At Issue

Executive compensation at higher education institutions is under increased scrutiny by the public and the IRS. Further, if your executive compensation is deemed by the IRS to be unreasonably high, it can result in substantial penalties levied against the executive and, potentially, the board of trustees.

Situation

Denali Christian College (DCC) is a private college that is exempt under I.R.C. section 501(c)(3) and section 170(b)(1)(A)(ii). At their recent board meeting, the topic arose of executive compensation. Specifically, the compensation committee wondered what they should be doing to satisfy one of the three required areas of Treasury Regulation 53.4958-6 (known as the “rebuttable presumption” clause), namely “comparable data”.

The CFO is not totally sure how to answer the question, so they call us. First, we tell them that they should ensure that all three of the “rebuttable presumption” facets are met – including independent board approval, use of comparable data, and documentation of the process. Schedule J (Form 990) contains check boxes in a section (Part I, Line 3) that asks which, if any, of the following methods were used to arrive at executive compensation: compensation committee, independent compensation consultant, Form 990 of other organizations, written employment contract, compensation survey or study, approval by the board or compensation committee. In the instructions to Schedule J, “compensation survey or study” is described as follows: “refers to a study of top management official compensation or functionally comparable positions in similarly situated organizations.”

As an aside, all institutions should ensure that their description of the process for determining executive compensation (on Form 990, Schedule O) conforms to the IRS’ expectations in this arena.

We encourage the team at DCC to contract to have a “compensation study” done by an outside consultant for any executives listed at Form 990, Part VII, Section A. Further, the “shelf life” of these studies is probably about 24 months.  They should be done more frequent if significant changes to compensation occur.

Rules

Treasury Regulation 53.4958-6(c)(2)(i):

In general. An authorized body has appropriate data as to comparability if, given the knowledge and expertise of its members, it has information sufficient to determine whether, under the standards set forth in §53.4958-4(b), the compensation arrangement in its entirety is reasonable or the property transfer is at fair market value. In the case of compensation, relevant information includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person. In the case of property, relevant information includes, but is not limited to, current independent appraisals of the value of all property to be transferred; and offers received as part of an open and competitive bidding process.

IRS Form 990 Instructions (2016):

Part VI, Line 15. Answer “Yes” on line 15a if, during the tax year, the organization (not a related organization or other third party) used a process for determining compensation (reported in Part VII or Schedule J (Form 990)) of the CEO, executive director, or other person who is the top management official, that included all of the following elements…

…[2] Use of data as to comparable compensation for similarly qualified persons in functionally comparable positions at similarly situated organizations.

Schedule J (Form 990), Part I, Line 3 instructions:

Compensation survey or study refers to a study of top management official compensation or functionally comparable positions in similarly situated organizations.

 

Bottom Line

More and more, executive compensation is becoming a hot issue in higher education. And, what your team thinks is “reasonable” may be disputed by the IRS if you have not taken the proper steps to meet the “rebuttable presumption of reasonableness” set forth in the regs. You should seek expert advice in this arena and get compensation studies done by outside experts.

Specific questions? Email Dave Moja.

The information provided herein presents general information and should not be relied on as accounting, tax, or legal advice when analyzing and resolving a specific tax issue. If you have specific questions regarding a particular fact situation, please consult with competent accounting, tax, and/or legal counsel about the facts and laws that apply.