Compensation planning is obviously a multiple step process even though nonprofit organizations have a tendency to either combine some of the steps or skip a few steps. Last week we discussed creating the umbrella of reasonable compensation for an employee. This week we are expanding on this step by reviewing the reasons why determining reasonable compensation is important to organizations.
The World of Excess Benefit Transactions and Intermediate Sanctions
Nonprofit organizations as a general rule are prohibited from participating in transactions that are deemed to be excess benefit transactions. These are transactions that involve disqualified persons and the provision of benefits in excess of what the organization receives in return for the benefit. In the mode of compensation, an organization is not allowed to pay more compensation than is reasonable for the services provided by the employee. Any compensation paid above reasonable compensation or above the "umbrella" to a disqualified person is considered to be an excess benefit transaction.
Disqualified Persons
Disqualified persons are generally officers, directors, trustees and key employees of an organization. In addition, the term also includes the family members of any of these individuals. I often tell my classes that this group is generally the movers, shakers & decision makers of the organization and their families.
It is important that this group of people be identified in order that the organization can properly handle any transaction related to a member of this group. Compensation is one of those areas that requires special attention for this group.
Excess Benefit Transactions & Intermediate Sanctions
As described above, payment of unreasonable compensation creates an excess benefit transaction for a disqualified person. Excess benefit transactions are subject to a set of penalties called intermediate sanctions. These sanctions are assessed to the recipient of the excess benefit and to anyone who agreed to the transaction giving rise to the excess benefit.
If an excess benefit occurs, the following are the consequences:
1. The benefit is required to be repaid to the organization; and
2. The disqualified person is required to pay a penalty or tax to the IRS of 25% of the amount of the benefit.
If the IRS discovers the transaction and it is not corrected before they discover the transaction, additional penalties may be assessed to the disqualified person equaling 200% of the benefit.
If someone else within the organization agrees to the transaction giving rise to the excess benefit transaction, they can be assessed a penalty of 10%. This includes such persons as other officers, directors, and trustees.
Excess Benefit Transactions & Inurement of Benefit
Nonprofit organizations are prohibited from entering into transactions that create inurement of benefit to control parties, i.e., disqualified persons. The Internal Revenue Code indicates that the mere existence of inurement of benefit is grounds for revocation of the organization's exempt status. Virtually all excess benefit transactions create inurement of benefit. Therefore, if an excess benefit transaction occurs, the IRS has grounds to revoke the tax exempt status of the organization. Normally the IRS will utilize the above described sanctions to punish the guilty insider and not revoke unless the activity is egregious. However, the law allows the IRS to both revoke the tax exempt status of the organization as well as assess the penalties described above to the disqualified person.
Conclusion
Defining the "umbrella" of reasonable compensation is critical to avoiding the creation of excess benefit transactions and the related consequences of such transactions as well as being vital to protecting the tax exempt status of the organization.
Wednesday, February 29, 2012
Wednesday, February 22, 2012
Compensation Planning - Part 2 of ?
As we continue our journey of taking an in-depth look at compensation, we will look this week at Step 2 - Defining the Umbrella.
One of my mentors who is a teacher and pastor once taught me that people retain concepts that are associated with pictures. I try to incorporate this philosophy into my technical training since technical topics tend to be "uninteresting" and sometimes downright boring. Keeping in line with this teaching technique, I created the idea of the compensation umbrella. The compensation umbrella is the amount of reasonable compensation that may be paid to an employee. In other words, it is the maximum amount that may be paid to an employee. It does not have to be paid, but it is the measuring stick used to determine the maximum that can be paid.
Defining the umbrella or the amount of reasonable compensation that may be paid should be accomplished using outside data compiled from an independent source.
These include salary surveys from organizations such as the National Association of Church Business Administrators and using independent compensation experts. These are people specifically trained in the arena of compensation and human resources and have practiced in this area for many years. (The IRS and some states' attorney general offices have declared that this does not include certified public accountants or attorneys unless compensation and human resources is their area of specific practice. In addition to a lack of qualifications, most attorneys and CPAs are not independent to the person whose compensation is being evaluated.) Additionally, smaller organizations, i.e., less than $1,000,000 in revenue may accumulate information from like size and like minded organizations.
After gaining data from outside sources, the data should be reviewed through the lens of the operations of the organization. To this end, the organization would want to consider the following factors:
The above steps only create the umbrella of reasonable compensation. The organization is not bound to pay this amount. However, if it pays more than this amount then the employee and the decision makers may be subject to penalties and the organization's exempt status could be jeopardized. This subject will be discussed in next week's post.
One of my mentors who is a teacher and pastor once taught me that people retain concepts that are associated with pictures. I try to incorporate this philosophy into my technical training since technical topics tend to be "uninteresting" and sometimes downright boring. Keeping in line with this teaching technique, I created the idea of the compensation umbrella. The compensation umbrella is the amount of reasonable compensation that may be paid to an employee. In other words, it is the maximum amount that may be paid to an employee. It does not have to be paid, but it is the measuring stick used to determine the maximum that can be paid.
Defining the umbrella or the amount of reasonable compensation that may be paid should be accomplished using outside data compiled from an independent source.
These include salary surveys from organizations such as the National Association of Church Business Administrators and using independent compensation experts. These are people specifically trained in the arena of compensation and human resources and have practiced in this area for many years. (The IRS and some states' attorney general offices have declared that this does not include certified public accountants or attorneys unless compensation and human resources is their area of specific practice. In addition to a lack of qualifications, most attorneys and CPAs are not independent to the person whose compensation is being evaluated.) Additionally, smaller organizations, i.e., less than $1,000,000 in revenue may accumulate information from like size and like minded organizations.
After gaining data from outside sources, the data should be reviewed through the lens of the operations of the organization. To this end, the organization would want to consider the following factors:
- The employee/minister's qualifications
- The nature and scope of the employment arrangement
- The size and complexity of the organization
- The prevailing economic conditions of the area
- The organization's overall salary philosophy
- The financial condition of the church
The above steps only create the umbrella of reasonable compensation. The organization is not bound to pay this amount. However, if it pays more than this amount then the employee and the decision makers may be subject to penalties and the organization's exempt status could be jeopardized. This subject will be discussed in next week's post.
Tuesday, February 14, 2012
Compensation - The Ins & Outs - Part 1 of ?
Reason for the Series
One of the most common areas that I speak on across the country is regarding the area of compensation. As a general rule, it seems that nonprofit organizations struggle with the intricacies of the rules regarding the payment of compensation and even the definition of what is compensation. Therefore, I have decided to start a multiple part blog series on this subject as a means of offering some much needed guidance. I plan to post once a week. I don't know how many weeks it will take, so join in for the next few weeks to brush up on your knowledge in this area and maybe learn a few new things along the way.
Compensation & the Overriding Philosophy of Tax Law
Perhaps the first stumbling block or hurdle to overcome in this area is to finally acknowledge how vast an array of information this topic covers. I generally find that the normal person does not realize one of the foundational truths of the U.S. tax code. This truth is based on two premises:
One of the most common areas that I speak on across the country is regarding the area of compensation. As a general rule, it seems that nonprofit organizations struggle with the intricacies of the rules regarding the payment of compensation and even the definition of what is compensation. Therefore, I have decided to start a multiple part blog series on this subject as a means of offering some much needed guidance. I plan to post once a week. I don't know how many weeks it will take, so join in for the next few weeks to brush up on your knowledge in this area and maybe learn a few new things along the way.
Compensation & the Overriding Philosophy of Tax Law
Perhaps the first stumbling block or hurdle to overcome in this area is to finally acknowledge how vast an array of information this topic covers. I generally find that the normal person does not realize one of the foundational truths of the U.S. tax code. This truth is based on two premises:
- Everything that benefits an employee is a form of compensation and
- Everything is taxable until the Internal Revenue Code says its not.
In general, it seems that the natural human response or thought process goes something like this:
- Compensation is what is reported on my paycheck stub and
- Nothing is taxable until somebody proves to me it is (or with my clients, until Elaine tells me it is.)
Needless to say, it is necessary for an organization to first come to a realization that compensation has a more far reaching definition than may have previously been considered and that taxation should be the assumed consequence of any benefit until otherwise proven. This is critical because there are very specific rules that apply to nonprofits, including religious organizations and churches. A deviation from these rules can be costly to the organization and the employee.
With this as the basis for the series, we will start to work through a 10 Step process for defining and dealing with compensation within a nonprofit organization. Next week - Step #1 - Who Gets to Decide on Compensation.
Update of the Driscolls' Two Houses
On February 8th, the 11th Circuit Court of Appeals slammed the door on the ability to use housing allowances for multiple homes. In a short but definitive ruling, the court states, in essence, that "a" means "one" and that it should not be construed to be able to mean "more than one". The court relies on the consistent use of the term "home" as holding a singular connotation within the statute. Therefore, if a minister was planning on utilizing his or her housing allowance for more than one "home", it is time to make the appropriate adjustments to the 2012 tax estimates.
Thursday, October 20, 2011
Relief From the IRS for Misclassified Workers
In Notice 2011-95 issued on September 21, 2011, the IRS announced a new voluntary compliance program focused on assisting employers in the proper classification of its workers. The new settlement program provides a hugh financial relief for those employers who have improperly classified certain workers as independent contractors that should be classified as employees.
The Issue
It is all too common that employers classify workers as independent contractors that should be treated as employees. There are many reasons this occurs, but some of the most common that I hear include:
The Issue
It is all too common that employers classify workers as independent contractors that should be treated as employees. There are many reasons this occurs, but some of the most common that I hear include:
- The employer is just hiring the worker on a trial basis
- The worker is only going to be working on an infrequent basis
- The worker is only going to be working on a one time occurence
- The worker is going to be paid a flat fee
- The worker wants to be treated as an independent contractor
- It is too expensive to treat a worker as an employee
Unfortunately none of the above excuses are valid. Relying on such excuses, an employer can end up in the expensive situation of having to pay back payroll taxes when the IRS or a state authority steps into the picture. Even voluntarily correction of a workers classification can be so expensive the an employer prefers to continue on an incorrect path rather than make the necessary corrections.
IRS Provides An Out
The new program announced by the IRS will allow an employer to properly classify a worker as an employee on a prospective basis for a very small payment. Employers are eligible to enter the compliance program if they:
- Consistently have treated the workers in the past as nonemployees;
- Have filed all required Forms 1099 for the workers for the previous three years;
- Are not currently under audit by the IRS; and
- Are not currenlty under audit by the Department of Labor or a state agency.
An employer can apply for the program by filing Form 8952 at least 60 days before they want to begin treating the workers as employees. For example, if an employer would like to begin treating certain workers as employees as of the beginning of 2012, then it must file the Form 8952 by November 2, 2011.
The form includes a calculation that assesses the amount due on the reclassification. The amount is based on the wages paid during the most recently completed tax year and it is the equivalent of approximately 1.3% of the wages paid. This is a substantial savings over the options that exist outside of this program.
Application of Program for Churches and Other Nonprofit Organizations
One of the greatest liabilities for a church or a nonprofit is errors in the area of payroll. While not all of them center around worker classification, it is one of the most common errors. Churches and nonprofits often make incorrect decisions in this area due to relying on what another church/nonprofit or by relying on what they believe should be the correct classification. The fact is that the definition of an employee is very broad and encompassses most workers in nonprofits other than outside consultants or workers that are clearly operating a business that is available to general public. Some of the most common workers that are misclassified include:
- Nursery workers
- Musicians
- Maintenance workers
- Other workers that work either part time or on an irregular schedule
Action Required
This program is a definite consideration for all churches/organizations that have a worker classification issue. All organizations should take the time to review the workers currently classified as independent contractors to determine if that classification is correct. It may be necessary to engage a professional to assist with the proper classification of a worker. If this review discloses workers that should be classified as employees, then an organization should consider filing Form 8952 to take advantage of this program. Employers that are accepted into this program will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special 6 year statute of limitations, rather than the usual three years than generally applies to payroll taxes.
Monday, October 3, 2011
IRS Offers Relief For Cell Phones
Previously I posted the update regarding the change in cell phone classification in regards to the strict documentation procedures that had been required to justify business use of the cell phone. However, despite the relief given, we were still a little in the dark about the position of the IRS in regards to employer provided cell phones and employer reimbursements for the use of personal cell phones.
The Guidance
Recently the IRS issued Notice 2011-72 granting an early Christmas present to all of us. The notice walks through the same analysis as offered in my previous blog, but it goes one step further. In the notice, the IRS stated that if an employer can determine that it has a bona fide business reason for issuing an employee a cell phone and the cell phone is not considered to be compensation for the employee's services, then it will deem that all the documentation standards of IRC Sec. 132 to qualify the benefit as a "working condition" fringe benefit will have been met and any personal use will be deemed to be a "de minimis" fringe benefit.
While the above notice does not address reimbursements to an employee for the use of their personal cell phone, the IRS issued a memorandum to their field examiners on Septemeber 14, 2011 extending similar logic to reimbursements. The example provided in the guidance allowed the tax free reimbursement of an employee's flat rate plan where the employer deemed that there was a business reason for the employee to have a cell phone.
The Gift
Having documentation "deemed" to be met is the gift from the IRS. Normally, a business would have to maintain documentation to show that the business useage was the predominant use of the phone. With this documentation burden relieved, the employer must only document the business reasons why an employee is required to have the phone. Providing the phone as a part of the employee's compensation package will disqualify this as a tax free benefit. Therefore, I recommend that it not be included in the employee's employment offer as a part of his package.
The Action
Since we are now down to one documentation step, I urge you to not skip this step. When documenting the arrangement with the employee, fully state why it is important that an employee have the cell phone. One word of caution, if the reason is so that the employer can communicate with that employee at any time, you could create a wage and hour issue with nonexempt employees. Remember, if you put them on call, you may have to pay them.
The Guidance
Recently the IRS issued Notice 2011-72 granting an early Christmas present to all of us. The notice walks through the same analysis as offered in my previous blog, but it goes one step further. In the notice, the IRS stated that if an employer can determine that it has a bona fide business reason for issuing an employee a cell phone and the cell phone is not considered to be compensation for the employee's services, then it will deem that all the documentation standards of IRC Sec. 132 to qualify the benefit as a "working condition" fringe benefit will have been met and any personal use will be deemed to be a "de minimis" fringe benefit.
While the above notice does not address reimbursements to an employee for the use of their personal cell phone, the IRS issued a memorandum to their field examiners on Septemeber 14, 2011 extending similar logic to reimbursements. The example provided in the guidance allowed the tax free reimbursement of an employee's flat rate plan where the employer deemed that there was a business reason for the employee to have a cell phone.
The Gift
Having documentation "deemed" to be met is the gift from the IRS. Normally, a business would have to maintain documentation to show that the business useage was the predominant use of the phone. With this documentation burden relieved, the employer must only document the business reasons why an employee is required to have the phone. Providing the phone as a part of the employee's compensation package will disqualify this as a tax free benefit. Therefore, I recommend that it not be included in the employee's employment offer as a part of his package.
The Action
Since we are now down to one documentation step, I urge you to not skip this step. When documenting the arrangement with the employee, fully state why it is important that an employee have the cell phone. One word of caution, if the reason is so that the employer can communicate with that employee at any time, you could create a wage and hour issue with nonexempt employees. Remember, if you put them on call, you may have to pay them.
Thursday, July 7, 2011
Consequences of Participant Designated Accounts
One subject that continually makes its way into practically every speech I deliver has to do with the tax consequences of maintaining participant designated accounts for fundraising activities. I have been speaking about this particular subject for approximately 4 years as the IRS has continued to get more and more serious about the ramifications of maintaining these types of accounts.
Possible Scenario:
Youth group needs money to help pay for camp fees for the students. A local advertiser tells the church that they will pay the church a set amount, if the students will go to a local stadium and place flyers in all the stadium seats prior to the big game on Sunday. The youth minister tells the kids that the funds paid to the church will be designated to the students' camp fees according to how long they assist in putting out the flyers.
Potential Consequences:
Payroll - The students have now been paid for their help in putting out the flyers. Therefore, they have been paid for their personal services. This has been done under the direction of the church staff. Therefore, all the students who have money credited to their camp fees have been compensated for their services and have been turned into employees of the church. Now the church is required to have all of the employment forms completed on the students and pay all the related payroll taxes. This was the result a few years ago with two booster clubs in Kentucky. See the story at http://www.kentucky.com/211/story/485490.html.
Tax Exemption - The IRS has ruled that this type of activity is private benefit to the students. Substantial private benefit to individuals can jeopardize an organizations exempt status. This was the conclusion in PLR 201035034 issued by the IRS last year. In the letter ruling, the IRS revoked the tax exempt status of a booster club due to the fact that practically all of their activities were performed to generate funds directed into participant accounts.
Income Tax - While not automatic, many fundraising activities do not generate unrelated business income due to the exception provided for activities conducted by volunteers. If all the volunteers have been turned into paid employees, this exception is no longer available. Therefore, it is possible that the activity will generate unrelated business income and subject the organization to filing Form 990-T.
Just How Serious????
Responses to this topic have varied from incredulous to skeptical to dismay. With the issuance of the above private letter ruling, it was obvious the IRS was beginning to take this issue to a more public level. Earlier this year I was informed that exempt organization agents were being trained in this specific issue.
On June 27, 2011, the Director of Exempt Organizations, Lois Lerner, issued a directive to the Director of Examinations and the Director of Rulings & Agreements. The directive clearly states that such programs are considered to be private benefit and could result in an organization losing its exempt status and the amounts credited to a participant's account could result in employment taxes. With this directive, the issue will be considered one for review for organizations that are undergoing examinations and/or that are requesting rulings as to their tax exempt status.
Conclusion
While these types of fundraising programs still can provide additional funds for a church, school or other type of organization, the distribution of the funds cannot be connected with the work performed by the person. The funds must be used for the general purposes of the organization or to provide for a reduced cost of an activity for all involved, working or not.
Possible Scenario:
Youth group needs money to help pay for camp fees for the students. A local advertiser tells the church that they will pay the church a set amount, if the students will go to a local stadium and place flyers in all the stadium seats prior to the big game on Sunday. The youth minister tells the kids that the funds paid to the church will be designated to the students' camp fees according to how long they assist in putting out the flyers.
Potential Consequences:
Payroll - The students have now been paid for their help in putting out the flyers. Therefore, they have been paid for their personal services. This has been done under the direction of the church staff. Therefore, all the students who have money credited to their camp fees have been compensated for their services and have been turned into employees of the church. Now the church is required to have all of the employment forms completed on the students and pay all the related payroll taxes. This was the result a few years ago with two booster clubs in Kentucky. See the story at http://www.kentucky.com/211/story/485490.html.
Tax Exemption - The IRS has ruled that this type of activity is private benefit to the students. Substantial private benefit to individuals can jeopardize an organizations exempt status. This was the conclusion in PLR 201035034 issued by the IRS last year. In the letter ruling, the IRS revoked the tax exempt status of a booster club due to the fact that practically all of their activities were performed to generate funds directed into participant accounts.
Income Tax - While not automatic, many fundraising activities do not generate unrelated business income due to the exception provided for activities conducted by volunteers. If all the volunteers have been turned into paid employees, this exception is no longer available. Therefore, it is possible that the activity will generate unrelated business income and subject the organization to filing Form 990-T.
Just How Serious????
Responses to this topic have varied from incredulous to skeptical to dismay. With the issuance of the above private letter ruling, it was obvious the IRS was beginning to take this issue to a more public level. Earlier this year I was informed that exempt organization agents were being trained in this specific issue.
On June 27, 2011, the Director of Exempt Organizations, Lois Lerner, issued a directive to the Director of Examinations and the Director of Rulings & Agreements. The directive clearly states that such programs are considered to be private benefit and could result in an organization losing its exempt status and the amounts credited to a participant's account could result in employment taxes. With this directive, the issue will be considered one for review for organizations that are undergoing examinations and/or that are requesting rulings as to their tax exempt status.
Conclusion
While these types of fundraising programs still can provide additional funds for a church, school or other type of organization, the distribution of the funds cannot be connected with the work performed by the person. The funds must be used for the general purposes of the organization or to provide for a reduced cost of an activity for all involved, working or not.
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