Executive compensation for exempt organizations has been a long-time focus of Internal Revenue Service (“IRS”) projects and likely will continue to be, as evidenced by a recent House Ways and Means Committee meeting that focused on the IRS Colleges and Universities Compliance Project Final Report.
Lois G. Lerner, Director of the Exempt Organizations Division of the IRS, gave testimony during the committee meeting regarding the project, stating that the IRS “plans to ensure that tax-exempt organizations are aware of the importance of using appropriate comparability data when setting compensation.” A recent IRS examination found that numerous tax-exempt organizations use comparability data from organizations that are vastly different in size, or other factors that prevent them from qualifying as comparable. This scrutiny of comparability data will likely increase both now and going forward.
The IRS Colleges and Universities Compliance Project began in 2008, with the distribution of questionnaires to 400 randomly selected colleges and universities. Based on their answers to the unrelated business income or executive compensation questions, the respondents were selected for examination for potential noncompliance. The IRS specifically analyzed compensation paid by colleges and universities to those serving as officers, directors, trustees, key employees (“ODTKEs”), and other highly compensated employees who did not fall into the ODTKE category. The highest-paid ODTKEs in the majority of these situations were college or university presidents.
The IRS also checked to see if the compensation was considered reasonable under IRS Code Section 4958, which is applicable to any 501(c)(3) or 501(c)(4) organization. An excess benefit transaction occurs when compensation paid exceeds what is reasonable, potentially subjecting the organization to excise tax. Regulations within Section 4958 give guidance on the procedures that organizations should follow to determine reasonable compensation. Compensation can be presumed reasonable if an independent body was used to review and determine the amount of compensation before any payments were made; appropriate comparability data was used to set the compensation amount; and the compensation-setting process was contemporaneously documented. The colleges and universities that failed to prove that compensation was reasonable during the IRS examinations typically failed to do so because they did not rely on appropriate comparability data when setting the compensation amount.
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