Compensation Provisions: Intermediate Sanctions

and Safe HarborsJanet Kleffner

ACCT 530Graduate Presentation

If you pay management or executives an excessive amount, penalties can be imposed on the board members who approved the compensation. 

The IRS has established new “safe harbor” provisions which relate to “intermediate sanctions” provisions for governments and not-for-profit organizations.

Introduction

Why should you care? “Intermediate Sanctions” Defined Caracci v. Commissioner (2002). “Reasonable Compensation”

◦ Disclosures◦ How to Report

Violation Consequences Introduction to “Safe Harbor Provisions”

Roadmap

Some of you may sit on a Board of Directors for a government or NFP organization

Some of you may be managers of a NFP organization or government workers

IRC 4958 is one of the most important regulation changes in history for governments and NFP organizations

Why Should You Care?

Exemption status revoked Needed a less harsh punishment

“Effective January 1, 2010, board members who knowingly and willfully approve excess benefit transactions are joint and severally liable for a 10% tax (limited to $20,000 per transaction).”

Intermediate Sanctions

1996-2002: regulations developed◦ January 2002: final implementation

No applicable to private foundations “Excess-benefit transactions” Penalize members with influence, not

organization◦ Board members◦ CEO/CFO◦ Compensated employee

Intermediate Sanctions (cont.)

First case reported under IRC 4958 Family-owned 3 health care organizations (exempt) Transfer of assets to become for-profit Gain on assets far exceeded liabilities

assumed◦ Classified as “excess benefit transaction”◦ Unreasonable compensation package

Exemption status revoked

Caracci v. Commissioner (2002)

IRS: “An amount that would be ordinarily paid for like services by like enterprises under like circumstances”

Specific factors◦ IRC 162 standards◦ Similar positions◦ Availability of services in the region◦ Compensation surveys◦ Offers from other firms for the position

What is “Reasonable Compensation”?

Unreasonable compensation=Excess Benefit Transactions (EBT)

Based on compensation increases and/or FV of assets transferred

Burden of proof◦ IRS: “willful and flagrant”◦ Defending parties: “reasonable cause”

“Reasonable Compensation” (Cont.)

All compensation and benefits◦ Automatic EBT if not reported

Any penalties must be disclosed◦ Names and amounts

Form 990 –Schedule J◦ http://www.irs.gov/pub/irs-pdf/f990sj.pdf

Disclosing Compensation

Implemented by IRS◦ Excise taxes◦ Repayment of EBT◦ Additional penalties◦ Interest◦ Revocation of tax exempt status

Compensated Individual◦ 25% and 200% excise tax

Board members◦ 10% tax (joint and severally liable)

Violation Consequences

Reduces or eliminates the liability of the compensated party◦ Good faith assumption◦ Excuses “legitimate and excusable violations”

“Rebuttable presumption of reasonableness”

3 steps◦ Review and approval of compensation by independent

firm◦ Decisions based on factors (similar positions, firms)◦ Documentation of deliberations, determination process,

and all decisions

Safe Harbor Provisions

Romano, Dan, Eric Gonzaga, and Ken Cameron. "Not for Profit Executive Compensation Trends." Lecture. Grant Thornton LLP, 2010. Web. 6 Dec. 2010.

"Safe Harbor." Wikipedia.com. Wikimedia Foundation, Inc., 30 Nov. 2010. Web. 7 Nov. 2010. <http://en.wikipedia.org/wiki/Safe_harbor>.

Bright, Lauren M. "Understanding Intermediate Sanction Rules." Ed. Jerald A. Jacobs. ASAE (2010). Web. 7 Dec. 2010. <http://www.asaecenter.org/Resources/AMMagArticleDetail.cfm?ItemNumber=10775>.

United Sates. Internal Revenue Service. U.S. Department of Revenue. By Lawrence M. Brauer and Leonard J. Henzke. Intermediate Sanctions (IRC 4958) Update. Internal Revenue Service, 2003. Web. 7 Dec. 2010. <http://www.irs.gov/pub/irs-tege/eotopice03.pdf>.

Works Cited