By: Randy Ramirez and Dan Mayfield
How have you documented the rationale of your executive compensation decisions? If not done properly, your organization risks intermediate sanctions from the IRS
The recently passed Tax Cuts and Jobs Act has brought a lot of attention to regulations and statutes imposed on tax exempt organizations as it relates to executive compensation. Under the prior and current regulations, organizations can take steps to ensure that top officials are in full compliance and not liable for the imposed intermediate sanction excise taxes under the IRC Section 4958 “Intermediate Sanctions”. Please note, this excise tax is different than the new excise tax that is now imposed on the tax-exempt organization for compensation in excess of $1M under the new Tax Cuts and Jobs Act. The excise tax imposed under intermediate sanctions is imposed on the executive receiving the compensation and approving body (often the Compensation Committee or Executive Committee) if compensation is deemed excessive. For the approving body in the tax-exempt world, this is often a very sensitive topic because these individuals typically volunteer their time and have a wide range of personal and professional backgrounds.
The intermediate sanction regulations allows for organizations to establish a rebuttable presumption that the compensation you pay your executives is reasonable. Throughout 2017, as the House and the Senate were debating over the final provisions of the Tax Cuts and Jobs Act the value of the process of establishing the rebuttable presumption of reasonableness for the tax-exempt organization was in jeopardy. The Senate’s version eliminated the rebuttable presumption of reasonableness all together and removed that level of protection for the tax-exempt organization. Luckily for tax-exempt organizations, this provision did not pass and the procedure of establishing the rebuttable presumption of reasonableness maintains its value to the tax-exempt organization and should be used by all tax-exempt organizations as a best practice to ensure proper pay governance.
What are the Intentions of the IRC Section 4958 “Intermediate Sanctions”?
Its intent is to promote due diligence in governance of executive compensation. Its expectation is that boards of tax-exempt organizations will document their decisions regarding compensation (and other transactions with insiders) better than they have in the past.
What does establishing the rebuttable presumption of reasonableness do?
The IRS clearly lays out the process that an organization can take to protect itself and highlights that the IRS is focused on process and documentations. If an organizations follows the procedure of establishing the rebuttable presumption of reasonableness, the burden of proof shifts to the IRS. With the burden of proof shifted, the IRS now has to rebut the rebuttable presumption of reasonableness regarding compensation.
How does a tax-exempt organization establish the rebuttable presumption of reasonableness?
The board or an approving committee must take the following actions:
- Rely on appropriate and comparable third-party market data in determining pay levels
- Document all decisions related to compensation in contemporaneous meeting minutes
- Approve compensation before it is paid by an authorized body of the organization composed entirely of individuals who do not have a conflict of interest regarding compensation levels
By following the “three prong” approach, described above, as part of a tax-exempt organization’s compensation governance process for each compensation decision that impacts a disqualified executive, they can ensure that risk relative to compensation levels and decisions is mitigated for the executives and the Board.
How does Gallagher help mitigate the risk to our tax-exempt clients?
Gallagher can help tax-exempt organizations by gathering and providing the appropriate compensation data from the appropriate market data sources. This assistance enables the organization to meet the “first prong” in the process described above. Our consultants have access to proprietary and secondary market data that reflect various subsectors within the tax-exempt market, as well as access to for-profit market data, which can (if documented with clear rationale) be used as part of the compensation review. We routinely assist clients with a review of the total remuneration (base salary, bonus and benefits) as part of their process of establishing the rebuttable presumption of reasonableness. Gallagher consultants can also further support clients by providing a written opinion as to the reasonableness of the total compensation provided to the executives by documenting the data and summarizing the process in which the Committee or Board took to approve the compensation levels. Our clients can then use our analysis as described in our opinion letter to form a solid basis for the compensation decisions and to meet the requirement of documenting the decisions for establishing the rebuttable presumption of reasonableness and thus meet the “second prong” in the process. Once the first and second prong/criteria are met, Gallagher consultants can assist the members of the Board or Committee in discussing and moving toward an approval of a competitive and reasonable compensation level prior to it being paid thus meeting the “third prong” to establish the rebuttable presumption of reasonableness.
Gallagher consultants work with tax-exempt organizations across the country on mitigating risk as it relates to compensation levels and design. While the process described above is relatively straightforward, the data procurement, executive job comparison, compensation valuation, and understanding of the liability and process of using good governance are areas where organizations often need assistance. Compiling the supporting data and justifying the compensation decisions can be time-consuming and challenging for many employers. As experienced consultants in executive compensation strategy, Gallagher can help by streamlining the process for clients so they can continue to thrive and fulfil their mission.
Start a conversation with Gallagher today. Contact Randy Ramirez at Randy_Ramirez@ajg.com for more information.