On March 1, 2007 the Internal Revenue Service released Parts I and II of its Report on the 2004 Exempt Organizations Executive Compensation Compliance Project. Part III and the IRS’s plans for future initiatives in the executive compensation area will be released in a supplement. Since the initiation of the Project in 2004 the IRS has reviewed executive compensation information from approximately 1800 charitable organizations (1428 public charities and 398 private foundations.) The first phase of the Project was information collection from 1200 organizations through a “compliance check.” In addition, nearly 800 organizations were examined to determine whether the compensation of “disqualified persons” (any person in a position to exercise substantial influence over the exempt organization) was “reasonable.” The most significant findings reported by the IRS from both the compliance check and examinations are as follows:

1. Reporting Errors.

The compliance checks uncovered “significant reporting errors and omissions,” particularly in reporting excess benefit transactions and loans made to officers, resulting in approximately 30% of the organizations filing amended tax returns.

2. Penalties.

Of the 600 examinations closed to date, the IRS reports the organizations “generally were compliant with intermediate sanctions rules and private foundation self-dealing rules,” however, twenty-five of the examinations resulted in $21 million in excise taxes being assessed against 40 disqualified persons or organization managers; including for:

  • excessive compensation 
  • personal expenses (vacation homes, legal fees, automobiles) not reported as compensation 
  • personal meals and gifts that were not reported 
  • excessive payments for services provided by entities related to officers

3. Rebuttable Presumption.

Only 51% of the public charities examined attempted to establish a “rebuttable presumption” of reasonableness for executive compensation.

4. Loans.

Of 100 public charities reporting loans over $100,000 to directors, officers, and employees, 92 were determined by the IRS to need further review and 37 were referred to examination.

The Report concludes with “Lessons Learned and Recommendations,” which are focused primarily on the need for the IRS to improve information collection for compliance projects, to increase information sharing and education about reporting requirements, and to review penalties and excise taxes related to reporting and excessive compensation. Part III of the Project, which is underway, is an additional 200 compliance checks and 50 examinations that are focused specifically on organizations that have made loans to executives.

Senator Max Baucus, Chairman of the Senate Finance Committee has expressed concern about the reporting problems and indicated his commitment “to pursuing abuse in this sector where so much good is otherwise done.” Senator Charles Grassley, ranking member on the Committee, who has been reviewing non-profit practices for several years stated that “the lack of transparency is inexcusable,” and characterized the compensation of non-profit executives as evidencing “champagne lifestyles.”

Boards of Directors and managers of public charities and private foundations will want to review the accuracy and completeness of the reporting of executive compensation and excess benefit transactions on the annual information return (IRS Form 990,) and the policies and procedures utilized to establish executive compensation. Following appropriate procedures to establish a rebuttable presumption of reasonableness and assuring accurate and complete reporting on Form 990 are critical factors in meeting the good governance practices expected of the Boards and managers of tax-exempt organizations.