Private Benefit and Nonprofit Executive Compensation

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We hope to have several segments which address Tax-Exempt Compliance with applicable IRS regulations and the Internal Revenue Code.

A 501(c )(3) public charity receives tax exempt status upon demonstrating that it is organized and operates for a public purpose under 501(c )(3) of the Internal Revenue Code.  To maintain tax exemption, tax-exempt organizations must follow all laws and regulations pertaining to tax-exempt organizations.  The law provides that engaging in certain activities will jeopardize a nonprofit organization’s tax exemption.  The focus of this article is on a salient issue concerning executive compensation.  Can a nonprofit organization lose its tax-exempt status due to unreasonable compensation?  The answer is yes.

Briefly, the law provides that no part of a tax-exempt organization’s net earnings may inure to the benefit of an insider. An insider is a person who has a personal or private interest in the activities of the organization such as an officer, director, or a key employee.  The key here is net earnings of the organization privately benefited a key employee of the nonprofit organization.  Authorizing key employees, such as an Executive Director, Chief Executive or other key officers, to receive unreasonable compensation put the nonprofit’s tax-exemption at risk.  In other words, if compensation is given to any officer, director or key employee it must be reasonable or it can be deemed to be a private inurement jeopardizing the organizations 501(c )(3) status.  What is reasonable compensation depends of the totality of the circumstances.  Comparability data is one means of substantiating the reasonableness of executive compensation.  However, there are caveats with respect to its use, such as whether the data provides an accurate comparison.  The Exempt Organization section of the IRS has two useful articles on its Website on nonprofit compensation.  If you have difficulty finding them, you can e-mail us at info@scottpractice.com and will be happy to assist you.

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