August 9, 2012

The Expanding Role of the Compensation Committee

At a time when the IRS is increasing its focus on tax-exempt organizations, the role of the board of directors has never been more important. Likewise, with the media always ready to turn their attention to excessive compensation, the role of the compensation committee is crucial and ever-expanding. When examples of excessive compensation come to light, they receive considerable media attention and negatively influence the public’s perception of non-profit organizations. Often the examples that are publicized involve compensation paid to the president or chief executive officer.

If the IRS determines executive compensation to be unreasonable, it can require the executive to promptly repay the excess amount and a 25 percent nondeductible excise tax. In addition, trustees who knowingly approved the unreasonable compensation can be assessed financial penalties. Establishing a compensation committee composed of educated and active board members not only protects the organization but provides a safeguard for executives and other board members.

Compensation Committee Best Practices
The American Hospital Association’s Center for Healthcare Governance recommends that an organization’s bylaws identify the board committee responsible for executive compensation. The committee’s charter should describe its purpose, roles and responsibilities, including decisions that may be approved by the committee and those that require board approval. Other suggested items to address include committee size, member appointment process, length of terms, and independence of committee members.

Compensation committee meeting minutes should be promptly drafted and distributed to committee members, and they must be approved within 60 days or by the next committee meeting, whichever is later.

Your Committee’s Safe Harbor:

The Rebuttable Presumption of Reasonableness
To effectively oversee executive compensation, committees charged with this responsibility should be aware of Internal Revenue Code provisions that allow healthcare organizations to establish a “rebuttable presumption of reasonableness,” which transfers the burden of proof for unreasonable compensation to the IRS.

A rebuttable presumption of reasonableness requires:

  • Advance approval of compensation decisions by an independent board or committee.
  • Reliance on appropriate comparability data.
  • Adequate, contemporaneous documentation of the process.

IRS regulations specify that minutes of meetings that address compensation decisions include:

  • Terms of the arrangement.
  • Date of approval.
  • Members of the committee present for the deliberations.
  • Members who voted.
  • Independent market comparability data relied on by the committee and how it was obtained.
  • Actions taken by any member of the committee who had a conflict with respect to the compensation arrangement.

For information on other best practices, including effective board review and approval of CEO compensation, or if you have any questions, please contact the experts listed below at PYA, (800) 270-9629.

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