By Mike Conover
There are tens of thousands of tax-exempt 501(c)(6) organizations that represent the interests of virtually every type of business in the United States. They are as diverse in their size and scope of activities as the businesses they represent. And the compensation paid to the executives that manage these organizations can range from less than $100,000 to multi-million dollar packages for the most highly paid executives. Somehow, despite their non-profit status, these organizations are not often the subject of much controversy concerning their pay practices, even when pay reaches levels that sound alarms in for-profit organizations. Does no one care?
Unlike charitable, educational or social welfare organizations (i.e., 501(c)(3) and (c)(4) organizations) whose executive compensation practices are subject to the Internal Revenue Service (IRS) Intermediate Sanctions (Internal Revenue Code (IRC) section 4958) penalties and remedies for excess benefit transactions, the 501(c)(6) (“trade associations”) are subject to the broadly defined private inurement prohibition, which is a fundamental requirement for securing tax-exempt status. Quite simply, revenue or assets of a tax-exempt organization are not allowed to benefit an individual associated with the organization without being directly related to the organization’s exempt purpose.
Of course, trade associations are not expected to be run by executives who volunteer their services, so compensation for staff members is a necessary and allowable expenditure that allows the organization to pursue its purpose. However, at what point does compensation reach a level that it becomes unreasonable and possibly creates a case of private inurement? If that does occur, what happens next?
Quite simply, the organization’s tax-exemption would be at stake. Fundamentally, its ability to continue to exist could hang in the balance if an instance of private inurement were confirmed. For this reason, a strong case can be made for ensuring that a trade association has its executive compensation practices well in hand.
Almost as troubling are the embarrassing disclosures of executive compensation practices that appear to be problematic to outsiders and can have lasting negative consequences for the organization, its executives and governing board. This is particularly true in light of the public’s skeptical or even hostile view of all things associated with executive pay, fueled by sensational media attention and online access to compensation information.
The Oversight Knowledge and Experience Gap
Clearly, someone in every trade association should care about the organization’s executive compensation and ensure that all necessary steps are taken to avoid any problems that might threaten the organization or interfere with its mission.
Let’s explore some of the issues facing trade associations and the steps that can be taken to address them.
Overall, responsibility for the oversight and governance of executive compensation rests squarely upon its outside or independent directors. Often, there is an executive committee or compensation committee specifically charged with this responsibility. In most cases, these outside directors (non-staff members) come from the organization’s membership or closely-related fields and are highly regarded for their expertise related to the trade association they serve. But they often have little to no knowledge or expertise in the area of executive compensation, particularly for a tax-exempt trade association. This can, and has, created some challenging issues, as boards address their executive compensation responsibilities.
- Board members drawn from a for-profit sector known for its high-pay or exotic compensation practices might well have a different frame of reference on what constitutes competitive or excessive compensation than those board members from a much more conservative sector. In both cases, comparisons of what the trade association’s executives are making versus what board members make are bound to occur. The comparisons are understandable, but may not have any bearing on the determination of the reasonableness of the trade association’s compensation.
- Board members from for-profit organizations may be accustomed to types of incentives, benefits and perquisite arrangements that are common in their own organizations but not allowed in a tax-exempt organization.
- Even those individuals familiar with executive compensation, may not realize that simply looking at the size (i.e., revenue, budget, membership, etc.) of a trade association alone to establish pay levels may not accurately or adequately provide the proper basis for determining what constitutes reasonable or excessive compensation. Trade associations vary greatly in their missions and the expertise required to carry them out (i.e., an organization simply promoting the industry vs. an industry’s self-regulating organization).
- Similarly, some trade association executives may have or require specialized experience and/or expertise that have a far more significant bearing on the competitive compensation than the type or size of the organization.
Complying with Regulations and Best Practices
Given the potential consequences of an executive compensation problem and the challenges that face the board members responsible for avoiding those consequences, what can be done to minimize the likelihood of problematic executive pay?
Rather than assuming no one cares, or that their own organization is somehow different, trade associations would be well advised to take all steps necessary to ensure that their executive pay practices are governed and administered in accordance with applicable IRS regulations and best practices that are widely recognized among tax-exempt and for-profit organizations alike.
Specific steps would include the following:
- If a specific group of outside or independent directors has not been charged with responsibility for executive compensation, one should be established. The group (compensation committee) of individuals would be well-advised to formally define the responsibilities and authorities assigned and their accountabilities to the overall board.
- A formal process should be established for the regular and ongoing oversight of the organization’s executive compensation. This would include the identification of the specific positions overseen by the compensation committee as well as the adoption of policies and processes that will be used to understand the role of each position, obtain valid information about competitive pay practices from other organizations that compete for similar executive resources and maintain such documentation, and make informed decisions about pay to ensure the organization’s business needs are met.
- Finally, the compensation committee should keep timely minutes of all its meetings detailing the topics, deliberations and decisions made about executive compensation or related matters (i.e., employment agreements, compensation surveys, consultant reports, etc.) associated with the committee’s work.
Readers who are familiar with IRS Intermediate Sanctions will recognize that these are the steps required for the “Rebuttable Presumption of Reasonableness.” Complying with these steps effectively shifts the burden of proof to the IRS to refute the value of the comparability data used and decisions made relying upon it. They are also quite consistent with generally recognized best practices for oversight of executive compensation used by all types of organizations, both non-profit and for-profit.
Further Enhancing Oversight
In addition to the steps above, the following should be considered as ways to further enhance the oversight of the trade association’s executive compensation program:
- Part III of Schedule J and Schedule O of IRS Form 990 provide opportunities for organizations to provide additional details about reported compensation amounts as well as the plans and policies associated with them. Many organizations ignore or underutilize the opportunity to proactively explain what might at first appear to be an alarming amount of compensation.
- Occasionally, a trade association might consider an independent review of its compensation governance process. An independent third party (attorney, consultant, etc.) who is knowledgeable of the compensation issues applicable to a 501(c)(6) organization should be retained to assess the overall quality of the governance process. These reviews not only provide assurance of sound practices but may also identify areas for improvement.
- Finally, all members of the trade association’s governing body should be provided with an annual briefing on the organization’s executive compensation program and governance process. The facts and circumstances of every organization will dictate the most appropriate manner for sharing information as well as the level of detail provided. However, every member of the organization’s governing body should be provided sufficient information to address questions that may arise from members or the public. After all, the pay information is only a few clicks away on the Internet.
Who cares about executive compensation at trade associations? The IRS, association members and the public at large, especially if there is ever a question or unusual compensation disclosure that may appear as if executive pay is excessive.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2015). Copyright © 2015 BDO USA, LLP. All rights reserved. www.bdo.com