Nonprofit Report - Winter 2006
What Does the Legislative Horizon Hold for Tax-Exempt Entities?
By: Eric A. Vendt, Esq.
In response to numerous press accounts detailing perceived abuses in the tax-exempt industry, both the Senate Finance and House Ways and Means Committees held hearings last Spring aimed at introducing possible reform legislation in the tax-exempt area.
In this pursuit, the Finance Committee encouraged industry organizations to form a panel to make suggestions concerning reform legislation. That panel, known as the Panel on the Nonprofit Sector, was created in October of 2004 and is a D.C. based coalition of about 400 charities, foundations and corporate giving programs. The Panel made an interim report to the Senate Finance Committee on March 1, 2005, with a series of recommendations and released its final 112-page report on June 22 and a supplemental report on September 26, 2005.
Among the highlights of these reports were the following recommendations:
- Federal and State Enforcement. Increase the resources available to the IRS for overall tax enforcement and implement a Federal program to help states establish or increase oversight of charitable
organizations. Eliminate statutory barriers to the sharing of information between Federal and State officials concerning on-going investigations of charitable entities. - Annual Audit. Require that all organizations with annual revenues equal to or greater than $1,000,000 obtain an audit, and all organizations with annual revenue between $250,000 and $1,000,000 have their financial statements reviewed by an independent account.
- Suspension of Status. The IRS should suspend the tax-exempt status of organizations that file inaccurate or incomplete Form 990s for two straight years.
- Supporting Organizations. Require supporting organizations to disclose their "type" - Type I, II, or II - on their Form 990. Also, Type III organizations would be prohibited from supporting more than five entities or from supporting any organization controlled by a donor or related parties.
- Board of Directors. Require public charities to have at least three members on their governing boards; also for public charities require at least one-third of their directors to be independent.
- Executive Compensation. Require organizations that compensate board members to disclose the amount of and reasons for compensation, as well as the method used to determine reasonableness. Amend the "self-dealing" and "intermediate sanction" regulations to clarify that authorization or approval of a compensation package by a state or local legislature or agency body or court does not determine whether such compensation is or is not excessive. Require that the compensation of institutional and individual trustees should be separately identified on a charitable organization's annual Form 990 return.
- Non-Cash Contributions. Strengthen the rules for appraisals taxpayers can use to substantiate deductions of non-cash property, and increase penalties on taxpayers who claim excessive deductions and on appraisers who knowingly provide overstated appraisals.
- Travel Expenses. Encourage organizations that pay for or reimburse travel expenses of board members, officers, employees, consultants, volunteers or others traveling to conduct business for the organization to establish and enforce policies that provide clear guidance on their travel rules, including the types of expenses that can be reimbursed and the documentation required to receive reimbursement.
- Conflict of Interest and Misconduct. Charitable organizations should adopt and enforce a conflict of interest policy and the Form 990 should require disclosure as to whether or not such a policy has been adopted. Charitable organizations should also adopt policies and procedures that encourage and protect individuals who come forward with credible information on illegal practices or violations of adopted policies of the organization.
These are just some of the possible reform issues that will be addressed in future legislation. However, the Panel's recommendations are only one of several proposals under consideration. At the beginning of the year, it seemed that charitable reform legislation was imminent. Almost a year later, in the wake of Hurricanes Katrina and Rita, this no longer seems to be a certainty.
Executive Compensation
Avoiding Excise Taxes on Deferred Compensation
By: Mary Claire Chesshire, Esq.
Many executives of non-profit organizations benefit under deferred compensation plans. These arrangements are seen as integral to attracting and retaining talent at the top tiers of a non-profit organization.
In an effort to curb abuses of deferred compensation plans (read: Enron, where the executives were able to cash in on the arrangements to the detriment of employees and bona fide creditors), Congress amended the Internal Revenue Code to add a layer of requirements for these types of arrangements and a biting 20% excise tax imposed on the executive for failure to comply with the requirements.
Congress cast a wide net by setting forth a broad definition of what constitutes a deferred compensation arrangement and carving out exceptions to that definition. Deferred compensation plans that meet certain requirements for limitations on employee deferrals and distribution requirements (sometimes referred to as "eligible 457(b) plans") are exempt from the new requirements. In addition, bona fide vacation, sick leave and severance plans are exempt. Finally, arrangements for compensation that is paid within 2-1/2 months after the executive becomes entitled to receive it are exempt from the new rules.
Therefore, the impact of the new rules will be felt mostly by executives covered by deferred compensation agreements that do not meet the requirement of eligible 457(b) plans. Typically, these arrangements provide for the accumulation of an account balance payable to the executive upon death or termination of employment with the organization after a specified number of years. Because the Internal Revenue Code requires that the executive be taxed on the amounts once he or she has an unfettered right to receive them, the executive usually is not vested in the benefit until a point when the executive is no longer employed by the organization.
The new rules most notably impact two areas of operation of deferred compensation plans:
- Election and Timing and Form of Distribution - Restrictions on Distributions
Elections to defer pay must be made before the end of the year before the year in which pay is deferred. At the time of the deferral of pay, whether by the employer or the employee, an election must be made as to the date the deferred compensation will be paid and the form in which it will be paid, be it a lump sum, installment payments, or another form. The new rules limit the events that allow for distribution to death, disability, termination of employment, or upon a fixed time or schedule. An executive who can elect to receive payment at any time will be immediately taxed on the amounts deferred and, usually, will be subject to a 20% excise tax. - Changing Elections - Deferring Vesting
Before 2005, many executives routinely extended the vesting of their benefits under deferred compensation to avoid immediate taxation on the amounts deferred. Usually, the extension of the vesting coordinated with an extension of the executive's contract. Now, if an executive wishes to defer vesting to avoid immediate taxation on amounts deferred, or to delay the receipt of payment, the election may still be made, but is subject to restrictions. Specifically, the election must be made at least 12 months before the date of payment or vesting and the extension of payment or vesting must be for at least five years
beyond the original payment or vesting date. Managers and executives are cautioned to review existing
deferred compensation arrangements - including provisions in employment agreements that result in a deferral of compensation - to ensure that changes are not required to address the new requirements.