compensation

What Can They Be Paid? Advising Charitable Organizations on Executive Compensation

Compensation for executives of tax-exempt charitable organizations is subject to strict rules and limitations under federal and state law.  I note the key considerations in advising charitable organizations and their boards.

Total compensation must be reasonable under federal law such that the organization complies with the private inurement doctrine. 
A 501(c)(3) organization must be organized and operated so that no part of its net earnings inures to the benefit of any private shareholder or individual.  It has long been held by the federal courts that “the payment of reasonable salaries by an allegedly tax-exempt organization does not result in the inurement of net earnings to the benefit of private individuals.”[1]

Assessing the reasonableness of compensation is largely a market driven analysis. 
An executive’s compensation is properly compared to individuals in similar positions at organizations of a similar size, in the same or a comparable geographical area, performing similar services.  The experience, expertise, and accomplishments of the individual are also taken into consideration.  It is appropriate to hire a qualified independent consultant to conduct a market analysis to ensure that compensation is reasonable.

The total compensation of an executive, and not merely the base salary or cash compensation, must be considered in determining whether compensation is reasonable. 
All compensation and benefits, including bonuses, deferred compensation, pension payments, and other perks not provided for legitimate business purposes are to be considered in calculating the total compensation at issue.

In the event that an executive is paid severance upon termination, any severance payments must be reasonable to assure compliance with applicable laws. 
The payment of excessive severance can itself be deemed excess compensation in violation of state and federal laws. An exception, for example, might be in connection with the reasonable settlement of a claim against the organization for improper termination.

Entering into a formal written contract with a senior executive can be advantageous for both the organization and the executive to ensure compliance with the laws governing executive compensation. 
Such a contract should set forth the duties and responsibilities of the executive, and thereby set standards for evaluating the executive.  It should also establish appropriate severance in the event of termination without cause.

Board members of charitable organizations in the various states have a fiduciary duty to preserve the organizations’ charitable assets, to supervise and oversee the administration of the organization’s’ assets, and to establish mechanisms designed to protect against the squandering or misuse of such assets.
This includes the authorization and payment of reasonable compensation and benefits to executives, and establishing mechanisms and internal controls to protect the organization’s expenditures.  Some states have specific laws requiring that compensation be reasonable.

The federal “intermediate sanctions” law, enacted by Congress in 1996, permits the IRS to impose excise tax penalties on charities executives who receive excess compensation (an “excess benefit transaction”) and on an organization manager or other person who is in a position to exercise substantial influence over the affairs of the organization.[2] 
In addition to paying a 25% excise tax on any excess compensation received, the executive must also make a correction and return the excess amount to the organization or face a confiscatory second tier tax.  The executive can be assessed the tax even if he or she acted in good faith and without knowledge that the compensation was excessive.

An organization manager can be assessed an excise tax only when he or she participated in an excess benefit transaction “knowing that it is such a transaction, … unless such participation is not willful and is due to reasonable cause.” 
If a board member or other organization manager has relied in good faith on professional advice that the compensation paid is reasonable, this would provide a strong defense against any IRS claim that excise taxes should be imposed.

It is significant to note that, under formal IRS rules, an executive is entitled to a rebuttable presumption that his or her compensation is reasonable if a three-step test has been satisfied.  

First Requirement: Compensation Fixed by An Independent Board
Board members must act independently and at arm’s length, and relatives and business associates of an executive should be excluded from any participation in fixing such individual’s compensation and benefits.

Second Requirement: Reliance on Appropriate Data as to Comparability
The IRS Regulations specify that the relevant information upon which the authorized body may rely “includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person.”

Third Requirement: Adequately Document Basis for Determination of Compensation
The board of a charity should, through formal board minutes, a written employment contract, an independent compensation survey, and/or other relevant documentation demonstrate the basis for the compensation paid.

Improper excess benefits can be quite varied. 
Areas which might be scrutinized by government regulators could include: purchases or leases of automobiles; payments of country-club dues; use of apartments, interest-free loans; travel expenses; use of charity credit cards without documentation; and blanket amounts to spend on expenses.

Summary: General Considerations in Fixing Compensation

  • Decisions should be made by an independent board of directors at arm’s length.
  • There should be Board minutes and/or other documents reflecting the criteria and basis for fixing compensation.
  • Total compensation should reflect the fair market value of the executive’s services.
  • Where appropriate, there should be reliance on an independent compensation survey.

 

[1] Founding Church of Scientology v. U.S., 412 F.2d 1197, 1200 (Ct. Claims, 1969), cert. denied, 397 U.S. 1099 (1970).
[2] The intermediate sanctions rules apply to both 501(c)(3) and 501(c)(4) organizations.  They do not apply to private foundations, as the well-established self-dealing rules in the Internal Revenue Code already barred payment of excessive compensation to executives of private foundations.

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Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

A.B. Data
AB InBev Foundation
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
Association of Fundraising Professionals
Avalon Consulting
Baton Rouge Area Foundation
Black Lives Matter Global Network Foundation
Bleeding Blue for Good Fund
Bradley Cooper’s One Family Foundation
BrightFocus Foundation
Brooks Brothers
Chadwick Boseman Foundation for the Arts
Changing Our World
Charity Defense Council
Christian Appalachian Project
Doctors of the World/ Medecins du Monde
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Estee Lauder Companies, Inc.
Feed The Children
Food For The Poor
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Hope for New York
International Campaign for Tibet
International Crisis Group
International Justice Mission
J. Crew Group
Johns Hopkins University
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation

Marts & Lundy
Meyer Partners, LLC
Milken Institute
NAACP Foundation
National Alliance on Mental Illness (NAMI)
National Marrow Donor Program
National Park Foundation
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
PopSockets
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rockefeller Philanthropy Advisors
Save the Children Federation
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Subaru of America
The Little Market
Touro University
United States Equestrian Team Foundation
United Way Worldwide
University of Connecticut
University of Virginia
Vote.org
Whitney Museum of American Art
World ORT
World Wildlife Fund
YWCA USA

A.B. Data
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
American Rivers
Association of Fundraising Professionals
Baton Rouge Area Foundation
BrightFocus Foundation
Burger King McLamore Foundation
Cancer Care
Carnegie East House and James Lenox House Association
Center for Car Donations
Changing Our World
Charity Defense Council
Christian Appalachian Project
Coca-Cola Scholars Foundation
Convoy of Hope
Cornell University
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Feed The Children
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Helen Keller Services
Hope for New York
Human Rights Watch
Humane Society of US
Indiegogo
International Campaign for Tibet
International Crisis Group
International Justice Mission
Japanese American National Museum
Johns Hopkins University
Lane Bryant Charities
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation
Mattel
Meyer Partners, LLC
Milken Institute
National Breast Cancer Coalition
National Marrow Donor Program
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Obama Foundation
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rock and Roll Hall of Fame and Museum
Rockefeller Philanthropy Advisors
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Steinhardt Foundation
Subaru of America
United States Equestrian Team Foundation
University of Montana Foundation
University of Nevada, Las Vegas Foundation
Whitney Museum of American Art
World ORT
World Wildlife Fund
YMCA USA
YWCA of New York City
YWCA USA

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Our attorneys’ recent contributions to the media and nonprofit sector publications.

news & events

Check out our attorneys’ recent contributions to the media and industry publications.

Secure Your Data – Seriously, AFP New York Chapter News
As Jon Dartley, a data privacy and security attorney at Perlman and Perlman says, “It is vital to have the appropriate legal terms in the contract to protect your interests.”  Find out what your liability limit is.  Have it in writing who bears the responsibility and cost of a data breach.  And, have the vendor agree on a specific timeframe within which they need to advise you of a data breach.

Warning: Don’t Cut Legal Corners When Mixing Social And Business Impact,  Forbes
Particularly striking is that (Karen) Wu believes this is the “first multi-state regulatory activity involving cause marketing in almost two decades.”

Is stealing, then giving back, OK?
Cliff Perlman lends his advice on theft within a nonprofit.

Buyer Beware: Negotiating Terms in Technology Agreements
Jon Dartley provides tips on negotiating contracts with technology vendors.

Four Ways Charitable Giving Could Change with a Tax Overhaul
Cliff Perlman remarks on the possible threat of a change to charitable deduction.

How To Deal With Residual Data, Nonprofit Times
Jon Dartley’s advice on addressing “data exhaust”.

Secure Your Data – Seriously, AFP New York Chapter News
As Jon Dartley, a data privacy and security attorney at Perlman and Perlman says, “It is vital to have the appropriate legal terms in the contract to protect your interests.”  Find out what your liability limit is.  Have it in writing who bears the responsibility and cost of a data breach.  And, have the vendor agree on a specific timeframe within which they need to advise you of a data breach.

Warning: Don’t Cut Legal Corners When Mixing Social And Business Impact,  Forbes
Particularly striking is that (Karen) Wu believes this is the “first multi-state regulatory activity involving cause marketing in almost two decades.”

Is stealing, then giving back, OK?
Cliff Perlman lends his advice on theft within a nonprofit.

Buyer Beware: Negotiating Terms in Technology Agreements
Jon Dartley provides tips on negotiating contracts with technology vendors.

Four Ways Charitable Giving Could Change with a Tax Overhaul
Cliff Perlman remarks on the possible threat of a change to charitable deduction.

How To Deal With Residual Data, Nonprofit Times
Jon Dartley’s advice on addressing “data exhaust”.

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perlman & perlman philanthropic sector law firm blue and green logo

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silk lanterns

who we work with

Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

who we work with

Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

A.B. Data
AB InBev Foundation
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
Association of Fundraising Professionals
Avalon Consulting
Baton Rouge Area Foundation
Black Lives Matter Global Network Foundation
Bleeding Blue for Good Fund
Bradley Cooper’s One Family Foundation
BrightFocus Foundation
Brooks Brothers
Chadwick Boseman Foundation for the Arts
Changing Our World
Charity Defense Council
Christian Appalachian Project
Doctors of the World/ Medecins du Monde
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Estee Lauder Companies, Inc.
Feed The Children
Food For The Poor
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Hope for New York
International Campaign for Tibet
International Crisis Group
International Justice Mission
J. Crew Group
Johns Hopkins University
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation

Marts & Lundy
Meyer Partners, LLC
Milken Institute
NAACP Foundation
National Alliance on Mental Illness (NAMI)
National Marrow Donor Program
National Park Foundation
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
PopSockets
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rockefeller Philanthropy Advisors
Save the Children Federation
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Subaru of America
The Little Market
Touro University
United States Equestrian Team Foundation
United Way Worldwide
University of Connecticut
University of Virginia
Vote.org
Whitney Museum of American Art
World ORT
World Wildlife Fund
YWCA USA

A.B. Data
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
American Rivers
Association of Fundraising Professionals
Baton Rouge Area Foundation
BrightFocus Foundation
Burger King McLamore Foundation
Cancer Care
Carnegie East House and James Lenox House Association
Center for Car Donations
Changing Our World
Charity Defense Council
Christian Appalachian Project
Coca-Cola Scholars Foundation
Convoy of Hope
Cornell University
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Feed The Children
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Helen Keller Services
Hope for New York
Human Rights Watch
Humane Society of US
Indiegogo
International Campaign for Tibet
International Crisis Group
International Justice Mission
Japanese American National Museum
Johns Hopkins University
Lane Bryant Charities
LSU Foundation
Mattel
Meyer Partners, LLC
Milken Institute
National Breast Cancer Coalition
National Marrow Donor Program
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Obama Foundation
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rock and Roll Hall of Fame and Museum
Rockefeller Philanthropy Advisors
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Steinhardt Foundation
Subaru of America
United States Equestrian Team Foundation
University of Montana Foundation
University of Nevada, Las Vegas Foundation
Whitney Museum of American Art
World ORT
World Wildlife Fund
YMCA USA
YWCA of New York City
YWCA USA
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law

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