The Astron Road Show

First, National Director Michael Maciekowich will exhibit at the Wisconsin State SHRM Conference, October 10 – 12, in LaCrosse, WI. Astron Solutions will also conduct the post-conference satisfaction survey. If you will be at the conference, be sure to stop by and visit Mike in the exhibit hall, and complete your survey feedback questionnaire on time!

Also on October 10th, Senior Statistical Analyst Eric Katz will exhibit at the 2007 HRATT Fall Conference in Corning, NY. Eric is excited to meet with attendees from both New York State and Pennsylvania during the one day conference.

For many years the Internal Revenue Service had only one main weapon to enforce the various rules and requirements applicable to organizations exempt from federal income tax: revoking tax-exempt status. As part of the 1996 Taxpayer Bill of Rights 2, Congress enacted an intermediate sanctions rule imposing penalties on excess-benefit transactions by some types of tax-exempt organizations. On January 23, 2002, the final regulations implementing the law were issued. The law and regulations apply to all organizations exempt from taxation under Sections 501(c)(3), other than private foundations, and 501(c)(4). Intermediate sanctions regulations impose penalties on what the Internal Revenue Service (IRS) considers excess-benefit transactions of most 501(c)(3) and all 501(c)(4) organizations.

Background basics

Intermediate sanctions may be imposed by the IRS on any "disqualified person" who receives an "excess-benefit" from a "covered organization." In the event that an excess-benefit, such as unreasonably high compensation, is paid to a disqualified person, the excess-benefit must be corrected to the extent possible. Any necessary additional steps must be taken to restore the organization to a financial position no worse than it would have been had the excess-benefit transaction not occurred.

Defining a disqualified person

Under the law, a disqualified person is any person who was in a position to exercise substantial influence over the affairs of the organization at any time during a five-year period ending on the date of the transaction in question. Specifically, this would include officers, directors, and executive employees of tax-exempt organizations, or a family member of a disqualified person. In addition, an organization's manager, defined as "any officer, director, or trustee of an organization (or any individual having powers or responsibilities similar to those of officers, directors, or trustees of the organization)," who knowingly participates in an excess-benefit transaction, may also be subject to financial penalties.

For purposes of demonstrating knowing participation, a manager must have actual knowledge of facts indicating that the transaction is an excess-benefit transaction, must be aware that the transaction may violate the law, or must negligently fail to ascertain whether the transaction is an excess-benefit transaction. Participation includes silence or inaction, when the manager is under a duty to speak or act, as well as any affirmative actions that may be taken. An organizational manager's actions may not, however, be deemed knowing if the manager relied on the advice of legal counsel, certified public accountants, or other professionals with relevant expertise.

Clarifying excess-benefit transactions

An excess-benefit transaction is defined in the law to mean 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 received for providing such benefit." In short, the excess-benefit is the difference in value of that received by the organization and that given by the organization to the disqualified person. All benefits from the organization to the disqualified person must be considered, regardless of whether the benefit was directly or indirectly received.

The most common area of potential excess-benefit transactions is that of compensation arrangements with directors, officers, managers, or vendors. Under general principles of corporate law, directors and officers are prohibited from making monetary profit from a nonprofit corporation as a result of their positions. However, unless provided in statute or corporate bylaws, directors and officers are not legally prohibited from receiving reasonable compensation for services provided. This means that the payment must relate to, and be no more than, the fair market value of the services being rendered.

Determining reasonable compensation

The facts and circumstances test is generally the basis for determination of reasonable compensation. Under the test, the IRS will review the totality of circumstances to determine whether a compensation plan was created to serve the interests of private individuals. In addition, the IRS will review the structure of the salary or compensation plan to determine whether the payment reflects fair market value or competitive market price.

The IRS has identified three criteria that, if met, provide a presumption that compensation is reasonable. Under this safe harbor rule, compensation is presumed to be reasonable if it meets these three criteria:

1. No conflict of interest. The compensation arrangement must be approved in advance by an authorized governing body of the exempt organization, which is composed entirely of individuals who do not have a conflict of interest with regard to the transaction.

2. Appropriate data as to comparability. The authorized body must have obtained and relied on appropriate data as to comparability prior to making its determination. Relevant information might include compensation levels paid by similar organizations for comparable positions, the availability of similar services in the geographic area, and examples of offers from similar organizations competing for the services of the disqualified person. An organization with gross revenues of less than $1 million will be deemed to have appropriate information if it obtains compensation data from three comparable organizations.

3. Appropriate documentation of the determination. Concurrent with making the determination, the authorized body must adequately document the basis for its decision. The written or electronic records of the authorized body must state the terms and date of approval of the transaction, the members of the authorized body present during the discussion on the transaction, a record of the vote, the comparability data used, and notation of how the body treated any individual with a conflict of interest in the transaction.

Given the significant amount of attention focused on this issue, we urge all tax-exempt organizations affected by the intermediate sanction provisions to carefully analyze and evaluate all compensation proposals and arrangements and make every attempt to conform to IRS rules.

Looking for a top-notch presenter for your human resource organization's meeting? Both Jennifer Loftus and Michael Maciekowich present highly-rated sessions on a variety of compensation and employee retention issues. For more information, send an e-mail to info@astronsolutions.com.

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Copyright 2007, Astron Solutions, LLC

ISSN Number 1549-0467