United States: IRS Report Released On Executive Compensation Study

On March 1, 2007, the Internal Revenue Service released its report on the Exempt Organizations Executive Compensation Compliance Project. The IRS reported that it found substantial reporting issues, but out of 1,826 organizations contacted, only 25 organizations with 40 disqualified persons/organization managers, collectively, have been determined by the IRS to have received excess compensation. However, over $21 million in excise taxes have been assessed against those individuals. There is no indication in the report regarding how many of the 40 individuals assessed are challenging the IRS’ determinations.

Section 4958 was enacted in 1996, and imposes excise taxes on "disqualified persons" (i.e., insiders) of section 501(c)(3) public charities and section 501(c)(4) social welfare organizations if any of the insiders received any excess benefits. In the past, the only option for the IRS was to revoke the organization’s exempt status if benefits were found to inure to the benefit of an insider. Under section 4958, the IRS can instead preserve the exempt status of the organization and require the disqualified person to return the excess benefit to the organization and to pay a hefty excise tax to the IRS. An organization manager can be assessed an excise tax in the amount of the lesser of 10% of the benefit or $10,000 per transaction during the years at issue.¹ By contrast, the IRS has had this capability with regard to private foundations since the Chapter 42 excise taxes were enacted effective January 1, 1970.

In 2004 the IRS implemented the Executive Compensation Compliance Initiative, and initially sent letters to 1,223 public charities. Subsequently, in Part II of the Initiative, 782 examinations of public charities and private foundations (governed by the similar section 4941— which imposes excise taxes on self-dealing) were initiated. Currently, 77 examinations remain open; 434 were closed without change; 156 were closed prior to contact with the taxpayer after surveying the information already available to the IRS; and 115 were closed with a written advisory suggesting modifications to future operations with future review to be conducted by the Review of Operations office.

The IRS found significant reporting errors on the Forms 990 and 990-PF, and is recommending additional training materials. The IRS also found significant issues with regard to loans to officers and employees. Of 100 public charities reporting loans over $100,000 to persons with key positions within the charity, 92 required follow-up by the IRS with 32 ultimately referred for examination. As a result of this high rate of compliance issues, the Exempt Organizations division initiated Part III of the Initiative, which includes 200 compliance checks and 50 additional single issue examinations focusing on organizations with loans to executives.

Senate Finance Committee Chairman Max Baucus and Senator Charles Grassley, Senate Finance Committee ranking member, responded immediately to the report by issuing statements expressing concern with the executive compensation reporting errors by the charities. Senator Grassley found the lack of transparency to be inexcusable. He stated that the IRS Chief Counsel had personally committed to him that "the IRS would revisit the guidance and regulations regarding executive compensation after the IRS completed this study. The IRS study and the recent revelations of the champagne lifestyles of certain non-profit executives make it clear that the IRS needs to send clear signals of what's acceptable for disclosure and compensation at our nation's charities. Sadly, some individuals running charities view it as an opportunity to do well for themselves as opposed to doing good for those in need. Our charities are too important to allow that to continue."²

A copy of the complete report can be found at http://www.irs.gov/pub/irs-tege/exec._comp._final.pdf

Please contact one of the individuals in our Exempt Organizations Practice should you have any questions.

Footnotes

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