A new Internal Revenue Service report about tax-exempt hospitals has triggered questions about compensation of all nonprofit executives and may embolden investigations by federal and state regulators who already are taking a hard look at how charities compensate their top officials.
What’s more, recruiters and others say the scrutiny may contribute to organizations’ decisions to freeze or cut salaries, moves that already are starting to become more prevalent as organizations face pressure to trim costs because of weak fund-raising returns in the down economy.
The IRS surveyed nearly 500 nonprofit hospitals, asking them about their compensation practices and how they provide charitable health services to needy people.
According to the 178-page report, the average total compensation—including noncash benefits and payments to employee-benefit plans—paid to hospitals’ top management officials was $490,000; median compensation was $377,000.
The IRS, which did not reveal the names of the hospitals it examined, also audited 20 hospitals that provided larger salaries relative to institutions with similar revenues and geographic locations.
At those organizations, the average total compensation paid to top management officials was $1.4-million, while median compensation was $1.3-million.
The IRS said at least one hospital had paid excessive compensation and may be assessed a fine. And while the other compensation did not violate the law, the IRS said, it may raise concerns among the public.
‘May Be a Disconnect’
“Amounts reported appear high but also appear supported under current law,” the IRS said. “For some, there may be a disconnect between what, as members of the public, they might consider reasonable and what is permitted under the tax law.”
Or as Steven T. Miller, commissioner of the IRS’s tax-exempt division, said last month in a speech previewing the report’s findings: Regarding “pretty high” pay, “while permissible under current law, I wonder how it will be received in the court of public opinion.”
Indeed, Ken Berger, president of Charity Navigator, a nonprofit watchdog group in Mahwah, N.J., said the million-dollar salaries were too much.
“Six-figure incomes? Okay. But seven figures? I mean, give me a break. It just doesn’t sit right,” said Mr. Berger. “From a donor perspective, this is absolute abomination.”
The American Hospital Association, a Washington group that represents 5,000 hospitals and other health organizations nationwide, argued that given the size and complexity of health-care systems, large salaries for hospital leaders are warranted.
In response to the report, the association touted the fact that the IRS found almost no examples of excessive compensation and also said that the tax agency’s survey was “poorly worded and incomplete” and overcounted the pay of top hospital leaders by including bonuses and deferred compensation that may be one-time payments.
The report arrives at a time when big paydays are a hot-button issue in Washington.
Sen. Charles E. Grassley, an Iowa lawmaker who is the senior Republican on the Senate Finance Committee, has concerns about the compensation disclosed in the report, said Jill Kozeny, a spokeswoman for the lawmaker. “Some of those that provide very little charity care are paying their executives the biggest salaries,” she said.
In addition, President Obama last week signed a new law that limits pay to $500,000 a year for executives at financial-services companies that receive federal aid.
While charity leaders don’t receive the massive bonuses of Wall Street investors—and most earn far less than the level of compensation identified in the IRS report—Michael W. Peregrine, a lawyer in Chicago who advises nonprofit organizations, said charities need to take heed: Lawmakers and the American public today are questioning any institution that receives government assistance—whether it’s bailout money or beneficial tax treatment.
“They are saying, In this environment, with huge economic problems and deficits, tell me again why we are providing certain groups with tax exemptions,” he said. “The IRS is saying, Everybody here play by the rules. And the broader charitable sector should say, All right, let me understand again what are those rules and double-check that we are complying with them.”
One question raised by the hospital report: Are the IRS rules that govern how charities establish their compensation levels adequate?
The IRS said nearly all hospitals in the study followed “important elements” of a voluntary section of the federal rules. The section provides a series of steps—including the use of data to compare salaries earned by executives at similar charities and for-profit institutions—by which charities can establish that they have done everything possible to set a reasonable salary.
That threshold is known as the “rebuttable presumption” of reasonableness.
Of the 20 hospitals that had high salaries in relation to their peers, 85 percent met the requirements of the rebuttable-presumption process, the IRS said, putting the burden of proof on the tax agency to show that compensation was not justified.
But the report also said that the salary rules—and efforts to measure whether hospitals met standards for providing charitable services—“have proved difficult for the IRS to administer.
“Both involve application of imprecise legal standards to complex, varied, and evolving fact patterns.”
The tax agency said it “will seek a better understanding of the impact of certain aspects of existing law.”
Specifically, the IRS said that it would look at whether nonprofit organizations should be allowed to compare their salaries to those at for-profit institutions and that it would review an exemption from many compensation-setting rules that currently applies to an organization’s first contract with an individual.
The agency said it will use the new 990 informational tax return to collect better data on nonprofit pay.
Some charity experts applauded the IRS’s examination of compensation, but said it should scrap the approach that allows charities to justify their salaries by comparing them to similar organizations.
“Rebuttable presumption is the equivalent of a school-aged child defending their actions by saying, ‘Everyone else is doing it,’” said Trent Stamp, executive director of the Eisner Foundation, in Los Angeles, and former head of Charity Navigator. “It’s silly, and it’s time for Congress to step in.”
Susan Egmont, a recruiter in Boston who works with many nonprofit clients, took a more modest stance, saying that the IRS may want to adopt different rules to govern health-care and higher-education institutions, where the bulk of the nonprofit world’s big salaries are.
“I do believe that clearer IRS guidelines would be helpful,” she said. The tax agency should say, “This is what we consider egregious and this is what isn’t.”
Other observers caution that the current standards work well—and that the report reinforces that point.
“We don’t need new laws,” said Betsy Buchalter Adler, a San Francisco lawyer who represents charities and a former member of the IRS Advisory Committee on Tax-Exempt and Government Entities.
The rules “are causing boards to pay attention, to consider what’s reasonable, to focus on objective data, and to act responsibly.”
The questions about federal regulation may embolden state attorneys general, said Mr. Peregrine, the Chicago lawyer. States do not allow the rebuttable-presumption “safe harbor” and can be more aggressive in their investigations of nonprofit pay, he said.
Karl E. Emerson, a nonprofit lawyer in Philadelphia who used to head Pennsylvania’s Bureau of Charitable Organizations, disagreed, saying the report showed that IRS rules worked.
At the same time, he said, state attorneys general are keeping tabs on nonprofit pay. “The whole idea of excessive compensation is definitely a hot topic right now,” he said.
With so much scrutiny of nonprofit and for-profit pay these days, Mr. Peregrine described the situation as a “toxic environment” for board members and trustees who set the compensation levels within groups.
“The boards of charities cannot be tone deaf to the broader concerns,” he said. “You’d be nuts in this environment not to take a closer look at executive compensation.”
But Ms. Egmont, the nonprofit recruiter, said the stigma on pay couldn’t have come at a worse time. The sour economy has already put pressure on charities to scale back administrative expenses—and the watchful eyes of regulators may increase it.
“I am very concerned that many [organizations] are freezing salaries,” she said. “CEOs as well as senior staff are taking cuts—as much as 20 percent—when their salaries were quite low to begin with.”
Grant Williams contributed this article.