The information contained in this site is of general nature and should not be acted upon in your specific situation without further details and/or professional assistance

Incentive compensation programs in the nonprofit arena are becoming more and more prevalent. Why? Because of increased competition for top executives. As nonprofits transform and competition becomes fiercer, talented people are a necessity for success.

The trick is creating a program that the IRS won’t deem excessive. If you take care to stay within the rules, you can offer an incentive compensation package that will attract the best of the best.

Why should you consider an incentive compensation program? As nonprofit organizations become more complex, they demand talented senior management. You are competing with both for-profit and nonprofit sectors for talent. Turnover is costly, and compensation programs that appropriately reflect talent and efforts will help attract and retain the right people.

Incentives can take many forms, including:

In a study called "Innovative Compensation Practices in the Nonprofit Sector," Applied Research and Development Institute International found that the benefits with the greatest impact were flex time, flexible spending accounts and 403(b) retirement plans.

The National Center for Nonprofit Boards, in "Nonprofit Boards’ Guide to Chief Executive Compensation," lists several other benefits that are common for chief executives, including: health insurance; life, accident and disability insurance; professional dues; severance pay; incentive plans; car allowance; entertainment expense accounts; tuition assistance; and social club memberships.

Staying within the guidelines is now more important than ever. The law penalizes 501(c)(3) and 501(c)(4) organizations for excessive compensation of senior executives. Previously, revoking of tax-exempt status was the only punishment that could be levied against an organization committing violations. Revoking of tax-exempt status was reserved for only the most acute cases of mismanagement.

These new sanctions were passed with the intention of gaining increased regulatory power over the burgeoning nonprofit sector, which now constitutes 11% of the U.S. economy. Increased scrutiny of tax-exempt organizations has followed in instances such as the United Way scandal, in which the organization’s president bilked the group of more than $1 million.

The rules impose intermediate sanctions that include excise-type taxes on recipients of excessive compensation as well as on the officers and directors responsible for authorizing excessive compensation.

Penalties include:

Any compensation plan needs to be developed with an awareness of the IRS’s concerns. In determining whether compensation is reasonable or excessive, the IRS looks at salary and benefits, as well as cash bonuses, housing allowances and family travel.

But don’t get the wrong idea — incentive compensation programs do not automatically raise a concern about inurement. The IRS’s basic organizational test for nonprofits is that "no part of their net earnings inures to the benefit of any private shareholder or individual."

The new law mandates that nonprofits take steps to obtain a "presumption" that their incentive compensation programs are reasonable. For example, salaries must be approved by a board of individuals who are not related to or influenced by the person whose salary is being decided. Decisions should be based on the pay and benefits of comparable positions and similar organizations. Above all, document your rationale.

The most important issue in ensuring that incentive compensation plans are not unreasonable is to coordinate compensation with

responsibilities and performance rather than purely with success of the agency itself, which may be unrelated to executive efforts.

Executive compensation can be a confusing task to take on, so give us a call today to get on the road to an effective (and legal) program.

(c)2001-06 Fraser CPA - Last Updated 05/01/2006