This Astronology® , the third in our three-part series, examines non-profit executive compensation. In considering non-profit executive compensation, employers and Board have two primary legal concerns. The Tax Cuts and Jobs Act of 2018 is the most impactful change to the way non-profit organizations will plan their executive compensation programs going into 2019. The second most impactful change is the clarifications from the Internal Revenue Service on the use on “incentive” and “bonus” programs for non-profit executives.
The Tax Cuts and Jobs Act of 2018
A little known regulation that found its way in this sweeping piece of legislation was the penalty imposed on non-profit executives and their total compensation. In particular:
- The law imposes a new 21% excise tax on non-profits that pay compensation of $1 million or more to any of their five highest-paid employees. There also will be a tax on certain employee benefits.
- The tax is paid by the exempt organization, and applies to all remuneration of a covered employee (including non-cash benefits), except for tax-qualified retirement plans, amounts that are excludible from the covered employee’s gross income.
- Any portion of compensation paid to a licensed medical professional (e.g., doctor, nurse, or veterinarian), which is for the performance of medical or veterinary services by the professional, is excluded.
- Payments from related organizations and governmental entities also are included. Those entities pay their pro rata share of the tax.
- If an employee qualifies as a covered employee for any year, the excise tax applies to compensation in excess of $1 million and to certain parachute payments paid to the person by the organization in any future year.
- The Tax Reform Bill subjects tax-exempt organizations to Unrelated Business Income Tax (UBIT) on the value of certain employee fringe benefits, including transportation, parking facilities, and on-premises athletic facilities. The provisions go into effect immediately, for all amounts paid or incurred after December 31, 2017.
- A non-profit organization also is liable for the excise tax if payments made in connection with a termination of employment to any of its top five most highly compensated executives equals or exceeds three times the executive’s average earnings over the preceding five years.
Astron Solutions’ Perspective
According to the IRS there are over 3,000 non-profit organizations across the country that will be impacted by these provisions. Based on a review of Astron’s clients, our healthcare clients in major urban areas most likely will be impacted. As noted in the regulations, “tax-qualified” retirement plans are exempt from this provision. Tax qualified plans meet the requirements of Internal Revenue Code Section 401(a) and are therefore eligible to receive certain tax benefits. Such a retirement plan is established by an employer for the benefit of the organization’s employees. Broadly speaking, examples of qualified plans include the following:
- Profit-sharing plans
- 401(k) plans
- 403(b) plans
- 457 plans
- Money purchase plans
- Target benefit plans
- Employee stock ownership (ESOP) plans
- Keogh (HR-10)
- Simplified Employee Pension (SEP)
- Savings Incentive Match Plan for Employees (SIMPLE)
The majority of Astron’s non-profit clients have moved or are planning to move to 457 plans for their top executives. This is true even for those under the $1 million-dollar tax threshold. Astron recommends looking at all elements of their executive team’s compensation as part of 2019 planning, and closely reviewing retirement planning options with trusted advisors.
IRS Guidelines on Non-Profit Executive Incentive Compensation
The Internal Revenue Service (IRS) has a multi-factor test for a permissible compensation package, including any bonus, which is described below. A 501(c) tax-exempt organization may award a bonus to an employee if the employee’s total compensation package:
- Is established by an independent board of directors or by an independent compensation committee;
- Is reasonable in terms of the employee’s specialty and geographic locale;
- The result of arms’ length bargaining;
- Includes a ceiling or reasonable maximum;
- Does not have the potential to reduce the charitable services or benefits the organization would otherwise provide;
- Takes into account measures of the employee’s performance;
- Keeps the organization within budget without charging more for services;
- Does not transform the principal activity of the organization into a joint venture between it and the employee;
- Is not merely a device to distribute all or a portion of the organization’s surplus to persons who are in control of the organization;
- Serves a real and discernable business purpose of the exempt organization;
- Does not result in abuse or unwarranted benefits; and
- Rewards the employee based on services the employee actually performs.
Astron Solutions recommends auditing all incentive and bonus programs, especially those for executive level employees, to ensure that the plan(s) is in compliance with the guidelines noted above. In particular, Astron suggests that organizations particularly focus on guidelines 1, 5, 10, and 12. Compliance with these guidelines will go a long way to help prevent any future IRS scrutiny.
What challenges are you seeing with respect to executive compensation or compensation planning in general for 2019? Please let us know in the comments section below. We look forward to hearing from you!
And if you haven’t done so already, please be sure to register for our upcoming webinar Planning for 2019 and Compensation Budgeting. This concise, interactive, data-filled presentation will help you on the road to successful compensation planning! You can learn more and register at https://attendee.gotowebinar.com/register/4205976510804728578. See you on September 26th!
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