June 1, 2005
If you haven't recently reviewed your process for establishing a rebuttable presumption of reasonableness for your tax-exempt organization's compensation packages, now is a good time to do so. The environment for tax-exempt organizations in general is becoming more strained, and compensation is a particular area of concern.
In August 2004, the IRS launched the Tax Exempt Compensation Enforcement Project, under which the IRS has started to send requests to charities for detailed information on their compensation practices and procedures for specific executives. The project will scrutinize insider transactions such as loans and the sale, exchange, or leasing of property to officers and others in the organization. (Because one of the objectives is to gather information about current practices, the notice stated, IRS contact will not necessarily connote wrong-doing.)
Protection Under the Rebuttable Presumption of Reasonableness Provision
The IRS intermediate sanctions rule authorizes excise taxes on transactions that provide excess economic benefits to "disqualified persons" (that is, anyone within the exempt organization who exercises substantial influence over the organization). Organization managers, accountants, and others who do not receive the benefit but who knowingly participate in the transaction are also liable for excise taxes.
The rule allows organizations to create a "rebuttable presumption" that a transaction is reasonable, and therefore not subject to intermediate sanctions. The presumption is created if the organization:
- Has the transaction approved by an independent board or board committee without the disqualified person participating;
- Relies on "appropriate comparability data" that documents the arms' length nature of the transaction, such as a compensation survey or appraisal; and
- Documents the approval in writing, such as through board minutes.
How to Document the Rebuttable Presumption
It's important to have the right people and the right data to determine arms-length executive compensation, but documentation is also vital to demonstrating the organization's efforts to establish reasonable compensation. In an article on the IRS web site, Steven Miller, current commissioner of the Tax Exempt and Government Entities Division, suggests guidelines and a useful checklist to document that the rebuttable presumption process has been followed. He outlines the following key points in documenting compensation decisions:
- The decisionmaking body must document the basis for its determination concurrently with the approval. The documentation must contain:
1. The terms of the approved transaction and the date approved;
2. The members of the decisionmaking body who were present during debate on the transaction that was approved and those who voted on it; 3. The comparability data that was relied on by the decisionmaking body and how the data was obtained; and
4. Any actions by a member of the decisionmaking body having a conflict of interest.
- The documentation must be prepared before the next meeting of the decisionmaking body or 60 days after the final actions of the body, whichever is later. In addition, the decisionmaking body must approve the documentation within a reasonable time after preparation.
- Organizations must follow this process yearly for disqualified individuals whose compensation changes yearly. For fixed multi-year contracts, the procedure must be conducted again only when there is a material change or a new contract.
Benefits of Rigorous Compliance Documentation
The steps taken by a healthcare organization to comply with the intermediate sanctions legislation also can be very useful in audits by a state regulatory agency. Further, a board that obtains a written, well-reasoned opinion letter on compensation from a qualified attorney or other professional will find such a letter to be invaluable in responding to an audit by the IRS or a state regulator.
SOURCES:
- "Rebuttable Presumption Procedure is Key to Easy Intermediate Sanctions Compliance," by Steven Miller, IRS web site
- "IRS Finds Growing Abuses in the Tax-Exempt Sector," April 8, 2005, HFMA Express News
- "Intermediate Sanctions for Healthcare Organizations," September 2002 hfm
Additional Resources
- "Easier Compliance is Goal of New Intermediate Sanction Regulations," by Steven Miller, IRS web site
- "IRS Initiative Will Scrutinize EO Compensation Practices," August 10, 2004, IRS Press Release
- HFMA's Guide to Compensation Surveys
- Tax-Exempt Status of Non-Profit Hospitals: Best Practices for Compliance -- Part I, March 2005 HFMA Audio Webcast
- Tax-Exempt Status of Non-Profit Hospitals: Best Practices for Compliance -- Part II, March 2005 HFMA Audio Webcast
If you have questions or comments about HFMA Wants You to Know, contact editor Laura Noble.
HFMA Wants You to Know ISSN: 1540-0697. Volume IV, Issue 11. Copyright 2005, Healthcare Financial Management Association. All rights reserved.