C-suite and top-tier employees often have a different set of issues to consider than those further down the career ladder. As one example, highly-compensated executives who work in the non-profit college and university sector can find themselves at particular risk because compensation considered an “excess benefit” may be subject to a significant penalty tax known as Intermediate Sanctions.
How Intermediate Sanctions Came into Being
In 1996, Intermediate Sanctions were enacted into law to stop “insiders” with influence from being unjustly enriched from charities. Prior to this change in the tax code, the only thing the IRS was able to do in these situations was to threaten the non-profit with loss of its tax exemption. This hurt the non-profit organization and the larger community rather than the “overpaid” employee.
What Happens When Key Executives Earn in Excess of Fair Market Value?
Once Intermediate Sanctions became a part of the Internal Revenue Code, any compensation earned by key executives in excess of fair market value could be taxed an additional 25 percent surcharge. Should the issue not be immediately corrected, the IRS could force the executive to pay back excess compensation with interest, in certain situations effectively imposing as much as a 200 percent tax.
What is a Disqualified Person?
Once Intermediate Sanctions are found to be appropriate, the executive, almost always at the Presidential level, as well as the Board members who approved the excess compensation are at risk for penalties. The IRS imposes Intermediate Sanctions on anyone they consider a Disqualified Person. A Disqualified Person is anyone who could significantly influence a non-profit organization — a non-profit private college or university, in this case. Officers and Board members are Disqualified Persons as are the Presidents being paid the excess compensation.
What is Included in “Excess Benefits”?
Excess benefits could be any amounts of compensation deemed “unreasonable” as compared to other executives in the non-profit private college or university sector. Excess compensation can also encompass other types of benefits. As an example, a high-ranking executive of a non-profit private college or university takes his family on a trip to Hawaii so he can attend an educational conference. Even if none of the expenses are reported as compensation, and even if the basic salary of the executive was in line with other non-profit college or university executives, such an act could trigger an excess benefit.
How is Reasonable Compensation Determined for Executives Working in a Non-Profit Private College or University?
If you are President or top executive at a non-profit private college or university, you may wonder how you can ensure you are in compliance with the IRS rules. You must start with reasonable compensation. The IRS requires that compensation packages for any executive who works for a non-profit college or university (or any other private non-profit) be “reasonable.” Unfortunately, and not all that surprisingly, “reasonable” is not clearly or simply defined in the IRS code. To define whether a compensation package is reasonable, the IRS considers the following:
- The job description at the college or university;
- The levels of education and experience necessary for the executive position;
- The average levels of compensation in the immediate area as well as in other similarly-sized non-profit private colleges and universities across the nation (those “comparators” are probably the most important criteria);
- The number of hours the executive is expected to work; and
- The non-profit’s overall budget.
While there are many variables, however any non-profit private college or university whose top executives make several hundred thousand dollars should be prepared to defend their compensation package. If you are a President or other C-suite executive in a non-profit private college or university and have concerns that you may be subject to this type of onerous tax penalty, speak to a knowledgeable executive employment compensation attorney to ensure that your contract is conceived and drafted so as to avoid Intermediate Sanctions.