IRS Scrutinizing Not-for-Profit Pay Practices

As the Taxpayer Bill of Rights 2 enters its 10th year, the IRS is expanding its scrutiny of thousands of charities and private foundations to collect information on their compensation practices and procedures. While some not-for-profits have heeded the warning of the IRS and been proactive in ensuring their practices are sound and compliant, many have not, and are exposed to the risk of penalty and bad publicity.

Through its research and extensive work with not-for-profit firms, Hay Group, a global organizational and human resources consulting firm, has found that some charities and tax exempt organizations are unprepared for the level of IRS scrutiny and the extent of work that needs to be done to make sure the compensation practices are appropriate.

ìBoard members of not-for-profits ñ just like their for-profit peers ñ must realize their roles and responsibilities when it comes to executive compensation,î said Adam E. Meyers, Vice President and Director of Hay Groupís Not-for-Profit Practice. ìThere are a number of key questions that boards and executives must consider when developing these plans or pay potential penalties.î

Key sectors affected by this are hospitals and healthcare systems, educational institutions, community service organizations, and foundations.

Stakeholder Expectations

Fairness is a key consideration when reviewing pay practices and issues regarding executive reward structures. Other issues include insurance, retirement, and deferred compensation.

Boards should be prepared to answer the following questions:

1. Are compensation plans, approval processes, and reporting sufficiently transparent?
2. Is the board governance process on compensation appropriate?
3. Do executive benefit programs conflict with all-employee benefit policies?
4. Are the severance payments appropriate for voluntary and involuntary termination?
5. Are compensation programs tax compliant?

Strategy, Environment, and Operational Performance

ìWhile many not-for-profit organizations want to attract the best talent to their executive ranks and compensate them appropriately, the compensation plan must still be competitive with executives in the relevant peer group,î said Meyers.

Hay Group recommends that these organizations ensure that all elements of the reward structure for their executives are appropriately aligned with their internal and external competitive environments (questions 6-8) as well as with the organizationís operational strategy and performance (questions 9-12).

6. Is the compensation internally equitable?
7. Is it appropriately balanced for both short- and long-term reward and motivation?
8. Is it reflective of the scope of operations?
9. Does the plan encourage and reward ethical and appropriate behaviors?
10. Are goals and rewards tied to significant improvements in key metrics?
11. Are plans comprehensive and comprehensible?
12. Does pay correlate with performance?

Organizations are no different than people when it comes to being contacted by the IRS. As such, boards and executives want to ensure that they are prepared to respond to any such inquiry with confidence. Hay Group has helped a number of not-for-profit organizations, particularly in the healthcare sector, establish reward structures that meet IRS standards, reflect the organizationís philosophy, and are fair to executives and stakeholders alike.