Transparency in Executive Pay, Part 2
Author's Note: This article is the second of a two-part series addressing executive compensation challenges arising from the new IRS Higher Education Initiative. The first article which appeared in the April issue, reviewed changes the IRS has made to Form 990 and how disclosures by independent colleges, universities, and foundations may affect executive compensation at these institutions. This article focuses on the potential traps and examination triggers within these disclosures and explores compliance tactics and strategies.
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David M. Nygard |
The IRS has ratcheted up its ability to identify institutions that may have possible executive compensation compliance issues. College and university leaders must be aware of what has changed and take steps to protect their institutions from problems that may result from outsized compensation, benefits, and expense reimbursements made to executives, officers, directors, or other named employees. Chief business officers are in a unique position to assist trustees in this process.
Audit Yourself Before They Audit You
The IRS uses a multifaceted process to identify independent colleges and universities at risk of non-compliance in the area of executive compensation. The redesigned 2008 Form 990 provides clues to what will be scrutinized. A staff of more than 400 examination specialists will be selectively deployed to address potential compliance issues and determine what should be done to correct any problems they identify. The first, and least invasive, step in this process is a review of operations, which does not require the direct involvement of the institution in question because the IRS uses publically available information and data it already has on file.
A review of operations may examine disclosure data from the new Form 990 for calendar year 2008 in conjunction with other Form 990 information. This review may also use feedback and insights obtained from the survey conducted earlier this year by the IRS Higher Education Initiative and other information sources for institutions that do not file their own Form 990s. A review of operations may conclude satisfactorily, or it may lead to a compliance check, an examination, or a follow-up review in later years. This approach has increased the overall efficiency of IRS field examinations to a point where 80 percent (four out of five) of all examinations conducted in 2008 resulted in corrective actions.
Colleges and universities should consider a self-test using the same filters that the IRS plans to use to see whether they should expect anything more than a cursory review of compensation levels and practices. Specifically:
- Will disclosed compensation levels appear high relative to other colleges or universities of similar size using a compensation comparison tool on a position-by-position basis?
- Will the existing compensation arrangements with other former executives, officers, directors (trustees), or other named employees appear defensible given the levels or disclosed hours of service?
- Are there any sizable loans outstanding, forgiven loan principle, or forgiven loan interest payments to or for any executives, officers, trustees, or named employees? Are these arrangements documented and consistent with prevailing market rates?
- Are reported reimbursed expenses (e.g., private transportation, including planes; home renovations; employment of relatives; spousal travel, severance agreements; personal staff; second homes; multiple club memberships; and/or attendance at international events) defensible?
- Have the institution's compensation levels and policy been established or reviewed by an independent compensation committee? Were these deliberations documented?
- Was market data used to establish compensation levels and/or policies? Does this market data reflect the size and scope of the institution?
The relative size of compensation and dramatic expansion of or increases in benefits and expense reimbursements may attract unwanted attention from the IRS, especially in the absence of other governance and management procedures to address executive pay.
Compliance Tactics and Best Practices
At colleges and universities, most executive officers, highly compensated employees, and trustees do not intentionally enter into agreements that result in paying compensation, funding benefits, or reimbursing expenses in a manner that would be characterized under IRS rules as an excess benefit transaction (EBT). It is more likely that an EBT is the result of a well-intentioned, one-time fix to a special employment situation. CBOs are uniquely positioned to guide an institution away from these situations and resulting problems. One of the best ways to avoid adverse attention from the IRS is for the CBO to educate the institution's officers and trustees about EBTs, the possible excise taxes that result from non-compliance, and how to create a rebuttable presumption of reasonableness defense under the intermediate sanctions guidelines. (See sidebar below, "The Rebuttable Presumption Guidelines Within Intermediate Sanctions for Tax-Exempt Organizations.")
Another key role for CBOs is to keep officers and trustees informed about the competitive market practices of other peer institutions. Most boards welcome and value their CBO's insight in selecting a peer group of institutions or identifying reliable survey data to test the reasonableness of their compensation levels and policy decisions. Once a formal peer group of institutions or survey data sources have been established, periodic updates on compensation levels and practices within this group of institutions or survey participants will be a valuable resource for the board and its committees in evaluating alternative approaches of addressing observed market trends and other compensation, benefits, and expense reimbursement issues.
Finally, one often overlooked way that a CBO can support trustees is by providing logistical support to the board and its committees by taking comprehensive notes and drafting meaningful summaries for the minutes of each meeting. While this may seem mundane, one of the three necessary components for establishing the rebuttable presumption of reasonableness is documentation. A sentence or two in the minutes of a committee can make the difference between the successful conclusion, and the continuation, of an IRS field examination.
Richard V. Smith is a senior vice president and David M. Nygard is a senior consultant of Sibson Consulting, a division of Segal, New York City. E-mail: rsmith@sibson.com; dnygard@sibson.com.
The Rebuttable Presumption Guidelines Within Intermediate Sanctions for Tax-Exempt Organizations
The intermediate sanctions mentioned in Part I of this series contain an important protection for disqualified persons and organization managers: a rebuttable presumption that compensation levels are reasonable. The rebuttable presumption is significant in that it places the burden of proof on the IRS to show that a transaction is an unreasonable excess benefit transaction (EBT) from disqualified persons. To obtain the benefit of the rebuttable presumption, the following three conditions must be satisfied:
- Independent board or committee approval. The arrangement must be approved in advance by the board of trustees (or a committee of independent non-employees composed entirely of individuals who do not have a conflict of interest or a material interest with respect to the arrangement or transaction under consideration.
- Comparable data. In approving the transaction, the board or committee must obtain and rely on appropriate comparability data:
- The information must be sufficient to allow the trustees or committee to determine whether the transaction is reasonable.
- Second item of embedded list Relevant information may include for-profit or not-for-profit compensation surveys or data compiled by independent firms reflecting the size, complexity, and location of the organization.
- Third item of embedded list All of the elements of compensation should be considered as they relate to functionally comparable positions.
- Documentation. The board or committee must adequately document the basis for its approval and be consistent with its formally stated policy of statistical compensation, pay-level targets, and position comparison methodologies (what, when, who, and follow-up actions, if any, in a formal and approved document). In an examination, the IRS will ask for meeting notes or minutes to verify the composition of the committee vote and the extent to which comparable data was used in the decision-making process.
