Continuing my discussion of recommended policies – the final policy asked about on the Form 990: Compensation Policy. As with the other policies previously discussed (conflict of interest policy, document retention policy, and whistleblower policy), the organization cannot answer “yes” to questions as to whether they have such a policy unless it meets the requirements as laid out in the instructions to the Form 990. Also like the other policies --- the main reason you should have one is that it is a best practice for governance (assuming you have employees).
What do the instructions say?
**note that bolded terms are terms defined in the glossary to the instructions of the 2011 Form 990**
“if, during the tax year, organization 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.
- Review and approval by a governing body or compensation committee, provided that persons with a conflict of interest regarding the compensation arrangement at issue were not involved. For purposes of this question, a member of the governing body or compensation committee has a conflict interest regarding a compensation arrangement if any of the following circumstances apply.
1. The member (or a family member of the member) is participating in or economically benefiting from the compensation arrangement.
2. The member is in an employment relationship subject to the direction or control of any person participating in or economically benefiting from the compensation arrangement.
3. The member receives compensation or other payments subject to approval by any person participating in or economically benefiting from the compensation arrangement.
4. The member has a material financial interest affected by the compensation arrangement.
5. The member approves a transaction provided economic benefits to any person participating in the compensation arrangement, who in turn has approved or will approve a transaction providing economic benefits to the member. See Regulations section 53.4958-6(c)(1)(iii).
- Use of data as to comparable compensation for similarly qualified persons in functionally comparable positions at similarly situated organizations.
- Contemporaneous documentation and recordkeeping for deliberations and decisions regarding the compensation arrangement.”
If you can answer yes to the above – then you then have to describe in Schedule O the process used for setting compensation, identify the individuals/offices for which the process was used, and when it was last used for each of those persons/officers.
By having a policy in place that addresses the above requirements, the organization can ensure that it regularly implementing procedures that meet this standard.
Why else is the policy a good idea?
At risk of sounding like a broken record – its good governance, the 990 is public record, and your donors, future employees, and other stakeholders will know if you don’t have a policy.
Additionally, it is worth noting a couple of related concepts in exempt organization tax law that are relevant to the area of compensation:
- All 990 filing organizations are subject to a prohibition on private inurement. This generally means that the organization cannot engage in activities that seem to funnel money towards certain persons in a position of power or influence to the organization, simply by virtue of their relationship to the organization.
- For 501(c)(3) and 501(c)(4) organizations, you want to avoid the occurrence of an excess benefit transaction (see prior post on this topic) and any excise taxes that can arise from same. The policy should incorporate the standards to meet the “rebuttable presumption of reasonableness” for setting executive compensation – essentially a set of procedures that, if followed, put the burden on the IRS to prove that compensation was excessive
So -- if you are paying compensation -- please adopt a compensation policy. A properly drafted policy will not only help you to show the world that you engage in good governance -- but it could help your organization avoid legal troubles down the line.