Guidance Released on Taxable Income from Parking and Other Fringe Benefits

By Marc Berger, CPA, JD, LLM

The bill known as the Tax Cuts and Jobs Act, enacted in December 2017, added new Section 512(a)(7) to the Internal Revenue Code (IRC).  This new section requires tax-exempt organizations to increase their unrelated business taxable income (UBTI) by the amount paid or incurred for qualified transportation fringe benefits (QTFs) provided to employees.

For this purpose, QTFs include the provision of parking and mass transit benefits, and taxable income is created whether the employer pays for the benefits directly or allows employees to pay for the benefits on a pretax basis.  Made effective Jan. 1, 2018, mere days after the new law was enacted, many tax-exempt organizations were facing the daunting requirement to calculate, report and pay income tax for the first time.

In December 2018, the Treasury Department provided organizations and their tax advisors with some much-needed guidance on the new law in Notice 2018-99.  As described below, some compliance questions have been answered, and underpayment of estimated tax penalties will be waived for certain organizations.

Notice 2018-99 (the Notice) indicates that the Treasury and the Internal Revenue Service intend to publish proposed regulations under Section 512 on the calculation of the increased UBTI attributable to QTFs, but until such guidance is issued, organizations may use any reasonable method to calculate the increase in UBTI under Section 512(a)(7).  This includes being able to rely on the guidance provided in the Notice.

Guidance on how to determine the amount of parking expenses that should be treated as an increase in UBTI, indicates that the approach is dependent on how the organization provides the benefit.  If the organization pays a third party so that its employees can park at the third party’s garage, for example, then the amount of UBTI is the organization’s total annual cost paid to the third party.  However, to the extent that the amount paid for an employee exceeds the Section 132(a)(2) monthly limitation on exclusion ($260 for 2018), the excess amount must be treated as taxable wage compensation to the employee.  In this situation, the excess over $260 per month will not be treated as additional UBTI under Section 512(a)(7).

If an organization owns or leases all or a portion of one or more parking facilities where its employees park, the amount included as UBTI may be calculated using any reasonable method.  For this purpose, “parking facility” includes indoor and outdoor garages and other structures, as well as parking lots and other areas where employees may park on or near the business premises of the employer, or on or near a location from which the employee commutes to work.  “Parking expenses” include repairs, maintenance, utilities, insurance, taxes, security, snow removal and parking lot attendant expenses, but notably does not include depreciation expenses.  The Notice provides a four-step method which is deemed to be a reasonable method. These steps are:

  1. Reserved Employee Spots

The organization must determine the percentage of reserved employee spots in relation to total parking spots and multiply that percentage by the organization’s total parking expenses for the parking facility.  The resulting amount is included in UBTI.  In addition, the Notice gave organizations the ability, until March 31, 2019, to change their parking arrangements to reduce or eliminate their reserved employee spots and treat those parking spots as not reserved.  Any change made under this provision will apply retroactively to Jan. 1, 2018.

  1. Determine Primary Use of Remaining Spots

If the primary use of the remaining parking spots in the parking facility is to provide parking to the general public, then the remaining parking expenses are not included in UBTI, and you can stop the calculation here.  For this purpose, “primary use” means greater than 50 percent of actual or estimated usage, tested during the normal hours of the organization’s activities on a typical day.  The “general public” includes, but is not limited to, the organization’s visitors, customers, clients, patients, students and congregants.  The organization can use any reasonable method to determine the average actual or estimated use.

  1. Reserved Nonemployee Spots

If the primary use test in the previous step is not met, the organization should identify the number of spots reserved for nonemployees, if any (e.g., reserved for visitors and customers).  Like the calculation in the first step, the organization should determine the percentage of reserved nonemployee spots in relation to the remaining total parking spots and multiply that percentage by the organization’s total parking expenses for the parking facility.  The resulting amount is not included in UBTI.

  1. Remaining Use and Allocable Expenses

If after the completion of steps 1-3 there remain parking expenses not specifically categorized as includible or excludable in UBTI, the organization must reasonably determine the employee use of the remaining parking spots during normal hours on a typical day.

The Notice provides 10 examples applying the methodologies described above to various factual situations, determining the amount of reportable UBTI in each situation.  Tax-exempt organizations with UBTI in excess of $1,000 for the tax year are required to file Form 990-T and to pay federal income tax at the rate of 21 percent on their UBTI.

It should be noted that even though UBTI is increased under Section 512(a)(7), the provision of parking and mass transit benefits is not considered a separate unrelated trade or business for purposes of Section 512(a)(6).  As a result, UBTI reportable under Section 512(a)(7) is calculated in the same “silo” as the income and deductions from an existing unrelated trade or business.  Thus, organizations with a net loss from their one unrelated trade or business can offset their UBTI from Section 512(a)(7).  However, the Notice does not specify whether or how organizations with multiple unrelated trades or businesses can offset their UBTI from Section 512(a)(7).  We hope future guidance will address this issue.

Notice 2018-100, a companion notice, provides relief from estimated tax penalties for 2018 for those tax-exempt organizations that did not pay estimated income tax in connection with their UBTI reportable under Section 512(a)(7).  This relief is available only to organizations that were not required to file Form 990-T for the previous tax year and requires timely compliance with their payment of the tax due for the current tax year.

Finally, the State of New York, which imposes a state unrelated business income tax of 9 percent on UBTI, enacted legislation exempting UBTI reportable under IRC Section 512(a)(7) from the state tax.

These actions by the IRS and the State of New York help tax-exempt organizations comply with the new law, but additional guidance could be forthcoming.  We will continue to monitor the situation as it develops.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

GASB Simplifies Accounting for Capitalized Interest

By Susan Friend, CPA

The Governmental Accounting Standards Board (GASB) Statement No. 89 (Statement), Accounting for Interest Cost Incurred before the End of a Construction Period, which is effective for reporting periods beginning after Dec. 15, 2019, brings a welcome relief to state and local governments by eliminating complex capitalized interest calculations.

Under this Statement, for financial statements prepared using the economic resources measurement focus, interest incurred during construction will be recognized as an expense of the period. This means that interest costs will no longer be included as part of the historical cost of a capital asset. Interest costs on ongoing construction in progress will be capitalized only through the implementation date. Furthermore, the provisions of this Statement are to be applied prospectively and therefore do not require restatement of any prior period balances.

This Statement does not change the treatment of accounting for interest costs incurred before the end of a construction period in financial statements prepared using the current financial resources measurement focus (modified accrual basis) where an expenditure is recorded, or for governmental activities which never required capitalizing interest. With the implementation of this new Statement, capital asset and cost of borrowing information for a reporting period for both governmental activities and business-type activities will be more comparable.

Prior to implementation, state and local governments should determine how additional interest expense that will be recorded will affect bond covenants and their budget. An additional item to note is that this new Statement is a departure from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) standards, both of which require the capitalization of interest. As a result, financial statements of public sector entities and similar privately run entities will not be comparable.

Although accounting is simplified for many organizations, there is an exception for regulated operations and some concerns for component units.
For governments that have regulated operations (as defined by paragraph 476 of GASB Statement No. 62), the requirements of paragraph 485 of GASB Statement No. 62 are not eliminated with this new Statement. What this means is that if a regulator requires your organization to calculate and capitalize construction period interest, you will still be required to capitalize qualifying interest costs as a regulatory asset.

As a best practice, most component units of a primary government adopt new standards in the same fiscal year as the primary government so that the financial statements are presented consistently. It is a good idea for representatives from each component of the reporting entity to meet and discuss planned implementation dates to ensure consistency.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

The Uniform Guidance – Five Years and Counting

By Matt Cromwell, CPA

It has been over six years since Title 2 U.S. Code of Federal Regulations (CFR) Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards, more commonly known as the Uniform Guidance (UG) was released. The date of Dec. 26, 2013, will forever be seen as the day compliance took on a new meaning for recipients of federal funding.

During this time, entities have worked to establish, update and critically review internal policies and procedures to ensure compliance with the Uniform Guidance. From my clients’ perspective, the amount of resources, both time and money, spent on meeting the new requirements has been staggering. Much progress has been made, but there continue to be key areas where we find that entities encounter issues. A few areas in which we continue to see issues and findings are discussed below:

Performance Reporting (UG §200.38) – Although an audit under the Uniform Guidance does not include programmatic data testing, it does focus on the performance reporting process. Entities must maintain adequate systems and controls over the programmatic reporting process. Entities must ensure that program teams: have a full and complete understanding of the reports required, have complied with submission requirements, perform programmatic reviews and present the data on the reports accurately and in compliance with the requirements of the award.

Equipment / Real Property (UG §200.13) – The Uniform Guidance requires that entities comply with requirements related to equipment and real property purchased with federal funds. The UG established specific requirements nonprofits must follow related to equipment additions (utilizing the definition of equipment in UG §200.33) and equipment disposals. In addition, if the entity has purchased equipment with federal funds, it must perform an inventory of federally purchased equipment no less than once every two years. Even if an entity has no federal equipment purchases in the past two years, but still holds material amounts of equipment purchased in the past with federal funds that have not been disposed, the nonprofit must still comply with equipment disposal requirements and perform the required inventory.

Procurement (UG §200.317-§200.326) – An inordinate amount of time has been spent in the area of procurement, including multiple revisions, delays and then additional revisions of the UG during 2018. However, the requirements to clearly and accurately document the rationale for a vendor selection remain and must include: systematic rationale for selection of the vendor; basis for selection of contract type; basis for contractor selection, including rejection reasoning; and finally the basis for price. Each procurement must have each of these four required components clearly documented to substantiate compliance. Another area that continues to pose challenges is the sole sourcing of procurements. UG §200.320 establishes a point of emphasis that has drastically reduced the ability to sole source procurements in all but the following circumstances:

  • the item is only available from one source
  • the public exigency or emergency is such that the delay of competition is deemed reasonable (extremely rare instances and in this case it is strongly encouraged to obtain approval from your oversight agency)
  • express authorization from an agency after a written request from the federal recipient
  • after solicitation of a number of sources, competition is ultimately deemed inadequate

Subrecipient monitoring (UG §200.330 – §200.331) – A few key areas continue to cause overall challenges for entities. The primary areas of emphasis continue to focus on enhanced documentation around monitoring of the subrecipients and related follow-up on any findings or issues. Often times when performing testing, we will see the entity has vast amounts of documents from the subrecipient which address a portion of the monitoring requirement; however, the documentation will often include the latest audit report of the subrecipient which details compliance findings. However, there is no documented evidence of how the entity has increased its scrutiny and monitoring around the compliance findings reported. Additionally, we continue to see that entities are not performing the pre-award assessment as required. There are multiple proscribed steps in the Uniform Guidance on the pre-award assessment that are required to be performed at the time of each award, regardless of how many times you use a subrecipient on other awards.

Mandatory Disclosures (UG §200.113) – This section states “The Non-Federal entity or applicant for a Federal award must disclose, in a timely manner, in writing to the Federal awarding agency or pass-through entity, all violations of Federal criminal law involving fraud, bribery, or gratuity violations potentially affecting the Federal award. Non-Federal entities that have received a Federal award including the term and condition outlined in Appendix XII – Award Term and Condition for Recipient Integrity and Performance Matters are required to report certain civil, criminal, or administrative proceedings to SAM. Failure to make required disclosures can result in any of the remedies described in §200.338 Remedies for noncompliance, including suspension or debarment.” We continue to encounter instances where entities have a multitude of reasons not to disclose this within their own reporting. Unlike OMB Circular A-133, where there were thresholds of reporting such matters, under the Uniform Guidance, that de minimis reporting threshold no longer exists. Oftentimes, entities had historically considered the Form 990 fraud disclosure thresholds as a compass in this area, but clearly the two concepts have diverged with the explicit nature of UG §200.113. Secondarily, the “timely manner” concept is also widely debated. In this case, we strongly encourage timely reporting with clear guidelines from the client’s general counsel.

We have also seen instances where an international nonprofit has notified the local agency mission overseas; however that notification did not reach the appropriate officials at the offices in Washington, D.C. As a result, the entity has been deemed to be in violation of this notification requirement. Entities should inform all parties of any issues subject to UG §200.113 in writing in a timely manner to clearly document the actions they have taken.

One final consideration – We continue to find instances where entities establish internal policies and procedures that are more restrictive than the UG requirements. One example we have seen on many occasions is where an entity establishes a policy that all transactions with any vendor are required to have a suspension and debarment check performed and documented. Per the UG, this is a requirement for certain covered transactions and above certain dollar thresholds. If the entity complies with the UG requirements, it will still have a finding since it did not comply with its internal policy. This applies even if the transaction may not have exceeded the UG thresholds. We strongly encourage entities to review their policies and procedures and consider the UG requirements and determine what is best for them.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

IRS Answers Many Questions on New 21% Executive Compensation Tax

By Norma Sharara, JD and Joan Vines, CPA

On Dec. 31, 2018, the IRS released Notice 2019-09 (the Notice), providing interim guidance regarding Section 4960 of the Internal Revenue Code (the Code) that was enacted on Dec. 22, 2017, by the Tax Cuts and Jobs Act (the Act). The Notice provides the first guidance on new excise taxes that tax-exempt and governmental entities (and their related for-profit entities) may need to pay on the amount of remuneration in excess of $1 million in compensation and any excess parachute payments paid to a covered employee as early as May 15, 2019 (for calendar year entities). Affected organizations must report and pay the tax on recently updated IRS Form 4720.

The 2017 Tax Reform and Jobs Act established new Code Section 4960, effective Jan. 1, 2018, which imposes an excise tax on “excess” executive compensation paid by tax-exempt and certain governmental entities. The excise tax rate is established in Section 11 of the Code and is currently 21 percent. For-profit employers related to such entities may also need to pay their pro rata share of the tax (such as for-profit entities within a tax-exempt hospital or university’s controlled group).

EMPLOYERS PAY THE TAX

The excise tax is the employer’s responsibility — it is not withheld from employee compensation. The 21 percent excise tax applies to employers who pay, after taking into account payments by members of its controlled group:

  • More than $1 million in annual “remuneration”—wages subject to withholding, including 457(f) income but excluding Roth contributions, certain retirement plan contributions and payments, and wages for certain medical services paid to any “covered employee” (five highest compensated employees for the current or any prior year starting with 2017)
  • “Excess parachute payments”—amounts over three times the employee’s five-year average wages that are contingent on an involuntary termination (including a “good reason” termination or non-renewal of an employment agreement), but only if the employee makes over the IRS’ qualified retirement plan limit for “highly compensated employees” during the year (currently $125,000)

EVEN SMALL EMPLOYERS ARE AFFECTED

Notice 2019-09 clarifies that even if an employer never pays anyone more than $1 million per year, it could still owe the tax on excess parachute payments. But employers who do not pay anyone over $125,000 for a year may never have a 4960 tax liability. Nevertheless, employers of all sizes must track “covered employees.”

COVERED EMPLOYEES

Since there is no minimum dollar test to be a “covered employee,” tax-exempt employers who do not have a 4960 tax liability for a year would still need to make a list of covered employees each year. Per the Notice, once someone is a covered employee, he or she is a covered employee forever under 4960, even after termination of employment. Since the definition of “covered employee” is cumulative, the list will likely include more than five individuals over time.

Note that each applicable tax-exempt employer within a controlled group must make a cumulative list of its covered employees for 2017, 2018 and all subsequent years (there isn’t one list for the whole controlled group). The Notice confirms that even though 4960 took effect Jan. 1, 2018, employers need to make a covered employees list starting in 2017, because remuneration paid to those individuals in 2018 or later could trigger the 4960 tax.

REMUNERATION IS A NEW CONCEPT

Section 4960 created its own concept of “remuneration” that is different from any other way that employers calculate annual compensation. To determine 4960 tax liability, employers need to look to when amounts are vested under 457(f)’s special timing rule (not when the amounts are paid). The Notice confirms that this analysis is required even if the amount is not technically subject to 457(f). For example, certain bona fide disability plans are exempt from 457(f)’s special timing rules because they are not treated as deferred compensation. But such amounts would be counted for 4960 tax liability purposes when they are vested (not when they are paid).

The Notice confirms that for 4960 purposes, amounts provided after an involuntary separation are excluded if all of the benefits vested before the separation (since the separation affected only the timing of the payments, not the employee’s right to the payments). But any new increase in value (such as earnings) that accumulate after the vesting would be treated as remuneration subject to 4960 testing. Also, if the termination of employment accelerates vesting, then the value of the acceleration is treated as remuneration for 4960 purposes.

The Notice also clarifies that certain amounts are excluded from “remuneration” entirely, such as wages paid for medical services (which are discussed in detail in the Notice) and amounts paid to independent contractors (such as director’s fees). The Notice also says that certain other amounts are included in “remuneration”—such as payments conditioned on a release of claims, damages for employment agreement breaches, payments under early retirement or other “window” programs, payments for non-compete and non-disclosure or similar agreements.

WHO’S THE EMPLOYER

This Notice makes it clear that “common law” employers of the covered employee owe the 4960 tax. Employers with related entities will need to determine which entity is the common law employer under applicable IRS tests. Employers cannot avoid liability by using payroll agents, common paymasters, professional employer organizations (PEOs), etc.

If a covered employee is also employed by another entity related to the tax-exempt entity, each employer, including taxable entities, is separately liable for its pro rata share of the 4960 tax, regardless of any arrangement between them to bear the cost of the tax liability. So the amount of 4960 tax owed could change if the related entities restructure their employment relationships.

RELATED ORGANIZATIONS

The Notice says that for 4960 purposes, an entity is “related” to an employer if it:

  • controls (or is controlled by) the employer
  • is controlled by one or more persons which control the employer
  • is a “supported” or “supporting” organization with respect to the employer
  • establishes, maintains or contributes to a voluntary employees’ beneficiary association

The Notice defines what “control” means for stock corporations, partnerships, trusts and non-stock organizations. The Notice also explains how to determine the 4960 tax if the entity becomes or ceases to be related to the employer during the calendar year.

In addition, the Notice adopts (for 4960 purposes) the broad definition of “related organization” for annual Form 990 reporting. While using the Form 990 definition reduces burdens when determining 4960 liability, it is likely to cause more tax to be paid than if a more narrow definition was selected.

GOVERNMENTAL EMPLOYERS

Despite much publicity about highly paid public university sports team coaches being subject to the tax on annual remuneration over $1 million, some schools may avoid paying the 4960 tax unless Congress enacts a technical correction. Per the Notice, governmental entities that rely on the doctrine of “implied sovereign immunity” for their tax-exempt status are not subject to 4960. The Notice also clarified that a governmental unit (including a state college or university) that received a favorable IRS determination letter confirming its 501(a) tax-exempt status may voluntarily relinquish that status (which may exempt it from 4960 tax).

HOW TO CALCULATE THE EXCESS PARACHUTE PAYMENT TAX

While calculating the 4960 tax on annual remuneration over $1 million may be fairly straightforward, calculating the tax on excess parachute payments is more complicated.

The Notice sets out six steps for determining the excess parachute tax (which is separate from the $1 million tax). Remember that the tax applies to the excess over one times the base amount (not the excess over three times the base amount).

Generally, a covered employee’s base amount is the average of the employee’s Box 1, Form W-2 annual taxable compensation for services performed as an employee of an applicable tax-exempt organization (ATEO) (and any predecessor entity of the ATEO) or a related entity for the five years prior to the termination year.

Compensation for short taxable years generally must be annualized before determining the five-year average (but a special rule applies to covered employees who have a separation from employment during their initial year of employment). If the covered employee was not employed by the employer for the entire five-year period, use the portion of the five-year period during which the employee performed services for the employer, a predecessor entity or a related entity.

CALENDAR YEAR TAX LIABILITY

The Notice clarifies that 4960 tax will be based on the calendar year ending with or within the employer’s taxable year. For example, assume an employer’s taxable year began on July 1, 2018, and ends on June 30, 2019. The employer may owe 4960 tax on remuneration paid between July 1 and Dec. 31, 2018 (remuneration paid from January 1, 2018 to June 30, 2018 would not be subject to 4960 tax, which gives an initial, first-year advantage to entities that use non-calendar year fiscal years).

To avoid penalties and interest, the employer should remit any tax owed by filing IRS Form 4720 on or before Dec. 15, 2019 (5 1/2 months after its fiscal year end). This approach aligns with employers’ Form W-2 and Form 990 disclosures.

NO TRANSITION RULES

Despite what many had hoped, the IRS declined to provide any 4960 transition rules. The Notice confirms that the Act clearly mandates the Jan. 1, 2018 effective date. So employers should already be complying.

Nevertheless, the Notice may help employers review and revise existing employment, deferred compensation, severance and other agreements or design and implement new arrangements. Employers may also want to consider whether changing existing management service arrangements among related entities may reduce 4960 liability exposure.

IRS intends to propose regulations under 4960, but until further guidance is issued, employers can apply a reasonable, good faith interpretation, which would include taking the Notice into account.

ACCOUNTING CONSIDERATIONS

Booking a contingent tax liability. Before reporting and paying the 4960 tax, employers may need to book a contingent tax liability if they are reasonably certain that they will incur a 4960 excise tax (for example, upon an employee’s termination of employment based on existing employment agreements, deferred compensation agreements, etc.). Adjustments may need to be made ratably over the number of years between 2018 and when the tax is expected to be due. Many tax-exempt organizations may not be accustomed to booking contingent tax liabilities, so this may be uncharted territory for them.

Book/tax difference. The employer may also need to track a book/tax difference due to the timing of when the liability is accrued for financial statement purposes and when the amounts are subject to 4960 excise taxes (i.e., when the amounts are vested).

For further information access the Notice. The Notice has a detailed frequently asked questions section and examples that clarify certain scenarios.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Spring 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Significant Rule Change for Certain Tax Exempt Organizations Reporting Donor Information

By Marc Berger, CPA, JD, LLM

On July 16, 2018, the Internal Revenue Service (IRS) released Revenue Procedure 2018-38, modifying the information reported to the IRS by certain tax-exempt organizations on their annual Form 990 or Form 990-EZ information return. Affected organizations will no longer be required to report the names and addresses of their reportable contributors on Schedule B of their Forms 990 or 990-EZ.

This change affects all organizations that are tax-exempt under Section 501(c), other than charitable organizations described under Section 501(c)(3). This includes labor unions, trade associations, social welfare groups, issue-advocacy groups, local chambers of commerce and veteran groups. Nevertheless, Section 527 political organizations, like charitable organizations, will still be required to report the names and addresses of their reportable contributors on their annual returns.

The reasons provided by the IRS for the change include decreased compliance costs for affected organizations, reduced consumption of IRS resources in connection with the redaction of such information and reduced risk of the inadvertent disclosure of information that’s not open to public inspection.

The tax-exempt organizations relieved of the obligation to report the names and addresses of their contributors must continue to keep this information in their books and records in case the IRS wishes to examine this information. In addition, the change does not affect the reporting of contribution information on Schedule B, other than the names and addresses of contributors, including the dollar amount of contributions.

The revised reporting requirements apply to information returns for tax years ending on or after Dec. 31, 2018. Thus, the revised requirements generally will apply to returns that become due on or after May 15, 2019.

Implications for Nonprofits

Reactions to the new rules from those affected are strong.

Advocates claim it as an important win that supports:

  • Data privacy: While the IRS isn’t allowed to disclose confidential donor information, it has inadvertently done so in the past. Eliminating this information from tax filings will reduce the chances it may be accidentally released or fall into the wrong hands.
  • Free speech: Free-speech advocates believe donor information should be kept private, so that it can’t be used by the government to target donors. For example, the IRS was previously accused of unfairly targeting Tea Party and progressive groups.

Critics express several concerns:

  • Hampers fraud detection: The IRS may not need donor information for tax administration purposes, but it is useful for detecting fraud. The government will now have no means to track how cash is being funneled into these tax-exempt organizations, leaving the door open to potentially dangerous and foreign influences.
  • Reduces fiscal transparency: The move is a major setback for those who champion more transparency around political donations. While donor information was never disclosed to the public, the government will now remain in the dark about how foreign actors might be influencing the political landscape.

Regardless of the new guidance, all tax-exempt organizations should still diligently collect information about their donors to prepare for a potential audit or change of course by the IRS down the road.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Identifying and Overcoming Common Nonprofit Challenges

By Laurie De Armond, CPA, and Adam Cole, CPA

Nonprofit organizations are uniquely shaped by their mission, history, size, program goals and community.

But leaders of these organizations—whether a CFO at a global health services charity, a CIO of an education endowment or the executive director at a museum—share a common goal of advancing their organization’s mission. To drive forward progress, it’s essential that leaders understand where their organization sits in relation to its peers on objective measures of performance.

The BDO Institute for Nonprofit Excellence’s 2018 benchmarking survey, Nonprofit Standards, surveyed leaders at midrange organizations (those with less than $25 million in annual revenue), upper-midrange organizations ($25-$75 million in annual revenue), and large nonprofits (above $75 million in revenue) to reveal insights nonprofits can leverage to strengthen their organization. Across the spectrum, the report finds that upper-midrange organizations face more significant challenges than their smaller and larger peers.

Funding Challenges Amid Rising Costs

While 56 percent of upper-midrange nonprofits saw their revenues grow over the past year, this was dwarfed by the 69 percent of large nonprofits and 70 percent of midrange nonprofits that also saw some revenue growth. At the same time, nearly half (49 percent) say declining revenue and funding is at least a moderate challenge, compared to 45 percent of midrange and large organizations. Perhaps as a result of this challenge, 49 percent of organizations at this scale maintain six months or less of operating reserves, and one third cite maintaining adequate liquidity as a moderate or significant challenge—indicating a potential gap in the fiscal safety net for these organizations.

Some of the funding challenges upper-midrange nonprofits face may be attributable to the types of funding sources these organizations rely upon, including individual contributions (15 percent), government grants (12.6 percent), fundraising/special events (11.4 percent), and corporate contributions (7.8 percent)—all of which can be either cyclical in nature or impacted by regulatory changes, such as tax reform.

Nevertheless, amid these challenges in securing funding, upper-midrange nonprofits face the same challenges as all other organization sizes in addressing rising overhead costs: 58 percent of upper-midrange nonprofits and nonprofits overall say rising costs is at least a moderate challenge.

Program Growth Emphasizes Importance of Communicating Impact

Despite challenges in securing funding, upper-midrange nonprofits are working to expand their program offerings and deliver on their core mission. Organizations in the upper-midrange devote 80 percent of their total expenditures to program-related activities—compared to 78 percent for large nonprofits and 68 percent for midrange nonprofits. Forty-two percent of upper-midrange nonprofits also say the inability to meet demand for their services is a high or moderate challenge, and 58 percent are responding by planning to introduce new programs in the next year without eliminating others.

This program expansion makes demonstrating impact to stakeholders more important than ever. When it comes to making an impact, nearly all nonprofits surveyed (93 percent) communicate their impact outside of the organization; meanwhile, 72 percent of upper-midrange nonprofits say some portion of their donors have demanded more information about outcomes and impact than before.

But as nonprofit leaders know all too well, reporting impact to donors and other stakeholders is no easy task. Organizations in the upper-midrange are more likely than midrange or large nonprofits to say they face moderate or significant challenges in reporting impact, including having no consistent framework for measuring and reporting (66 percent vs. 56 and 53 percent, respectively), lacking clear program objectives and/or key performance indicators (55 percent vs. 43 and 41 percent, respectively), and inadequate financial resources devoted to reporting (55 percent vs. 31 and 33 percent, respectively).

Recruitment and Retention Challenge Upper-Midrange Organizations

Nonprofits derive their strength from dedicated and driven employees, yet recruitment and retention remain a high or moderate challenge for 6 in 10 nonprofit leaders. Upper-midrange nonprofits are the most concerned, with 70 percent citing recruitment and retention as a high or moderate challenge, compared to 61 percent of large organizations and only 35 percent of midrange organizations.

Key factors in keeping employees engaged and growing employee satisfaction levels for all organizations include having competitive compensation levels (59 percent), up-to-date technology (58 percent), internal communications (54 percent), and management-employee relations (51 percent). These challenges were all most pronounced among upper-midsized organizations. While 7 in 10 midrange nonprofits were able to provide at least a 3 percent increase in employee compensation levels within the last year, only 44 percent of upper-midrange and large nonprofits were able to do the same.

Overcoming Key Challenges: Planning Ahead

Do the data show that upper-midrange nonprofits are doomed? Not at all. Instead, this year’s Nonprofit Standards highlights the success of many nonprofits that were able to overcome these classic scaling challenges to grow successfully and expand their programs.

While not comprehensive, below are some best practices for organizations looking to overcome these challenges.

Fundraising Effectiveness: Nonprofits looking to increase their fundraising effectiveness should:

  • Match their donor behavior. Nonprofits should consider what influences their donors to donate in general—and to their organization specifically—and tailor their messaging accordingly.
  • Reduce their giving barriers. It’s critical that organizations regularly update and modernize their donation channels (including online and mobile giving platforms) to keep pace with changing consumer behavior.
  • Leverage data analytics. Nonprofits should dig into their own data to understand the demographics of their core contributors and to identify new prospects. (See the article on page 10 entitled, How Predictive Analytics is Transforming NPO Fundraising.)

Donor Communications & Impact Reporting: To ensure smoother donor communications and reporting, nonprofits should:

  • Start with the end in mind. Organizations should identify the story they want to tell their stakeholders and paint a vision of what the world could look like if their mission were achieved.
  • Make reporting an ongoing process. Nonprofits should gather and report data on a quarterly or monthly basis to keep stakeholders in the loop and make year-end reports less daunting.
  • Remain transparent. Nonprofit reports offer an unparalleled opportunity to contextualize an organization’s metrics and finances.
  • Share their report widely. Organizations should distribute their report via multiple channels so both existing and prospective donors have a chance to see it.

Staffing and Recruiting: To maintain and attract top talent, nonprofits should:

  • Stay competitive in their local market. Nonprofits should ensure their policies make their organization an attractive place for potential employees.
  • Capitalize on flexible work options. Remote work arrangements can be both beneficial to employees and cost-effective for organizations.
  • Remain proactive about succession planning. With 4 million baby boomers retiring each year, the need for a succession plan is a “when” rather than an “if” scenario.

The more upper-midrange nonprofits—and those of all sizes—can learn from benchmarking against their peers, the better prepared they will be to advance their mission and support continued growth. Gaining intelligence is vital to staying afloat.

Adapted from article originally published in NC State University’s Philanthropy Journal News.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

Tax Reform & Tariffs Widen the Affordable Housing Gap

By Joseph Canataro and Kyle Paisley

The U.S. has an affordable housing gap, and the combined impact of tax reform and tariffs could make it a lot worse. What’s the scope of the current supply gap? The National Low Income Housing Coalition reports a shortage of 7.2 million affordable and available rental homes. This means that there are only 35 available units for every 100 extremely low-income renters (ELI). A household is characterized as ELI when their income is at or below the poverty guideline or 30 percent of their area median income (AMI). While the severity of the supply shortage varies greatly by state, the housing affordability gap stretches nationwide.

What’s taxing the affordable housing market?

Last year’s federal tax overhaul is the largest factor projected to negatively impact affordable housing development. The reduced corporate tax rate from 35 to 21 percent lowered the value of low-income housing tax credit (LIHTC) investments. Housing experts initially estimated tax reform could cut the growth of the affordable housing market by more than 230,000 units over the next decade.

While the reduced corporate tax rate has the most direct impact on LIHTC, it’s not the only tax change affordable housing developers are watching. The current tax code reduces the alternative depreciation system (ADS) cost recovery period for residential rental property from 40 to 30 years. Most LIHTC partnerships will elect under Section 163(j)(7)(B) to use the real property trade or business exception to the net business interest expense limitation. This election requires the use of ADS instead of the MACRS depreciation method, which has a useful life of 27.5 years for residential rental property.

With the one-year anniversary of the new tax law fast approaching, how has the affordable housing market shifted? Shortly after the 2016 presidential election, LIHTC pricing trends began their first sharp decline in anticipation of a reduced corporate tax rate. Pricing trends have stabilized and remained steady since March 2017, with average pricing fluctuating between 91 cents and 93 cents per LIHTC. Prior to the election, pricing was at a high over $1 per LIHTC. The reduction in LIHTC pricing increases need for other financing and funding from federal, state and local programs to support future affordable housing development.

Trade disputes abroad raise supply costs at home

In addition to tax changes, affordable housing developers also face increased construction costs of future affordable housing projects and those already in development. The price of lumber, steel and aluminum—all essential building materials—climbed steadily as a result of the ongoing trade disputes.

The cost of 1,000-feet of western Canadian lumber in June was up nearly 80 percent over the past 12 months, according to data from trade publication Random Lengths. Lumber prices first started rising in October 2015, when a decade-old softwood lumber agreement between the United States and Canada expired without a replacement. The Trump administration’s 20 percent tariff on Canadian lumber accelerated the commodity’s price hike. An overall reduction in the supply of Canadian lumber due to rail slowdowns and tree disease have also contributed to the cost increases.

After this summer’s record highs, lumber prices have started to settle. There is renewed hope that the U.S. and Canada can reach a new softwood agreement as well. U.S. and Canada trade relations are showing signs of improvement, with a tentative agreement to replace NAFTA with the United-States-Mexico-Canada Agreement (USMCA) in motion. Progress in NAFTA renegotiations have renewed hope that the United States and Canada could also reach a new agreement on softwood lumber trade agreement.

The United States also began imposing tariffs on imported steel and aluminum of 25 percent and 10 percent, respectively. Construction costs are expected to rise modestly as a result, particularly for the development of high-rise assets that require far more steel and aluminum than multi-family townhouses. Trade tensions may be easing in North America, but the outlook for global trade relations remains uncertain. For affordable housing developers, the question remains: Will the trade disputes reach a resolution, or are the tariffs here to stay?

Legislative bright spots for affordable housing

The future is not all doom and gloom, however. Congress has already taken measures to address affordable housing advocates and developers’ concerns. In March 2018, Congress increased the LIHTC volume cap by 12.5 percent with the passage of The Consolidated Appropriations Act of 2018. The four-year temporary volume cap increase does not fully mitigate the impact of tax reform on affordable rental housing development and supply, but it does improve the outlook.

The March 2018 Act also included a new income-averaging set-aside option for LIHTC properties. Under the new option, income and rent limits for at least 40 percent of the units must average 60 percent or less. The new legislation will assist an owner’s ability to offset lower rental revenues where certain funding sources may require lower set-aside for a number of rental units with greater rental revenues from units at 70 or 80 percent AMI. The change will also provide relief to owners that are acquiring new affordable housing developments or rehabilitating existing properties where certain units could be ‘over income.’

Changes still ahead

The affordable housing sector has several other policy changes on their wish list. There are bipartisan efforts in Congress to go beyond the 12.5 percent increase in volume cap allocated federal LIHTCs passed this March and obtain a 50 percent increase. Additionally, there are appeals to establish a minimum 4 percent rate for LIHTC used to finance acquisitions and bond-financed developments.

If enacted, both changes would improve the outlook for the development of new affordable housing units. As the market currently stands, the fallout from tax reform and tariffs still present a considerable barrier for new developments. With increased construction costs and a tax code that makes LIHTC investments less attractive, 2019 will not be the year the U.S. bridges its affordable housing supply gap.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Winter 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

How Predictive Analytics Is Transforming NPO Fundraising

By Joe Sremack, CFE, and Gurjeet Singh, MCP

The art of nonprofit fundraising is quickly becoming a science. Fundraising is a vital process for the mission of many nonprofit organizations (NPOs), and the better organizations are at this process, the more effective they become in their missions.

Historically, this process consisted of following standard fundraising processes and tracking the results to periodically adjust the processes based on results. This feedback loop could take months or years; however, NPOs have begun improving this process by utilizing analytics, rather than simply responding to past results.

Perhaps the most important technological breakthrough for NPO fundraising in recent memory is predictive analytics. This technology is enabling NPOs to run more effective fundraising campaigns and quickly boost their fundraising results. Rather than relying on evaluating the effectiveness of past fundraising efforts and basing decisions on opinions and experience, predictive analytics provide guidance on what will likely be the most effective campaigns, whom to target and how to allocate resources to maximize fundraising results. This article discusses how predictive analytics works and several ways it can be employed to enhance your fundraising efforts.

WHAT IS PREDICTIVE ANALYTICS AND HOW DOES IT FIT WITHIN NPOS?

Predictive analytics is a set of techniques and technologies that extract information from data to identify patterns and predict future outcomes. Based on a variety of statistical techniques and software technology, predictive analytics helps to understand the relationships between data points, and identify patterns within the data, as well as factors contributing to the prediction. This whole analysis can be configured to show prediction based on various factors and can be refined further over time as more information is included in the analysis.

Predictive analytics is being employed across numerous industries, including nonprofits. The most common examples of predictive analytics are found in data-centric industries—such as tech firms, finance, and insurance—where data is readily available and the ability to predict outcomes directly relates to the financial success of those organizations. The same is true of NPOs. While NPOs may or may not collect millions of records across hundreds of data points, they do collect a sufficient amount of donor information, marketing touch-point records, and other information that can be utilized for predictive analytics, and that predictive ability can make a significant difference in fundraising efforts.

NPOs are uniquely positioned to benefit from predictive analytics. Most NPOs house the kind of data that can fuel detailed analysis, which results in actionable insights. They have donor information that often includes a wide array of demographic information, historical behavior information and information about how donors responded to past fundraising campaigns. This type and breadth of information can quickly be converted into predictions and more effective fundraising campaigns. Even if the NPO only has hundreds or thousands of donor records—as opposed to hundreds of thousands or more—that is sufficient for creating effective predictive analyses.

When Should NPOs Consider Predictive Analytics?

  • Seeking to improve fundraising results
  • Facing competition for donors
  • Fundraising efforts not meeting goals and objectives
  • Exploring opportunities for new or enhanced fundraising campaigns
  • Shrinking donor base or difficulty reaching your donors

HOW PREDICTIVE ANALYTICS WORKS
In the traditional fundraising process, several steps are typically employed across different layers of an NPO’s data. First, key donors are identified and targeted. This may be done based on selecting key individual donors, by a prior donation level threshold, and/or demographic information. Next, past campaigns are assessed, and new campaigns may be discussed and evaluated. Finally, a plan is developed and executed to drive fundraising. For this entire process, the rigor of data analysis and the evaluation of past campaign effectiveness may vary by organization but, at a high level, the processes are similar: organizations make use of data and personal judgment to drive future fundraising efforts.

The predictive analytics process runs alongside this methodology to augment it, which acts as an advisor to existing activities and decision-making processes. Predictive analytics offers a way to look at the information in a new way by incorporating your existing methods and institutional knowledge. Predictive analytics can be run parallel to your process to offer new ideas, prove or disprove existing ideas and approaches, and provide a way to gauge how effective new approaches to fundraising will be.

A major misconception about predictive analytics is that it can replace a fundraising team or will serve as a stand-alone fundraising strategy function. A predictive analytic model is only as effective as the information and guidance that is provided to it, and performing predictive analytics effectively requires institutional knowledge and refinement. Predictive analytics is a statistical and technological way to utilize data based on institutional knowledge, so it is useful only if it is designed, implemented and evaluated by data and industry experts.

A typical scenario for NPOs to implement predictive analytics is when an NPO recognizes that its fundraising efforts could be improved. They currently may have sufficient data to understand what worked well in the past, but they often rely on comparisons between past approaches and new approaches, market research and small test campaigns for evaluating new ways to raise funds. They also recognize that these techniques test ideas and require an investment of time and resources, which may not deliver the level of results they want. This leads them to work with a data science team or a predictive analytics software package to improve their process. This begins the predictive analytics development, which may produce immediate results.

The predictive analytics process involves several steps. First, the organization’s goals are outlined and historical data is surveyed to map the goals to key data points. In this step, the organization determines which questions it wants answered and whether the data it needs is available. Next, a predictive model is developed, and the data is analyzed and visualized to derive insights. This step is where forward-looking analyses and findings are derived from historical data, and it involves specialized analysis using specialized software and/or custom-developed logic in a programming language, such as Python or R. The results are next evaluated to determine whether the analysis was effective and, if so, how to apply the findings for meaningful actions. Finally, an iterative process of refining and re-running the analysis is performed based on the findings and changes. These steps are outlined below:

WHAT CAN NPOS PREDICT?

One way that NPOs can increase fundraising results is by using predictive analytics to identify the people who are most likely to donate as well as those who will not. Through this analysis, NPOs can identify potential donors based on utilizing past donor information to identify the characteristics that most accurately determine whether someone donates. Unlike traditional analysis methods that only examine past donation information, predictive analytics leverages information—such as age, income, lifestyle, past donation information and associations to NPOs with similar missions—to pinpoint donors. With this information, NPOs can more precisely target a pool of potential donors to maximize fundraising results.

For example, an NPO with a list of 3,000 past donors and 2,500 potential donors may only be able to directly contact 2,000 donors through in-person meetings, phone calls and/or direct/digital mailing due to budget constraints. Because of this constraint and the need to maximize fundraising, the NPO wants to know which of the 5,500 potential donors to contact. The NPO utilizes predictive analytics to assign a donation probability to each potential donor based on historical donation information and each potential donor’s characteristics to then target only the donors with a high probability. This helps reduce the overhead of devoting resources to individuals or groups who are unlikely to donate and maximizes the donor conversion rate.

In addition to discovering the likelihood of donations, predictive analytics can be used to predict donation amounts. Analyzing donors for both their donation likelihood and predictive donation amount further helps NPOs identify key donor targets. An NPO may not get much value from identifying donors if they will donate in small amounts or if there is a high degree of donation amount variability. Instead, predictive analytics can be performed that assigns both a donation probability and an expected donation amount if they donate. This is an expected value for donors, and this information can be calculated to optimize the fundraising campaign. If an NPO identifies five high-value donors who only have a 40 percent donation probability, targeting those may still be more valuable than pursuing five low-value donors who have a greater than 90 percent probability of donating.

Predictive analytics can be applied to almost any area of NPO operations. While improving fundraising is often the first goal, predictive analytics can be used to improve other areas of the organization.Several examples of these are:

 Mission-specific goals
 Operational performance
 Cost forecasting
 Community and government outreach

CONCLUSION
Predictive analytics is an important method for improving your fundraising process. Just as major retailers, financial institutions and healthcare companies are utilizing predictive analytics to maximize revenue and reduce costs, NPOs have an opportunity to make use of this technology within their own organizations. Regardless of the volume of fundraising you are doing or the makeup of your donors, you can benefit from applying predictive analytics.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com

4 Changing Realities of Hurricane Season for Hoteliers

By Clark Schweers

Only a year has passed since the costliest hurricane season on record in the U.S. took thousands of lives and amounted in over US$306.2 billion in damages.

The hospitality industry was among the hardest hit from the year’s three most significant storms: Hurricanes Harvey, Irma and Maria. Hotels experienced—and many are still recovering from—physical property damage, business interruption losses and long-term impacts on occupancy rates.

Now, it’s déjà vu. Hurricane Florence—the first major hurricane of 2018—made landfall in the Carolinas in September. Hard-hit areas accumulated over 30 inches of rainfall, and more than 1.4 million people experienced extended power outages. This month, Hurricane Michael threatened the Florida Panhandle, hitting the coast as a Category 4 hurricane.

When a hurricane strike is looming, protecting the safety and well-being of guests is the hotel industry’s number one priority. While the core elements of an effective natural disaster response plan have not changed dramatically in the past year, hotels are encountering new and worsening risks and experiencing a shift in government response, prompting many to revisit their insurance policies and dedicate more resources to disaster response.

With more than a month left to hurricane season, hotel risk managers should consider four changing realities to better prepare for the remainder of the hurricane season:

  1. The frequency and severity of extreme weather events are increasing—and top business leaders are taking an active role.

Hotels are facing natural disasters and dealing with the fallout on a more consistent basis. To adapt to this reality, risk managers are no longer the only stakeholders involved in developing disaster response plans. Corporate boards and C-Suite executives of multinational hotel companies are increasingly playing key roles in deciding how to mitigate property damage risks and business interruption losses.

  1. Mandatory evacuation orders are becoming more common, but not all insurance policies offer full coverage for losses incurred during an evacuation.

Authorities are declaring states of emergency and issuing mandatory evacuation orders earlier than ever before, erring on the side of caution to protect human life. Hotels could be evacuated for several days, or even a week, prior to the storm making landfall. While there are avenues for hotels to recoup financial losses incurred during an evacuation, insurance policies are not always clear about the coverage provided.

Oftentimes, coverage begins the moment a hurricane makes landfall, which could leave hotels without grounds to recover financial losses in the days leading up to the storm. Protection and Preservation coverage allows for cost recovery for activities such as boarding up windows and sandbagging vulnerable areas, but the lost business associated with closing early may or may not be covered as part of this policy. Proactively discussing this issue with insurance carriers and brokers ca n help hotels reduce unwelcome surprises after an extreme weather event.

  1. Recovery and financial losses don’t end the moment business resumes.

In the midst of a storm and in the immediate aftermath, a hotel’s first priorities are accounting for the safety of its guests, restoring power, repairing physical damage and resuming operations. But after the lights come on and all systems are up and running, the financial strain of a natural disaster is likely to persist.

Hotels are in the business of tourism, and occupancy rates rise and fall depending on the attractiveness of the destination. Some hotels are protected by loss of attraction insurance, which allows companies to make a financial claim if something that drives business to your asset has been impacted. If an airport, convention center, sporting events center or preeminent tourist attraction is under repair, hotels may recover lost revenue.

A severe weather event could decrease traffic to a location for a significant period of time. Travelers may be reluctant to visit an area still rebuilding from a natural disaster. Many hotels’ insurance policies include an extended period of indemnity provision, which accounts for the time it takes to regain guests and restore normal occupancy levels. After last year’s devastating hurricane season, hotels found that losses can go well in excess of the 60 days, or even 180 days, that most policies cover. In many cases, hoteliers are looking to extend their policies to cover one full year.

  1. Storms that have lower category designations can still produce significant financial losses.

Many people—seasoned hotel executives included—breathed a sigh of relief recently when Hurricane Florence was downgraded from a category 4 to a category 1. What few people understand, however, is that wind speed is the only factor considered when a storm is categorized. Rainfall and flooding, the primary causes of storm-related deaths and damages, are not reflected in the hurricane’s category. Hotel executives should take precautions and consider all elements of a storm when preparing for disaster response.

With the first major storms of the year behind us, hotels are staring down the rest of hurricane season, which ends November 30. To meet the challenges ahead, hoteliers should take steps to clarify their insurance policies and refresh their natural disaster response plans.

This article was originally published in Hotels Magazine. You can view the original here.

This article originally appeared in BDO USA, LLP’s “BDO Real Estate and Construction Monitor” (Winter 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com

Compensation Committee Wake-Up Call – The ‘Other Obstacle’ To Leadership Transition

By Michael Conover

I have previously discussed the inevitable transition of numerous baby boomers holding leadership posts in nonprofit organizations. The topic has been well-covered in a variety of publications for nearly a decade.

However, I believe the seismic shift that some have predicted has failed to materialize on a scale that was predicted. I attribute this to a variety of factors, including: delayed retirements out of financial need or resistance to change; belief that age 75 is the new 65; or just procrastination.

The slowdown in the rate of change will not soften its impact. It may intensify it. The delay on the part of these baby boomer executives and the boards to whom they report could increase the likelihood of an unexpected and disruptive leadership crisis. The problems can range from a noticeable decline in performance to an abrupt departure caused by sickness or death. Leadership changes under the best of circumstances are not 100 percent successful; thus, in crisis mode, the odds of success are much slimmer.

The other obstacle I allude to in my title is executive retirement arrangements (or lack of same). As organizations finally confront the departure of a long-tenured and critically important executive, the details of the retirement arrangements come to the forefront. This is the point at which many organizations and executives discover the price that will be paid for failing to address this important issue well in advance. Proper advance planning can not only minimize financial uncertainties for the executive and the organization that may interfere with retirement planning, but can prevent other potential and very expensive obstacles as well.

Many compensation committees have failed to proactively raise the subject of retirement plans and acknowledge the impact that they will have on an orderly retirement / leadership transition. There are a variety of reasons including: financial costs; reluctance to broach the subject of leadership change; mistaken assumptions that arrangements made many years ago will address the needs; embarrassment that arrangements are inadequate or have not been made; etc. Committee members must realize that time is not on their side for addressing retirement-related arrangements. Delaying can create many negative impacts for both the executive and the organization.

I would like to describe a few different scenarios that illustrate the types of situations we have discovered in “11th hour” reviews of retirement arrangements:

Plan Document Failures: Plan documents (e.g., employment contracts, deferred compensation arrangements, life insurance plans, etc.) developed many years ago and / or those that have been drafted without the benefit of needed expertise to ensure compliance with current requirements pose potential problems to the unwary.

The inclusion of what appear to be ordinary terms in the arrangements, or the failure to include critical details, can prove disastrous in terms of potential tax liability and penalties for the executive as well as the employer. Language included to ensure that retirement resources are secure may produce inadvertent vesting of a benefit and tax liability long before it is actually available. Similarly, incorrectly structuring payments can result in an unforeseen tax liability and punitive excise tax penalties.

If these issues are identified proactively or within a time period that corrective actions can be taken, the problems can be minimized. There is, however, a point at which it is simply too late.

Plan Administration Failures: In some instances, well-drafted plan documents are not adhered to from an administrative standpoint. Contributions, excess contributions, payment amounts and / or payment terms are made that fail to follow plan requirements. The failure to ensure compliance may result in adverse tax consequences to the executive and the organization.

Failure to properly recognize and report details of retirement arrangements are also common. The executive’s W-2 form, personal tax return and the organization’s Form 990 may all need to include information related to the plan arrangements as well as timely recognition of income when vesting occurs. Discovering these issues after the fact can necessitate amending prior year returns and also involve adverse tax consequences to the executive and the organization.

Improbable Catch Up: A compensation committee’s failure to establish a specific position on retirement benefits for the executive, as well as a specific objective for the level of benefits to be provided well in advance of the probable retirement event, drastically diminishes the likelihood of providing any level of benefit beyond that provided to all employees. Waiting until just a year or two prior to retirement will likely place an unreasonable financial burden on the organization to fund a benefit that might have been spread over many years of employment. Similarly, large contributions / payments toward the very end of employment may trigger an excess benefit situation, or the appearance of same, that may create adverse consequences for the executive and the organization.

The Wake-Up Call

Most compensation committees spend most of their time on decisions about current cash compensation (i.e., salary, bonus and incentive) matters for executives. Clearly, these are important matters and ones that require the committee’s attention in light of the disclosure of this information to external stakeholders and the public. I am not suggesting the committee members spend any less time on them.

I am however suggesting that compensation committees incorporate an immediate and recurring review of the organization’s retirement program to ensure that all documentation, administration and funding are in accordance with the organization’s policy, on track to meet stated objectives and fully compliant with pertinent regulatory and reporting requirements. Regular checkups may also be beneficial in helping the organization to be more attentive and proactive on succession / transition needs. As we have pointed out, delay on these matters is the enemy of effective solutions.

Executive management also has a role to play in this wake up call. Steps should be taken to ensure that the compensation committee has access to all internal and external information and advice that will assist them in their efforts to ensure that all steps have been taken to ensure that the retirement arrangements pose no obstacles to the inevitable retirement and leadership succession that every organization faces.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2018). Copyright © 2018 BDO USA, LLP. All rights reserved. www.bdo.com