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ECFA Commission Concludes No New Rules Needed on Unreasonable Nonprofit Compensation

About two years ago, Senator Chuck Grassley (R-IA), ranking member of the Senate Finance Committee, asked his staff to investigate media-based ministries and make recommendations about how to address self-dealing and questionable executive compensation levels and practices. Their recommendations were pretty dramatic: change which organizations are given nonprofit status by IRS, expand penalties on self-dealing, and establish new regulations to make sure that nonprofits, particularly religious organizations, did not reward their leaders in an extravagant and excessive manner.

Rather than press for these legislative and regulatory changes, however, Senator Grassley asked the Evangelical Council for Financial Accountability (EFCA) to seek solutions that relied on self-regulation and not new laws. ECFA, in turn, formed the Commission on Accountability and Policy for Religious Organizations and broadened the focus to the entire nonprofit sector. About 80 representatives of the nonprofit sector were members of the commission and various committees. The committee produced a report, Enhancing Accountability for the Religious and Broader Nonprofit Sector, in December 2012.

The report's 90+ pages provide a good review of the existing law and penalties for "excessive benefit transaction." The major conclusion is that little change is needed in the regulatory framework. Instead, the commission calls for effective administration of existing law together with education about the law.

Why Are No Changes in Legislation Needed?

The questions submitted to the commission included whether the current regulations on determining executive compensation should be changed. An organization can now establish a rebuttable presumption of reasonableness (that is, the burden of proof that the compensation is excessive shifts to the IRS) if the nonprofit board goes through the following steps (after first ensuring that no one making the decision has a conflict of interest):

  • approves the compensation arrangement in advance;
  • collects and uses appropriate comparable data; and
  • adequately documents the basis for the determination at the time of making it.

The commission found little evidence of frequent excessive compensation of nonprofit executives. A recent study by the Economic Research Institute (ERI) that analyzed executive compensation using 2009 IRS Form 990 data from more than 96,000 nonprofits was cited. That research found that:

  • Forty percent of Form 990 filers in 2009 have less than $100,000 in annual revenues, and only about 2 percent of them have any paid staff at all.
  • Organizations with greater than $1 million in annual revenue show greater than 60 percent with paid staff, but they only account for roughly 14 percent of all nonprofit organizations.
  • The highest-paid CEOs—defined as those that are paid more than two standard deviations than expected—represent only about half of 1 percent of all nonprofit organizations.

The commission also interviewed IRS representatives, who stated that current regulations were adequate, but that effective administration and enforcement were necessary to create an environment of compliance. This conclusion was also included in a recent IRS report on hospitals.

Specific Recommendations for Nonprofits

  • Ensure that compensation (which includes benefits) is reasonable and that it will be perceived by the public as reasonable—the credibility of the entire sector is damaged and the threat of more legislation increased when it is not.
  • Adopt policies providing clear and practical guidance for establishing reasonable compensation, for addressing conflicts of interest, and for avoiding excess benefit transactions. Make the policies for setting the compensation of top leaders and conflicts-of-interest policies available to donors upon request.
  • When a compensation consultant obtains comparable data for executive compensation, check to make sure the data actually are comparable—it is not enough just to accept the final number from the consultant report.
  • Require the total compensation of the top-paid leader to be disclosed to or approved by the full governing body.
  • For religious organizations not required to file Form 990, have one or more independent organizations conduct compensation surveys and make the information publicly available. Also participate in salary surveys to improve the amount and quality of data available.

Other Recommendations

The commission recommendations for IRS/Treasury and Congress included few changes.

The commission did say that if data show that nonprofits are frequently abusing the rebuttable presumption of reasonableness by improperly using non-comparable data from the for-profit sector, the rebuttable presumption standards could be changed to allow only nonprofit data. For-profit data could be used to support setting a certain level of compensation, but the presumption of reasonableness would not be provided if only for-profit data were used.

One change was mentioned for the Form 990. Although the details of compensation studies and the related compensation data do not need to be disclosed on Form 990 now, a requirement that the use of for-profit data be reported on the annual filing is recommended.

What Difference Does This Make to My Nonprofit?

Don't expect new legislation, but also don't expect the scrutiny of compensation for nonprofit executives to disappear. The IRS and states will be enforcing the existing laws, and the media will be researching the Form&nbsp990 filings for outliers.

The commission also notes that there is a missing key element in the discussion of self-regulation in the sector—donors have a duty to make informed giving decisions, which will lead to improved self-regulation and accountability. Whether donors have the interest and the available data to increase their engagement remains to be seen.

But in the meantime, the advice remains the same for nonprofits setting executive compensation. First and foremost, the IRS is looking for "good compensation practices"—that is, having established policies and procedures, doing the homework of finding and assessing comparables, making decisions based upon them, and then recording the actions taken. You are not likely to get in trouble with the IRS if you develop and follow procedures for setting compensation and if you make an honest, responsible effort to determine appropriate compensation based on your size, revenues, organizational structure, and mission.

Linda M. Lampkin, ERI Economic Research Institute
© 2013, ERI Economic Research Institute

Linda M. Lampkin is research director of ERI Economic Research Institute, a company that provides Form 990 compensation data for use by nonprofits, and former director of the National Center for Charitable Statistics at the Urban Institute. She can be reached at linda.lampkin@erieri.com or (877) 799-3428.

Topics: Policy