Big Nonprofit Salaries Face Government Scrutiny

Many charities may rethink their pay policies as the IRS and some states embark on ambitious compensation reviews

Federal and state regulators are shining a new spotlight on salaries of charity executives, and as

their scrutiny intensifies, many charities are expected to rethink their compensation policies.

The Internal Revenue Service is in the initial stages of an ambitious compensation review to determine whether some nonprofit groups are awarding their leaders too much in salary and other forms of compensation, including loans and deferred pay. The effort marks the first systematic attempt by the IRS to review compensation; in the past, the agency has mainly focused on salaries at groups it was auditing for other reasons or organizations where compensation was questioned by news-media reports.

In addition, the Senate Finance Committee this week plans to hold a hearing to examine charity practices that “may be unfairly enriching individuals and corporations.”

And several states have been pursuing nonprofit-compensation lawsuits, most notably in New York, which is suing former officials of the nonprofit New York Stock Exchange, and Texas, which last week persuaded a jury to require two men to pay $21-million to the Dallas foundation they headed, part of that fines for overly high compensation.

The increased scrutiny by regulators could prompt nonprofit leaders to become more conservative in setting executive pay, according to charity lawyers and compensation experts.

Barnaby Zall, a lawyer in Rockville, Md., who has many nonprofit clients, says the increased attention from the Internal Revenue Service reminds him of a Japanese saying: “The nail that sticks up gets hammered down.” Any charity paying a salary that differs too far from the norm can expect a letter from the IRS asking for details on how that salary was set, he says. And even groups that are contacted by the IRS for another reason should be ready to answer salary-related questions, he adds: “This has permeated everything they do.”

Hiring 73 More Auditors

While in the past the Internal Revenue Service has said it did not have sufficient money, staff members, or other resources to devote a lot of attention to monitoring issues such as charity compensation, IRS Commissioner Mark W. Everson said this month that enforcement of the laws regarding charities has become one of the federal agency’s top priorities. The IRS Exempt Organizations division plans to hire an additional 73 auditors this year, the first substantial increase in more than a decade, to work with the 300 auditors already on its staff.

As part of its review, the IRS may look at the highest-paid chief executives of nonprofit groups — those who earn more than $1-million a year — said Steven T. Miller, commissioner of tax-exempt and government entities.

To determine how many executives might fit that profile, The Chronicle analyzed GuideStar’s database of nonprofit financial information and found 52 who make at least that amount listed on the most recently available tax returns for the approximately 230,000 organizations that are required to file with the IRS. The vast majority of these were chief executives of nonprofit hospitals and medical centers, but the list also includes charity investment managers and symphony leaders.

The IRS has been careful to say that salaries in excess of $1-million may well be justified and that its review is intended to help the agency determine which factors support such a salary and to be sure that no group in that range is paying an unreasonable sum.

While many nonprofit groups can meet the legal standards for justifying million-dollar salaries, such compensation has irritated some donors and others. At Harvard University, for instance, Terry M. Bennett, a doctor who donated $4-million to the school in 1991, has started a campaign to urge his fellow alumni to stop giving as a way to protest the salaries of investment managers of Harvard’s endowment.

Harvard officials have defended the salaries, which have gone as high as $34-million a year in one case, saying that it would cost the university more overall to have a private investment firm manage its assets. But Dr. Bennett thinks nonprofit groups should not compare themselves with for-profit companies when it comes to pay. “I thought I was giving to a charity that was being run by the charity-minded,” he says.

‘Put People on Notice’

The IRS’s plan to contact hundreds of groups later this summer signals the first wave of a larger compensation project expected to continue through next year, Mr. Miller says. Not only will the IRS pursue cases against any charities that are paying too much, he says, but it also wants to send a message to the rest. “We want to put people on notice that we’re going to take a look at how compensation is set,” he says.

Mr. Miller says that the IRS is not just looking at the highest salaries, but will examine any charity or foundation where top leaders’ pay doesn’t seem to be justified by an organization’s revenue. It will also question some large organizations that say they pay their executives little or nothing to be sure that those executives are not receiving improper “sweetheart” deals or other payments that they are not reporting to the government.

Tax lawyers who work with charities say the IRS’s interest in charity pay has caused many groups to worry. “The phone is ringing off the hook,” says Victoria B. Bjorklund, a New York lawyer who also serves on an advisory committee for the IRS Exempt Organizations division. She says groups are calling her and her colleagues to figure out what to say to the IRS to prove that their compensation packages are in line.

Many charity experts and state regulators praised the IRS’s action as a way to force charities to take a harder look at how much they pay, a move some said was long overdue.

Congress enacted a law against excessive nonprofit compensation eight years ago, but it has only been in the past two years that the tax agency has issued several rulings and reviewed compensation as part of its audits.

The law was largely intended to make sure that charity leaders didn’t receive exorbitant pay and perquisites and that trustees and top officials didn’t approve any overly generous financial arrangements for friends or family members. The law is known as “intermediate sanctions” because it allows the IRS to fine the wrong doers rather than imposing the ultimate sanction of taking away a charity’s tax exemption.

One charity adviser, however, doubts that much will really change, despite the IRS’s announced intentions to do more. “The IRS has shown itself toothless in the arena of charity oversight,” says Renata J. Rafferty, a Palm Springs, Calif., consultant who works with donors and nonprofit groups.

State Lawsuits

In addition to the federal efforts, some states are stepping up reviews of charity compensation.

Marc Owens, former head of the IRS Exempt Organizations division and now a lawyer in private practice in Washington, says charity leaders should take special note of the case brought by Eliot Spitzer, the New York attorney general, against Richard A. Grasso, former chairman of the New York Stock Exchange, for allegedly violating state law by receiving $187-million in compensation, an amount that the state calls unreasonable for a tax-exempt organization and the result of conflicts of interest. Lawyers for Mr. Grasso and for the stock exchange board’s former compensation-committee chairman, who is also named in the suit, have said the officials did nothing improper.

While the stock exchange is not classified by the federal government as a charity, Mr. Owens says that if New York wins this case, “it will clearly have implications for charities that will echo throughout the U.S.” He says such decisions would give federal and state regulators ammunition when challenging tax-exempt salaries they view as unreasonable.

Texas scored a victory on this front just this month when a court convicted two former officials of the Carl B. and Florence E. King Foundation, in Dallas, of committing fraud against the fund and ordered them to pay $14-million in punitive damages and repay $7.5-million in excessive salaries, personal credit-card charges, and lawyer fees. The foundation spent $1-million on grants in 2002, while it paid $3.3-million in salaries. The officials have denied any wrongdoing and are considering an appeal.

Declines Ahead?

While the full impact of increased government attention to charity salaries has yet to be felt, nonprofit experts say charities are already changing their behavior. More and more organizations are appointing compensation committees and asking consultants to help them set fair salaries, says Bruce Flessner, a Minneapolis executive-search consultant.

Some advisers on nonprofit compensation say they expect to see salaries level off or even decline as a result of the attention, a reversal of the trend of recent years. Despite the slow economy, the salaries of chief executives rose 4.3 percent in 2002, according to The Chronicle’s annual salary survey (October 2, 2003).

Despite predictions that the intermediate-sanctions law would reduce nonprofit compensation, salaries have tended to rise since it went into effect, say compensation experts. Over the past five years, salaries of more than four dozen executives at the nation’s largest charities and foundations rose by more than 50 percent, according to the Chronicle survey, while the pay of some executives more than doubled. That is because as boards have compared pay at their organizations with salaries at similar groups, those that found their compensation near the bottom of the list often provided raises to get closer to the middle. Such moves, over time, have ended up raising the midpoint in salary comparisons, according to hiring and pay consultants, as most employees have moved up but very few have moved down.

But new oversight of charity salaries may make charity officials more uneasy than in the past about being near the top of any salary comparisons.

Says James Abruzzo, an executive recruiter in Short Hills, N.J.: “People used to say, I don’t care how much it costs, just get us the best person. No one ever says that anymore.”

Mr. Abruzzo says that lately he has even been urging prospects not to demand top dollar. “I find myself saying to a candidate, I think you’re foolish to ask for that amount. If you take a little less, you’re less liable to come under any kind of scrutiny,” either from the IRS or from a board, he says.

But Hugh Mallon, a Baltimore compensation consultant, doubts that salaries will fall substantially at most groups. What will change, he says, is that charities will need to become much more open about why they pay what they do. “If you’re going to push the edge of the envelope, be prepared to defend it,” he says.

While few charity leaders relish the prospect of having to explain their pay to IRS or other government officials, compensation experts say charities as a whole stand to benefit from the scrutiny. Not only could it help deter nonprofit leaders with bad intentions from misusing charities to enrich themselves, but it could also provide assurances to the vast majority of charity leaders who want to pay fair salaries but are unsure where the line is between reasonable and unreasonable.

“The IRS hasn’t really defined what’s an excessive salary,” says Mr. Flessner. “Nobody really knows what it is. It will be interesting to find out what they will choose.”