Regulators Eye Nonprofit Salaries

With memories of executive-compensation abuses at Enron and Tyco lingering, the salaries of nonprofit executives have come under scrutiny. According to Paul R. Dorf, managing director of compensation-consulting firm Compensation Resources in Upper Saddle River, the Internal Revenue Service wants to prevent such ills from spreading into the nonprofit sector.

“There’s been so much in the media about excessive executive compensation and that it’s the root of all evil,” says Dorf. “Companies like Enron have done a tremendous job of focusing discontent on that.”

Meanwhile, the IRS has positioned itself to deal with the concerns. In 2004, IRS Commissioner Mark Everson stated in a hearing before the Senate Finance Committee that his agency had been lax in scrutinizing nonprofits and would examine the returns of about 400 organizations.

The tax agency has also been ramping up its staff to conduct audits of nonprofits. According to the IRS, employee levels at the exempt-organizations office, which monitors nonprofits, grew from 758 in 2004, 839 in 2005 and to 904 this year. Audits performed by the IRS have fluctuated in frequency from 5,800 audits in 2004, down to 4,953 audits in 2005. The agency expects to perform 6,000 audits by year’s end.

And the pickings are ripe. The number of tax-exempt organizations, including nonprofits, that file tax returns is on the rise. According to the IRS, 620,241 such groups filed tax returns in 2004. While the number dipped to 617,718 in 2005, the IRS expects 648,6000 such organizations to file returns for 2006.

Among well-publicized cases of lavish nonprofit salaries, Dr. Bernadine Healy, former CEO of the American Red Cross, pulled down $1.9 million in 2002; that included a $352,000 salary for six months of work plus a $1.6 million severance package.

Yet while the looting of charitable groups’ coffers is not unheard of, most cases that have come to light tend to lack the notoriety of for-profit abuses that led to creation the Sarbanes-Oxley Act. Managers of nonprofits generally receive less opulent salaries than do the chiefs of major businesses, and lack access to stock options.
Before the bursting of the Internet bubble, all eyes were on rising corporate valuations and not on the hands in the corporate cookie jar. Once the behind-the-scenes shenanigans were revealed, attention turned to the managers of organizations with sizable assets.

The government is within its rights to closely examine how executives at nonprofits are compensated for their efforts, says David G. Samuels, partner with law firm Duval & Stachenfeld in New York City and co-author of “Nonprofit Compensation, Benefits and Employment Law.” He sees such scrutiny as a reasonable expression of the law.

“Because charitable organizations get special tax status and contributions to charitable organizations can be tax deductible, the government plays an active role in a way they do not play with for-profits in overseeing the reasonableness of compensation,” says Stachenfeld.

“Because these are dollars which are donated for charitable purposes and there are tax breaks, the government feels, consistent with the law, that they can look at the compensation and take action if they feel it’s unreasonable,” Samuels says.

Charitable status not only invites IRS interest but opens the door to harsher penalties than those meted out for comparable infractions in the for-profit universe. Dorf says under Sarbanes-Oxley executives merely have to repay executive compensation to a company.

“The rules for nonprofits work differently,” he says. IRS rules call for nonprofit executives to be fined 25 percent of the alleged excess compensation and required to pay it back within 30 days. “If it is not disgorged within 60 days, the fine automatically jumps to a cumulative 200 percent [of the alleged excess compensation].”

While the punishments are more severe on the nonprofit side, Dorf says the salaries tend to be much lower there, too. “We were looking at three high-level positions in not-for-profit versus the same positions in a for-profit organization,” says Dorf. “If you are working at a not-for-profit, you are going to be paid 50 percent to 70 percent less than you would be if you are working in a for-profit organization.”
Dorf says there are usually five elements to executive compensation: salary; annual incentives or bonuses; long-term incentives; perks and supplemental executive retirement programs and change-of-control agreements. “It’s the total value of the package that becomes so important,” he says.

Samuels says watchdogs must base their assessments of compensation on the going market rates for the talent and expertise required in any position. “In other words, a charitable executive’s compensation cannot be assessed for reasonableness in isolation,” he says. “We have to look at what is being paid in the marketplace at comparable organizations.”

The heightened attention to nonprofits is making board members and executives more careful about ensuring that their practices are in line, but is unlikely to drive them from the sector. Samuels sees most these executives as honest brokers lending their energies to good causes.

“In my experience, the people I work with are not looking to abuse it, so they are not going to leave the nonprofit sector just because it’s being scrutinized,” he says. “They’re going to make sure they do things right.”

Dorf agrees that executives who are motivated by an organization’s mission will take closer examination in stride. “I think that as people start out in an early position, say right out of college, they decide to stay [in the nonprofit sector] because they believe in something,” he says.