Cracking Down on Abuse: How Law Works

In 1996, Congress passed a law that allows the Internal Revenue Service to levy fines on charity officials who receive inappropriately high salaries or excessively generous benefits, as well as the trustees who authorize those arrangements. In addition, penalties can be assessed on those who benefit from or approve sweetheart financial deals involving a charity’s assets.

Who it covers: Employees and officers who have a substantial influence over a charity, such as top executives and board members. The IRS said other people who are subject to the law include those who:

• Founded a charitable organization.
• Are major donors to a group. (That means they provided more than $5,000 and that amount was more than 2 percent of an organization’s total gifts.)
• Receive compensation based on revenue stemming from activities of the organization that the person controls.
• Have authority to control or determine a significant portion of the organization’s capital expenditures, operating budget, or compensation for employees.
• Have managerial authority or serve as a key adviser to a person with that authority.

The IRS says the penalties don’t apply to employees who took a vow of poverty; independent contractors, such as a lawyer, accountant, or investment manager (with some exceptions); or donors who gave significant sums and received preferential treatment from a charity, as long as the organization offered the same treatment to anyone who made a similar gift during a fund-raising campaign.

What is covered: The IRS rules explaining how the law will be enforced provide details about what kinds of compensation it considers to be acceptable and what is out-of-bounds. The guidelines apply to salary as well as to any bonuses, fringe benefits, deferred compensation, liability-insurance premiums, and forgone interest on loans. They also apply to property transactions that provide an influential executive, trustee, donor, or other top official with property at less than fair market value. The IRS said that it would not challenge reasonable expenses that charities pay to trustees to attend board meetings, but that reimbursement a charity provided for “luxury travel or spousal travel” would have to be returned and penalties would apply.

The penalties: Officials who get excessive salaries or perquisites can be forced to pay fines, known as excise taxes, equal to 25 percent of the portion of the compensation or other benefit found to be excessive. If the officials who received the excessive salaries or benefits fail to pay the penalties and return the portion of the compensation considered excessive, they could face fines of up to 200 percent of the money they receive improperly.

Board members who approve excessive benefits could be subject to a 10-percent tax on the amount of the excessive benefits they approved, up to $10,000.

A charity’s tax exemption could be revoked, if, for example, the charity grossly overpaid its executives or had repeatedly gotten into trouble because it provided overly generous financial benefits to top officials.

How to comply with the law: The IRS says it will presume pay and benefits to be reasonable if approved by a charity board that:

• Is composed entirely of people who did not have a conflict of interest with the person receiving the compensation or other benefits.
• Collected compensation figures for similar nonprofit and for-profit organizations and used them in determining salaries. Charities with gross receipts of less than $1-million annually would only have to obtain data from five other “comparable organizations in the same or similar communities.”
• “Documented adequately” the steps it took. For example, if the board decides “that reasonable compensation for a specific arrangement or fair market value in a specific transaction is higher or lower than the range of comparable data obtained, the governing body or committee must record the basis for its determination.”