IRS Bars Stock-Options Deal for Charities

By Harvy Lipman

The Internal Revenue Service has barred nonprofit organizations from offering their executives a type of deferred compensation similar to the stock options some corporations give their employees.

Aggressively promoted by some of the nation’s largest accounting firms, the stock-option plans have been provided by hundreds of nonprofit groups — mainly large organizations like hospitals and universities — as a way to compete with compensation packages offered by for-profit employers, according to Ruth Wimer, a partner at Ernst & Young who had been among those urging nonprofit clients to use stock options.

In corporate plans, executives are typically given the opportunity to purchase shares of the company’s stock at a set price, usually below the market price. If the stock goes up, they earn substantial profits when they sell the shares at a later date. If it goes down, they do not exercise the options and lose nothing. By deferring compensation until they actually sell the shares, usually after they have retired, executives can significantly reduce the taxes they have to pay on that income.

Charity Approach

In the nonprofit version, organizations would offer executives the chance to purchase options in mutual funds or other groups of stocks that the nonprofit organization would buy.

The IRS ruled, however, that such plans violate a section of federal tax law that forbids executives of tax-exempt organizations from receiving certain kinds of deferred compensation.

Ms. Wimer and other advocates of the stock-option plans had argued that they were covered under a set of exemptions from the deferred-compensation rules contained in another section of the tax law, but the Internal Revenue Service said that it disagreed.