Compensation and Transactions on the New Form 990
By: Laura Kalick
Q: What are the best practices for associations regarding compensation and transactions with persons who can substantially influence the association?
A: Best practices for these types of arrangements have been influenced by the new Form 990, indicating that an association should establish concrete policies regarding conflicts of interest and the review of compensation and transactions.
The new Form 990 for tax years 2008 and later requires information about an association's compensation review process for the CEO, executive director, key employees, and top management officials. Also, transactions such as grants, loans, and business transactions with "interested persons" (i.e., current or former officers, directors, trustees, key employees, and the five highest compensated employees) are now listed on Schedule L.
Conflict of Interest
In general, conflict-of-interest policies provide that an individual who has a personal interest in a transaction should not make decisions for the association regarding that transaction. In cases such as the determination of an individual's compensation or the rental of property from an individual, that person should not be involved in the decision-making process.
Review of Compensation and Transactions
Additionally, associations should adopt policies for the review of compensation and transactions with officers, directors, trustees, key employees, and those who can substantially influence the organization. The policies should establish that the association pays no more than fair market value for goods or services from the influential persons and should also provide for advance approval by independent persons using comparability data. The decision-making process should be contemporaneously documented and should indicate the individuals responsible for the decision, their independence, and the data relied upon. Documentation by the next meeting or 60 days after the final action by the decision-making body should satisfy this requirement.
In general, compensation includes any amounts paid in consideration for services such as base salary, bonuses or incentives, other reportable compensation, nontaxable benefits, and deferred compensation. Compensation would also include amounts paid for personal expenses such as most spousal travel and personal use of employer-provided automobiles and cell phones.
Penalties and Protections
Congress enacted intermediate sanctions to be imposed on 501(c)(3) and 501(c)(4) organizations (other than private foundations) that enter into excess-benefit transactions—those at other than fair market value—with disqualified persons (i.e., officers, directors, and others who can exercise substantial influence over an organization). Penalties are significant and can target the disqualified persons involved in the transaction and organization managers who knowingly and willingly approve such a transaction.
A 501(c)(3) or 501(c)(4) organization can establish the "rebuttable presumption of reasonableness" that would shift the burden of proof to the IRS to show that compensation is not reasonable if the organization were audited. This protection is written in the law, and all 501(c)(3) and 501(c)(4) organizations should consider establishing it, especially given that the new Form 990 asks all organizations if the compensation review policy includes the elements of this safeguard.
Fair Market Value
Fair market value is the price at which property or the right to use it would change hands between a willing buyer and a willing seller, neither being under any compulsion and both having reasonable knowledge of relevant facts. Similarly, reasonable compensation is the value of services that would ordinarily be paid for like services by like enterprises (whether taxable or tax-exempt) under like circumstances. Independent compensation surveys are typically used to gather data on establishing fair market value. Like circumstances include consideration of the geographic area. Written offers for the person's services from similar organizations are also relevant.
In the case of transactions such as sales, exchanges, leases, loans, and so forth with interested persons, associations should also consider review procedures that include a review of comparables. Comparability data would include current independent appraisals and offers received as part of an open and competitive bidding process.
Contemporaneous documentation of the approval is key and should include the terms of the transaction and date approved, the individuals who approved the transaction, the comparability data and how it was obtained, how conflicts of interest were dealt with, and the basis of decisions to enter into transactions where the compensation varied from
In conclusion, the new Form 990 has raised the bar on best practices for all associations, and they should consider the adoption of policies for conflicts of interest and compensation and transaction review.
Laura Kalick is director of nonprofit tax consulting at BDO Seidman, LLP, in Bethesda, Maryland. Email: firstname.lastname@example.org