The IRS Is Increasing Scrutiny of Executive Compensation
Executive compensation in credit unions is increasingly subject to scrutiny and regulation. CEOs and other officers are receiving compensation in a broader spectrum of delivery forms than in the past, including performance based bonuses and long-term incentives, perquisites (fringe benefits), reimbursements and allowances.
Given the compensation abuses in other financial sectors over the last several years, it is not surprising that credit unions have been included in the political and regulatory reaction compensation issues and concerns that have existed since long before the exposure of corporate bad actors. Their catalytic behavior in the financial crisis spurred Congress to pass legislation that is intended to limit compensation and impose compensation delivery rules and requirements for banks, public companies and other for-profit employers.
The basic rules that apply to the setting of executive pay and benefits by tax-exempts haven't changed since final regulations under Internal Revenue Code Section 4958. Since then, there have been some regulations and guidelines as to the structure of deferred compensation arrangements in so-called "troubled credit unions," and the pending issuance of the Interagency Rule that codifies some common sense rules for larger credit unions with regard to performance-based incentive compensation, sustainable performance results and delays in payments of performance-linked pay.
More recently, however, the IRS has signaled its intention to pay closer attention to exec compensation and benefits in exempt organizations. The well-publicized enhancements to the compensation disclosure requirements on Form 990 give the IRS plenty of information with which to work.
With this in mind, I wanted to offer a brief review of the so-called "intermediate sanctions" rules and a refresher on the simple process that tax-exempt employers should follow. Anyone involved in CU exec compensation issues should know about Section 4958 of the Code, which imposes excise taxes on both "disqualified persons" who receive an "excess benefit" from a tax-exempt organization and on any organization manager who knowingly participates in an excess benefit transaction.
If the IRS determines that there has been an excess benefit, the disqualified person must reimburse the organization to place the organization back in the position it was in before the excess benefit transaction was completed. There are also stiff interest penalties and excise taxes. These penalties are called "intermediate sanctions." An organizational manager who participated in the transaction may also be fined an aggregate of $10,000 per violation and is jointly and severally liable.
With regard to CUs, a disqualified person is anyone presumed to be in a position to exercise substantial influence over the CU's affairs. The IRS considers these individuals to be presumptively disqualified:
• Executive officers, such as president, CEO and COO- the exact title used is irrelevant; it includes any individual who has ultimate responsibility for implementing board decisions or for supervising others.
• Members of the board who are entitled to vote on matters over which the board has authority.
• The financial officers, including anyone who has or shares responsibility for managing the credit union's assets.
• A family member (spouse, siblings and their spouses, ancestors, children, grandchildren, great grandchildren, and spouses of children, grandchildren and great grandchildren) of a disqualified person.
• An organization (corporation, partnership, trust or estate) owned 35% or more by a disqualified person. An organization manager is any officer, director, trustee, or person having responsibilities similar to a disqualified person.
Excessive compensation or the receipt of an "excess benefit" is harder to define. In general, to determine whether someone's comp is reasonable, a comparison should be made of the compensation being paid to persons doing similar jobs in similar enterprises in the same geographical area.
The Safe Harbor
Under Section 4958, Treasury Regulations did create a "rebuttable presumption of reasonableness," or safe harbor as to compensation arrangements between an organization and a disqualified person that are presumed to be reasonable if the following conditions are satisfied:
• The board or a committee of the board has approved in advance the compensation,
• The board relied upon data as to comparable salaries.
• The board adequately documented the basis for its compensation award.
However, and more elusively, compensation may be deemed excessive if any payment is made by a credit union to a disqualified person and the credit union gets back less than the payment in values. In such circumstances the disqualified person is considered to have received an excess benefit. At a recent conference, an IRS official stated that fringe benefits have become the most common trigger of intermediate sanctions under Section 4958 of the Code.
According to Lois Lerner, IRS Director of Exempt Organizations, the biggest area of IRS audit concentration regarding noncompliance related to governance issues for tax-exempt groups (including CUs) is executive compensation. If an exe is paid too much, the organization, the executive, and the board members who made the decision to pay the unjustifiable salary, all risk paying penalties. The IRS is also imposing intermediate sanctions against exempt organizations not treating fringe benefits as income. All compensation must be included in required reporting on Form 990.
Additionally, Lerner said, "the intermediate sanction rules that apply to tax-exempt organizations also create a category of automatic excess benefit transactions." These are transactions where the compensation paid to an individual is reasonable, but in the process of using what the IRS calls "rebuttable presumption of reasonableness," the organization leaves a certain piece of the compensation out of its documentation, which will then trigger an automatic imposition of some taxes. A credit union must make its intent to treat such benefits as compensation clear in order to avoid the presumption that the provision of such benefits constitutes an excess benefit transaction.
Lerner also announced that the IRS is conducting a three-year National Research Program focusing on uncollected taxes in the area of employment, for taxable and nontaxable entities. If an organization has not treated fringe benefits provided to its chief executives as income, those payments will be considered an automatic excess benefit. One might say the study sounds like a broad audit program.
It is clear that CU boards, executives and others with financial authority and responsibility are under a brighter light of scrutiny. It might be time to conduct a comprehensive review of your executive comp policies and practices.
Alec Berkman is principal and CEO of Executive Compensation Solutions. For more information: www.ecs-m.com.