Five Things Nonprofits Should Know about Compensation
By Katie A. Ahern
Katie A. Ahern
Nonprofits may generally pay their people whatever they feel is appropriate, but they need to be mindful of rules that apply to deferred compensation and excessive pay, as well as what details need to be disclosed.
The following guidelines should help. Please note that the term "nonprofit" as used here specifically means entities holding 501(c)(3) status under the Internal Revenue Code.
1) Deferred Compensation May Be Taxed Sooner
A for-profit organization, if it meets certain criteria, may generally establish a deferred compensation plan (such as a Supplemental Executive Retirement Plan or a Severance Plan) that gives an employee a right to compensation today without subjecting the employee to income tax until the employee actually receives payment under the plan, even if payment is certain to occur.
However, additional rules apply specifically to nonprofit organizations.
Employees of nonprofit organizations are generally subject to tax as soon as there is no substantial risk of forfeiture with respect to a future payment. In other words, as soon as the payment vests and is certain to occur at some point, the employee may be subject to tax, even though the employee has not yet received the payment and may not have the funds to pay the resulting tax. Careful planning is required to ensure compliance by the organization and protection of the employee.
2) Deferred Compensation is Subject to Additional Rules
In addition to the above rule that applies specifically to nonprofit organizations, 501(c)(3)s are also subject to deferred compensation restrictions that govern all organizations. For example, Section 409A of the Internal Revenue Code affects employment, consulting, and severance agreements, as well as any other plan that gives an employee or independent contractor a right in Year One to a payment that will (or might)
occur in Year Two or later.
3) Excessive Compensation Can Trigger an Excess Benefit Transaction Subject to Penalty on Officers and Board Members
If a nonprofit organization officers salary is greater than what is reasonable for the services the officer performs, the officer receives an excess benefit.
The excess benefit amount is subject to enormous penalties, payable by the officer, and any director approving the compensation may be subject to penalties as well. Fortunately, the IRS has provided a way for a nonprofit to establish a presumption that a compensation arrangement is reasonable, based on board (or board committee) policy, compensation paid by similar nonprofits, and documentation supporting the policy.
4) Percentage-Based Compensation May Not Work
Compensation based on percentages, such as a percentage of revenue, or a percentage of money raised during a fundraising campaign, may give rise to private inurement and private benefit issues. This type of compensation, whether paid to employees or independent contractors, is frequently the subject of scrutiny by the IRS and other stakeholders.
5) Compensation is Reportable and Publicly Available Information
IRS Form 990 requires nonprofit organizations to disclose detailed compensation information with respect to certain employees and independent contractors, and the Form 990 is a public document.
Katie A. Ahern is an associate with Hinckley Allen, a multiservice law firm offering a full range of legal services and business advice to regional, national, and international clients. Email her at firstname.lastname@example.org.