September 21, 2009
Key Senator Seeks Legislation on How Charities Set Compensation
Sen. Charles E. Grassley, the senior Republican on the Senate Finance Committee, is trying to change the way that charities can set compensation of executives and to make sure the Internal Revenue Service can obtain information about governance policies and practices of nonprofit organizations.
Underlying the legislation on compensation: an effort to stop what Mr. Grassley says are abuses of the current system, with charities setting overly high pay for officials.
Mr. Grassley’s ideas come in proposed amendments to a key health-care bill pending in his committee. Debate will begin tomorrow on the bill, drafted by Sen. Max Baucus, the Montana Democrat who chairs the finance committee.
A law enacted in 1996 gives the IRS the authority to fine charity officials for receiving salaries and other benefits that are deemed excessive, as well as to penalize trustees who approve the compensation. The law is known as the intermediate-sanctions statute because it gives the government an alternative to revoking a charity’s tax-exempt status.
Under federal regulations, nonprofit organizations can, by taking certain steps, establish a so-called rebuttable presumption with the IRS in which the government would presume the compensation set by the charity to be reasonable and not an “excess benefit.” The steps include the use of data to compare salaries earned by executives at similar charities and for-profit institutions.
Mr. Grassley noted that a recent IRS report of a study of nonprofit hospitals said that the salary rules have proved difficult for the revenue service to administer.
The tax agency said in the report that nearly all hospitals in the study followed “important elements” of the rebuttable presumption rules.
Of 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. The revenue service said it would look at whether nonprofit organizations should be allowed to compare their salaries to those at for-profit institutions.
“Committee staff has encountered abuse of the rebuttable-presumption procedures in its review of charitable hospitals, foundations, supporting organizations, and certain media-based ministries,” says Mr. Grassley’s amendment on compensation.
“Many of these organizations were able to use the rebuttable-presumption procedures to justify paying compensation comparable to executives in for-profit organizations, including comparables from for-profit entities that had nothing in common with the tax-exempt organization,” the amendment says.
Mr. Grassley’s amendment would remove the rebuttable presumption “safe harbor” from federal rules. The procedures that now provide an organization with a presumption of reasonableness generally would establish instead that an organization had performed the minimum standards of due diligence, the amendment says.
The amendment also would require charities, in their annual filing of the Form 990 informational tax return, to provide “a summary of the comparable information used to determine an executive’s compensation.”
Governance Rules
Mr. Grassley’s amendment on governance would clarify what charities are required to report to the IRS.
The federal tax code does not explicitly set out governance standards for the IRS to enforce, but the tax agency has shown increasing interest in keeping an eye on charities’ governance practices.
The IRS’s revised Form 990 for the 2008 tax year includes a series of questions about organizations’ governance policies and practices. One question asks: “Does the organization have a written conflict-of-interest policy?”
Some charities and legal experts have applauded the IRS for its interest in governance matters. Others say the tax agency is overstepping its legal authority.
Mr. Grassley’s amendment says current law “clearly provides the IRS with authority to ask questions about governance and management policies.” However, the amendment says, “some lawyers have publicly questioned IRS’s authority and have indicated an intent to encourage clients not to answer such questions in order to mount a legal challenge should IRS assess a penalty for filing an incomplete return.”
The amendment says it “would protect IRS from such wasteful legal challenges by adding language” to the law “to specifically mandate that IRS require governance and management information be reported in annual filings.”
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