprises. Nonprofit organizations must do their due diligence to determine this amount. Factors set forth in the Federal regulations to determine reasonableness include comparing similarly situated organizations with similar services in the same geographic area.

Boards should keep in mind that compensation arrangements are likely to become public knowledge and should be prepared to answer any questions related to how salaries are determined. Board members should anticipate what types of questions may arise related to executive compensation. When a subcommittee is used to make the compensation agreement, it is important that each board member take responsibility for being aware of the entire arrangement. The board should make the final decision while the executive is not present.

Furthermore, organizations should have standard written policies and procedures determining compensation arrangements. Organizations should proactively take steps to avoid excess benefit transactions, and must demonstrate accountability with regards to setting executive compensation. In determining compensation agreements, organizations must exhibit best practices and should not wait for legislative oversight to exercise due care.

Angela Dotson ([email protected]) is a manager in the tax department for Tauber & Balser PC. Her experience includes corporate, personal and partnership taxation with an expertise in real estate and not-for-profit organizations. Reach her at (404) 814-4981.

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