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Five Things Nonprofits Should Know About: CompensationSeptember 3, 2014
Please note that the term “nonprofit” as used here specifically means entities holding 501(c)(3) status under the Internal Revenue Code.
- Deferred Compensation May Be Taxed Sooner. A for-profit organization, if it meets certain criteria, may generally establish a deferred compensation plan (such as a Supplemental Executive Retirement Plan or a Severance Plan) that gives an employee a right to compensation today without subjecting the employee to income tax until the employee actually receives payment under the plan, even if payment is certain to occur. However, additional rules apply specifically to nonprofit organizations. Employees of nonprofit organizations are generally subject to tax as soon as there is no “substantial risk of forfeiture” with respect to a future payment. In other words, as soon as the payment “vests” and is certain to occur at some point, the employee may be subject to tax, even though the employee has not yet received the payment and may not have the funds to pay the resulting tax. Careful planning is required to ensure compliance by the organization and protection of the employee.
- Deferred Compensation is Subject to Additional Rules. In addition to the above rule that applies specifically to nonprofit organizations, 501(c)(3)s are also subject to deferred compensation restrictions that govern all organizations. For example, see Lack of 409A Review Puts Compensation Arrangements at Risk.
- Excessive Compensation Can Trigger an Excess Benefit Transaction Subject to Penalty on Officers and Board Members. If a nonprofit organization officer’s salary is greater than what is reasonable for the services the officer performs, the officer receives an “excess benefit.” The excess benefit amount is subject to enormous penalties, payable by the officer, and any director approving the compensation may be subject to penalties as well. Fortunately, the IRS has provided a way for a nonprofit to establish a presumption that a compensation arrangement is reasonable. For more information, please see Establishing a Presumption that Compensation is Not an Excess Benefit Subject to Excise Taxes.
- Percentage-Based Compensation May Not Work. Compensation based on percentages, such as a percentage of revenue, or a percentage of money raised during a fundraising campaign, may give rise to private inurement and private benefit issues. This type of compensation, whether paid to employees or independent contractors, is frequently the subject of scrutiny by the IRS and other stakeholders.
- Compensation is Reportable and Publicly Available Information.The IRS Form 990 requires nonprofit organizations to disclose detailed compensation information with respect to certain employees and independent contractors, and the Form 990 is a public document. For additional information, see Five Things Nonprofits Should Know About: Mandatory Disclosure of Documents.
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