Nonprofit Law Blog

Executive Compensation

Section 4958(c)(1)(A) of the IRC defines an excess benefit transaction as “any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.”  An excess benefit transaction is prohibited and may subject the disqualified person and the directors who knowingly approved such transaction to significant federal excise taxes. IRC§4958(a), (b).

A disqualified person with respect to a transaction is “(A) any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization [including directors of the corporation], (B) a member of the family of an individual described in subparagraph (A), and (C) a 35-percent controlled entity.” IRC §4958(f)(1).

Persons having substantial influence include:  voting members of the governing body (e.g., directors, trustees), presidents, chief executive officers, chief operating officers, and chief financial officers, and chief financial officers.  Persons deemed not to have substantial influence include: employees who both: (1) receive economic benefits from the organization of less than $95,000 (in 2005), and (2) do not hold executive or voting powers.

Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances.  For determining the reasonableness of compensation, all items of compensation are taken into account (with certain exceptions that probably do not apply here), including:

1. All forms of cash and non-cash compensation, including salary, fees, bonuses, severance payments, and deferred compensation;
2. The payment of liability insurance premiums for, or the payment or reimbursement by the organization of, any penalty, tax, expense or correction owed under IRC Section 4958;
3. All other compensatory benefits, whether or not included in gross income for income tax purposes; and
4. Taxable and nontaxable fringe benefits, except fringe benefits described in IRC Section 132.

Reasonableness may be determined in part by (1) compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; (2) current compensation surveys compiled by independent firms; and (3) actual written offers from similar institutions competing for the services of the disqualified person.

Payments under a compensation arrangement are presumed to be reasonable if the following three conditions are met: ...

Fiscal Sponsorship Basics

A fiscal sponsorship is a type of relationship that a sponsored project (often a new charitable endeavor organized by an individual or group of individuals) has with its fiscal sponsor, typically conferring upon the project the benefit of the sponsor's 501(c)(3) tax-exempt status and certain administrative services.  There are several models of fiscal sponsorship.  Accordingly, it is important for a sponsor and its project to understand the exact nature of their relationship.

From the sponsor's perspective, it is essential to ensure that the activity of sponsoring a particular project is done in furtherance of its own exempt (e.g., charitable) purposes.  Before entering into a fiscal sponsorship relationship, the sponsor should also be aware of its exposure to liability for the actions of its project.

From the project's perspective, it is important to recognize that commonly the project will be the under the control of its sponsor, which may be legally responsible for the operations and activities of the project.  The benefits of immediate tax-exempt status and administrative support must be weighed against the lack of autonomy and fees typically charged by the sponsor.

Fiscal sponsorships may be a very attractive alternative to formation of an independent tax-exempt entity where the immediate viability of a separate entity is questionable or the charitable endeavor has a relatively short-term.  Often, projects "test the waters" through fiscal sponsorships before they determine whether to become independent tax-exempt entities.

Read more about fiscal sponsorships at the following sites:

Nonprofit Genie FAQs - Fiscal Sponsorship, CompassPoint Nonprofit Services

Guide to Fiscal Sponsorship, Foundation Center

FiscalSponsorship.com, San Francisco Study Center
- You can order Greg Colvin's book "Fiscal Sponsorship - 6 Ways To Do It Right" at this site.  I consider this book essential reading for organizations that are contemplating fiscally sponsoring projects and recommended reading for groups looking to become fiscally sponsored.

New Exempt Organization FAQs on IRS Website

The IRS recently released 7 new FAQs about Issues of Interest to the General Public about Exempt Organizations.  I found one particular answer not too helpful:

Are contributions to an organization that that has not received an exemption determination letter deductible (for example, while an application is pending)?

"If an organization is exempt under section 501(c)(3) of the Internal Revenue Code, charitable contributions to it are deductible.  To be exempt under section 501(c)(3), most organizations must file Form 1023 by the end of the 27th month after they were created.  If an organization does so, charitable contributions to it will be deductible back to the date of formation.  The extent to which donors may be assured that their contributions will be deductible in advance, however, will depend on whether the organization has -

• Timely filed Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, but not yet received a letter recognizing its exempt status,
• Filed Form 1023 later than the prescribed time, or
• Not filed form 1023."

So what's wrong with that answer?

First, it doesn't address the possibility that the organization is denied 501(c)(3) status.  This makes it impossible for donors to know in advance of the organization's receipt of its IRS determination whether their contributions are deductible.  Does this make it improper for a donor to take a charitable deduction in advance of the determination so long as the organization timely filed Form 1023?  From the information on the FAQ, it would appear not, provided that the donor amends his or her return if the organization is denied 501(c)(3) status after the donor's tax return has been filed.  On the other hand, taking the deduction before an IRS determination may be improper reliance on the organization's ability to meet all the eligility requirements for an organization to receive deductible contributions.  This conflict is where guidance is needed.

Second, the first sentence in the answer is not exactly correct and may be misleading.  Not all organizations exempt under 501(c)(3) are eligible to receive deductible contributions.  For example, a charitable contribution to a foreign organization which has received 501(c)(3) status from the IRS is not deductible.  IRC Section 501(c)(3) describes a type of organization exempt from taxes under IRC Section 501(a) and does not speak to the deductibility of contributions.  It is IRC Section 170 that provides for the deductibility of charitable contributions, and 170(c) describes the types of organizations eligible to receive deductible charitable contributions.

Third, even if the organization is eligible to receive contributions subject to the charitable deduction, the charitable contribution will not be eligible for a charitable deduction unless properly substantiated (i.e., documented by a bank record or an appropriate written communication by the donee organization) and within certain percentage limitations, as provided in IRC 170(b).

Click here for the new IRS FAQs.

Insurance - Presentation for YNPN

On December 5, 2006, Melanie Herman, E.D. of the Nonprofit Risk Management Center, and I gave a very short presentation on insurance for the Young Nonprofit Professionals Network.  I began the presentation with a discussion of liability.

Liability may be defined as a type of risk for which there is an attribution of fault and a resulting obligation of the party to which fault was attributed.  Commonly, liability refers to being sued.  In the nonprofit management context, leaders must manage the risks of liability imposed on the organization and liability imposed on individuals affiliated with the organizations (e.g., directors, officers, employees, volunteers).  The following list represents some areas of exposure:

• Employment-related claims (said to represent over 75% of all claims against nonprofits)
  • Sexual harassment
  • Discrimination (e.g., resulting in a failure to promote)
  • Wrongful termination
• Facility-related claims
  • Improper maintenance (e.g., slip and fall cases)
  • Improper use
  • Environmental dangers
  • Noncompliance with OSHA
• Event-related claims
  • Improper management/supervision
  • Liquor liability
• Automobile-related claims
• Negligence-related claims
  • Negligent hiring
  • Negligent training
  • Negligent supervision of staff, volunteers, clients (particularly children and other vulnerable clients)
  • Negligent provision of services (e.g., malpractice)
• Misuse of funds
  • Private inurement by an insider
  • Excess benefit transaction (including excessive compensation)
  • Other private benefit transactions (look for future posts on this complex area)
  • Misuse of restricted funds
  • Violation of the charitable trust doctrine (a concern when the charitable purposes of the nonprofit change over time)
  • In violation of anti-terrorist laws (check the SDN list)
  • Investments in violation of prudent investor laws
  • Endowment management inconsistent with UMIFA
  • Waste
• Intellectual property claims
  • Trademark/Servicemark
  • Copyright
  • Patent
  • Trade Secret
• Defamation claims
  • Libel (e.g., harmful written statement)
  • Slander (e.g., harmful oral statement)
• Privacy law claims
• Charitable solicitation violations
• Products liability
• Contract-related claims

The following steps represent some risk management strategies used to minimize a nonprofit's and its leaders' exposures:

• Incorporation (limited liability protection)
• Directors, officers and managers understanding and doing their jobs
• Training
• Written policies and procedures that are followed and enforced
  • Internal controls
  • Conflict of interest policies
  • Employee handbooks
• Proper maintenance of written records
• Audit
  • Financial
  • Risk management-related
• Timely, appropriate investigations of complaints
• Retention of competent help when appropriate
• Avoidance of certain activities where the risk outweighs the reward
• Indemnification and hold harmless agreements
• Attention to risk management in planning
• Common sense
• Insurance

Before proceeding to describe different types of insurance products that may be of interest to nonprofits, Melanie identified five preliminary questions nonprofits should consider:

Notice 2006-109 - Interim Guidance Regarding Supporting Organizations and Donor-Advised Funds

On December 4, 2006, the IRS released Notice 2006-109, which provides interim guidance on provisions of the Pension Protection Act of 2006 that affect supporting organizations and donor-advised funds.  I expect to update this post to show the nonprofit sector's responses to the interim guidance.

Click here for the Notice.