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Of the estimated 3 million tax-exempt organizations operating in the United States, roughly 1 million operate for charitable or social-welfare purposes (as 501(c)(3) and 501(c)(4) organizations). Although required to file annual Form 990 statements with the IRS, only a fraction of these (c)(3)s and (c)(4)s consistently file on time.

By the close of 2004, ERI had performed OCR (optical character recognition) scans of 245,000 Form 990s along with 84,000 Form 990PFs. Based upon the Form 990 reports that we analyze, we estimate that half of these reports provide meaningful executive compensation data.

Intermediate Sanctions Enforcement

Today 1,100 IRS employees are charged with overseeing the IRS Tax-Exempt Division, which includes Form 990 data. Due to the sheer number of tax-exempt organizations, the audit rate for 501(c)(3) organizations is historically low (0.5%) and even lower for private foundations. Despite the low audit rate, the IRS has begun to increase the number of audits relating to the specific issue of excessive compensation. IRS contact techniques include phone calls, limited-scope audits and full audits. In 2004, the IRS planned to make 11,000 contacts with 501(c)(3)s, of which 2,000 related specifically to excess compensation.

In addition to the IRS efforts, many state attorneys general offices regulate tax-exempt organizations. Specifically, these state regulators target areas such as professional fundraising. Some states take regulation of charities very seriously, with the New York Charities Bureau being the most noteworthy. A staff of 21 full- and part-time attorneys monitor those charities required to register and file annual reports with the Charities Bureau. Contact regarding a tax-exempt organization’s activities may just as likely come from the state level as from the federal.

Why Intermediate Sanctions?

Recent attention has been spurred with the newest IRS weapon, that which addresses executive compensation practices. The IRS can now assess penalties and fines for excess-benefit transactions under IRC § 4958. These penalties are more commonly known as “intermediate sanctions,” as they fall short of revoking the organization's nonprofit status. These intermediate sanctions allow the IRS to regulate charitable and social-welfare organizations in much the same way that the IRS has regulated “self dealing” within private foundations. (See IRC § 4941.)

Rebuttable Presumption of Reasonableness

For compensation purposes, those individuals (the “authorized body”) involved in setting compensation for top positions within charitable and social-welfare organizations can establish a rebuttable presumption of reasonableness regarding the compensation arrangement. (See Treas. Reg. § 53.4958-6(c).) Upon establishing this presumption, the burden shifts to the IRS to rebut by a sufficient amount of evidence contrary to the probative value of the executive compensation data relied on by the tax-exempt organization. (See Treas. Reg. § 53.4958-6(b).)

Corporate Governance

Sound executive compensation practices are far more than a reaction to government forces. ERI finds that intermediate sanctions do not just happen and that these penalties are rarely imposed on diligent nonprofit board members. Oversight of executive compensation for reasonableness must be standard board practice. A thorough and well-thought-out process for evaluating executive compensation is about more than merely establishing a rebuttable presumption. This is basic to each board member's duty of care, a duty that never ceases and must always be satisfied.

Importantly, in order to establish a rebuttable presumption, each member of the authorized body must obtain and rely on comparability data.

The most important steps are often related to the:

  • comparability data obtained and
  • methods undertaken by the board members in analyzing the comparability data

The “bookend” to unreasonable compensation is an inattentive Board of Directors. The burden placed on a Board is to establish procedures and to produce evidence of reasoned decision making.

Further Intermediate Sanctions Guidance

The IRS Code itself provides guidance. The following five examples are quoted word-for-word from Treas. Reg. § 53.4958-6(a)(c)(2)(iv).

Example 1. Z is a university that is an applicable tax-exempt organization for purposes of section 4958. Z is negotiating a new contract with Q, its president, because the old contract will expire at the end of the year. In setting Q’s compensation for its president at $600x per annum, the executive committee of the Board of Trustees relies solely on a national survey of compensation for university presidents that indicates university presidents receive annual compensation in the range of $100x to $700x; this survey does not divide its data by any criteria, such as the number of students served by the institution, annual revenues, academic ranking, or geographic location. Although many members of the executive committee have significant business experience, none of the members has any particular expertise in higher education compensation matters. Given the failure of the survey to provide information specific to universities comparable to Z, and because no other information was presented, the executive committee’s decision with respect to Q’s compensation was not based upon appropriate data as to comparability.

Example 2. The facts are the same as Example 1, except that the national compensation survey divides the data regarding compensation for university presidents into categories based on various university-specific factors, including the size of the institution (in terms of the number of students it serves and the amount of its revenues) and geographic area. The survey data shows that university presidents at comparable institutions in the same geographic area as Z receive annual compensation in the range of $200x to $300x. The executive committee of the Board of Trustees of Z relies on the survey data and its evaluation of Q’s many years of service as a tenured professor and high-ranking university official at Z in setting Q’s compensation at $275x annually. The data relied upon by the executive committee constitutes appropriate data as to comparability.

Example 3. X is a tax-exempt hospital that is an applicable tax-exempt organization for purposes of section 4958. Before renewing the contracts of X’s CEO and CFO, X’s governing board commissioned a customized compensation survey from an independent firm that specializes in consulting on issues related to executive placement and compensation. The survey covered executives with comparable responsibilities at a significant number of taxable and tax-exempt hospitals. The survey data re sorted by a number of different variables, including the size of the hospitals and the nature of the services they provide, the level of experience and specific responsibilities of the executives, and the composition of the annual compensation packages. The board members were provided with the survey results, a detailed written analysis comparing the hospital’s executives to those covered by the survey, and an opportunity to ask questions of a member of the firm that prepared the survey. The survey, as prepared and presented to X’s board, constitutes appropriate data as to comparability.

Example 4. The facts are the same as Example 3, except that one year later, X is negotiating a new contract with its CEO. The governing board of X obtains information indicating that the relevant market conditions have not changed materially, and possesses no other information indicating that the results of the prior year’s survey are no longer valid. Therefore, X may continue to rely on the independent compensation survey prepared for the prior year in setting annual compensation under the new contract.

Example 5. W is a local repertory theater and an applicable tax-exempt organization for purposes of section 4958. W has had annual gross receipts ranging from $400,000 to $800,000 over its past three taxable years. In determining the next year’s compensation for W’s artistic director, the board of directors of W relies on data compiled from a telephone survey of the three other unrelated performing arts organizations of similar size in similar communities. A member of the board drafts a brief written summary of the annual compensation information obtained from this informal survey. The annual compensation information obtained in the telephone survey is appropriate data as to comparability.

Source: Treas. Reg. § 53.4958-6(a)(c)(2)(iv)

All not-for-profit board directors have a duty of care to ensure that they act in an informed manner for the best interest of the organization. Establishing rational, well-thought-out organizational goals relating to executive compensation is far more than a matter of lessening governmental oversight concerns. It is good management practice that should serve the organization well, assist it in achieving its goals and purpose, and provide safety for those managers as well as board members.

For more in-depth analyses of executive compensation at tax-exempt organizations of all sizes, please see ERI’s Nonprofit Comparables Assessor™ software. This software reports data from the largest executive compensation survey ever conducted of tax-exempt organizations. Determine competitive and reasonable cash compensation levels for directors and other executives at 501(c)(3) organizations. Review the financial and executive pay histories of comparables of your choosing.

Note: ERI endeavors to update its database and to provide analysis of the most recent Form 990 data possible. However, ERI can only update its Form 990 data as fast as it can receive the contracted-for DVDs from the IRS. For example, in FY 2003, 542,759 organizations filed Form 990 and Form 990EZs. Roughly 100,000 filed in May, 60,000 in August and 90,000 in November. The reason for this is likely that 60,000 tax-exempt organizations took the automatic three-month filing extension and 90,000 took the automatic extension plus the additional for-cause extension amounting to a delay of six months in filing. It then takes time for the IRS to capture this data on “tif’s,” create the DVDs, and send them to ERI for our OCR reading. Consequently, ERI’s database will always report data that is at least 1+ years old.

Executive Compensation at For-Profit Organizations

Importantly, analyses of reasonable compensation in the tax-exempt world can take into account compensation paid in the taxable organizations. (See Treas. Reg. § 53.4958-4(b)(1)(ii).)

For analyses of executive compensation at for-profit organizations, please see:

ERI’s Executive Compensation Assessor® software provides consensus salary survey data for 500+ executive jobs at both public and private organizations. Executive compensation data may be adjusted for geographic area, industry, organization size, pay strategy, and compensation valuation or planning date. This one-of-a-kind interactive software is relied upon by Compensation Committees across the United States to ascertain competitive salary levels that meet the requirements of reasonable executive pay packages.


ERI Economic Research Institute is a leader in compensation information, providing salary survey and cost-of-living research reports and software used by thousands of subscribers to set pay for more than 10 million employees.

ERI's nonprofit executive compensation site provides executive compensation information on: intermediate sanctions, IRS rebuttable presumption of innocence, factors in determining nonprofit executive compensation, nonprofit organizations, nonprofit organizations executive compensation, nonprofit executive compensation, nonprofit organizations executive compensation survey data, nonprofit organization maximum reasonable compensation, IRS intermediate sanctions, nonprofits reasonable executive compensation, tax exempt organizations unreasonable compensation, nonprofits reasonable compensation, and tax-exempt executive compensation for nonprofits.