Noting a Kaiser Health News report about hospital CEOs with 7 figure bonuses, Sen. Grassley continued his challenge to the existing IRS “safe harbor” system, which according  to a recent article in the Washington Post, he views as having failed in its purpose.  The KHN/Post article is here.

The New York Attorney General has proposed two laws that would bring more rigor and clarity to the rules on compensation in nonprofits.  These are the Nonprofit Revitalization Act and the Executive Compensation Reform Act.

The laws would affect many aspects of nonprofit operation.  Regarding compensation, the laws would establish a rule that “Total Compensation” for any employee must be “fair, reasonable and commensurate with the services the employee provides to the organization.”  “Total Compensation” is broadly defined to include salary, bonus, deferred compensation and any benefits having monetary value such as housing allowances, fringe benefits and retirement benefits.

For charities that are required to register to conduct charitable solicitations in New York, there are two additional levels of rules regarding compensation.  First, all such charities would be required to have a Compensation Committee of independent directors, or have the independent directors on the Board perform the duties of the Compensation Committee.

The basic duties of the Committee are to review the Total Compensation paid to the organization’s “principal executive officer” and determine that it is “fair, reasonable and commensurate with the services provided.”  The law requires to Committee to be directly responsible for the appointment, compensation and oversight of any compensation consultant retained to assist the Committee, that the consultant report directly to the Committee, and that the Committee approve the compensation “peer group” that the consultant recommends be used to develop comparable data.  The law would impose an “independence” requirement in that the compensation consultant must not have received compensation from the organization with the past 2 years except for compensation consulting.  For organizations with annual revenue in excess of $2M, the requirements would be extended to the top five highest compensated employees who are officers or “key employees” and whose compensation exceeds $150K (or a higher amount set by the Attorney General).  For such organizations, the law also requires that the Committee consider relevant data of total compensation paid to individuals serving in similar positions at similar organizations, the employee’s qualifications and performance, and the organization’s “overall financial condition”

Readers who are familiar with the IRS regulations on compensation for nonprofit employees will recognize a significant similarity with many of the terms and requirements of the New York laws.  This article is a summary of a detailed set of laws and does not set out every requirement; also, changes may occur as the laws move through the legislative process.  Lawrence Associates is well-positioned to assist Compensation Committees to set compensation in accordance with the proposed laws’ requirements.

The IRS has issued its final report on the College and Universities Compliance Project, which is based on questionnaires sent in 2008 to a sample of 400 colleges and universities.  Regarding compensation, the report shows a significant portion of the surveyed institutions failed to obtain the advantage of establishing a “rebuttable presumption of reasonableness” of compensation.  Although almost all institutions followed the requisite procedures, about 20% used incorrect data for comparing their compensation to that of other organizations.  This was due to one or more of (a) using compensation surveys that did not show that the surveyed entities were similar to the institution in question, (b) including dissimilar institutions in the surveys relied on, and (c) insufficient data in the surveys about whether the compensation surveyed was total compensation, not just salary.  (It appears that the wide range of benefits offered makes it difficult for colleges and universities to identify all elements of compensation.)

Although intermediate sanctions (financial penalties) were not imposed by the IRS on any of the institutions examined, the effort nevertheless resulted in finding $36Mm of additional wages and in turn $7Mm in taxes and penalties.  The survey showed only about 21% of the surveyed colleges and universities used outside compensation consultants, which we feel may account for many of the defects found in the processes used.

The IRS announcement is here and the full report is here.

The IRS Exempt Organizations (EO) division has issued its 2012 Report and 2013 Workplan.  This document emphasizes the importance of getting the 990 right as it’s the starting point for the IRS in determining whether an organzation warrants a further look.  Highlights for the coming year are an emphasis on reviewing the community benefits activities of nonprofit hospitals and a continuing study of colleges and universities.  The report is here and a summary by GuideStar is here.

Following up on our July 3 post, Becker’s Hospital Review reports that New Hampshire’s Director of Public Trusts intends to monitor hospital executives’ compensation more closely as a result of a recent report by the New Hampshire Center for Public Policy report showing marked increases between 2006 and 2009.

Several recent posts from around the Web have pointed up potential flaws in states’ efforts to limit nonprofit compensation.  In New York, which recently imposed a salary cap tied to the amount of funding an organization receives from the state, methods of calculation and the potential for waivers built into the rules may limit their effectiveness, as pointed out in the article “The Holes in the Salary Ceiling” at http://www.cityandstateny.com/nonprofit/ .  In Illinois, the state is moving against a structure where an executive is employed by a for-profit company that in turn is engaged by the nonprofit to provide management services, thus potentially shielding the executive’s compensation from public scrutiny

The New Hampshire Attorney General(NHAG) announced the release of a report on nonprofit hospital executive compensation.  The report was commissioned by the NHAG and conducted by the New Hampshire Center for Public Policy Studies (NHCPPS).  Items of interest in the report, as summarized by the NHAG’s press release, include:

“[M} most hospitals follow the process established by the Internal Revenue Service (IRS) for determining executive salaries.  However, these hospitals do not necessarily follow the same process in determining other forms of executive compensation including hiring and retention agreements, bonuses, and perquisites . . . .”

“[I]n using IRS guidelines to set compensation, there is a potential “log-rolling” effect . . . In actual practice hospitals tend to target the 75 percentile, and often higher, in setting their CEO’s compensation . . . .”

Update:  Boston.com issued a summary of the report on July 2 (Link)

Following up on our Feb. 20 post on New York State’s proposed limits on nonprofit executive salaries:  Gov. Cuomo issued Executive Order 38 on January 18, 2012, seting the basic groundrules.  Proposed regulations implementing the Executive Order have been issued for public comment by 13 state agencies, notably including the Department of Health and the Office of Mental Health.  The regulations cover service providers who receive more than $500,000 per year of state funding and more than 30% of their funding from the state.

The proposed regulations set a limit of $199,000 per year on compensation for “covered executives”; a term which covers directors, trustees, and other officers whose salary and/or benefits are at least partly “administrative” expenses.  The limit is implemented in two ways.  First, entities covered by the regulations may not use state funds to pay compensation in excess of the limit.  Second, the limit applies regardless of the source of the entity’s funds if the compensation exceeds the 75th percentile of compensation provided to comparable executives, as established by a compensation survey “recognized” by the agency and the Director of the Division of the Budget, or it was not approved by the entity’s board including at least 2 “independent” directors, or it was reviewed by the board but without appropriate comparability data, and the entity is unable to substantiate that it has complied with these requirements.

The proposed regulations will clearly require close attention to executive compensation by the numerous service providers receiving fundng from New York State.  The comment period on the regulations closes July 14.  Lawrence Associates will continue to monitor the developments in this area and keep you up to date via this blog.

The Boston Herald reports that the MA state Senate has approved a bill introduced by State Senator Mark Montigny (D-New Bedford) which will ban public charities from paying compensation to directors.  The Nonprofit Times reports that the bill, which must now go to the House and then to the Governor for approval, is supported by Martha Coakley, the state’s Attorney General.

According to the Council on Foundations, “Rep. Charles Boustany Jr. (R-La.), chairman of the House Ways and Means Subcommittee on Oversight, said the subcommittee will hold t series of hearings [Wednesday] to look at the operations of tax-exempt organizations.  The Ways and Means Committee’s web site states that “[t]he hearing will focus on certain current issues related to tax-exempt organizations, including the current IRS compliance initiative related to Universities, recently enacted reporting requirements for tax-exempt hospitals, recent efforts by tax-exempt organizations to design and implement good governance standards, and taxpayer involvement in redesigning the Form 990.  In addition, the hearing will discuss the history of recent legislative changes to the tax code dealing with tax-exempt organizations and what prompted those changes.”