Commentary: Money Matters: Tax-exempt groups can use variable compensation

By Michelle M. Cain The Daily Record Newswire Some people assume that bonuses or incentive payments are not allowed for tax-exempt organizations. It seems these individuals operate under the assumption that these forms of "extra" compensation are somehow not compatible with their expectations for a charitable or tax-exempt organization. The fact is, however, that tax-exempt organizations can and do use variable, performance-based compensation. The number of organizations using them has grown over the years and, depending on the particular sector (e.g., hospitals, trade/professional organizations, etc.), they may be prevalent. Executive and other senior levels of management are most frequently the persons eligible for participation in formal plans. However, it is also not uncommon to find bonuses being given to deserving employees at all levels of an organization. Variable pay has long been used by for-profit organizations to accomplish a number of objectives. A well-communicated and administered plan can be very effective for focusing attention and efforts on the results that are critical for an entity's success. In addition, these plans can expand or contract payroll based on the entity's performance and ability to pay. The same benefits are also available to tax-exempt organizations. It is important to distinguish the bonus from the incentive plan. The terms are not interchangeable. An incentive establishes the criteria for determination and the potential award amount at the outset of a performance period before any payment is made. On the other hand, a bonus is a discretionary award made at the end, or after the performance period in appreciation for a particular accomplishment or some other notable performance. In both cases, clear communication with recipients about the terms and purpose of the payment is essential for success. Tax-exempt organizations can use both bonus and incentive plans. There are, however, some special considerations that must be addressed regarding how the plan is structured and how much compensation is offered. Tax-exempt organizations must structure all forms of pay and benefits, particularly variable pay, to avoid any occurrence or appearance of personal inurement/private benefit. One of the most common examples of an unacceptable bonus or incentive plan is one that shares any of the organization's revenue directly with an individual. Awarding funds that are intended for the organization's tax exempt purpose to an individual for personal benefit rather than the mission for which the organization has received its exemption is unacceptable. A specific example of such an inappropriate arrangement would be to establish an incentive plan that offered the participant a percentage of contributions raised in a fundraising drive. It is important for a tax-exempt organization to base any incentive or bonus on performance factors that are directly related to the accomplishment of an objective or the operation of the organization in a manner that can be demonstrated to have contributed to the efficiency/effectiveness of its mission. Caution should be exercised in developing the performance factors to ensure they do not operate in such a manner that entices a participant to skew financial results in his or her own favor. The more directly the "rewardable" factor can be linked to the success of the organization and its mission, the more likely the plan will escape any suspicion of inurement. This critical linkage will also increase the likelihood that the variable plan can be disclosed and understood as an integral and beneficial component of the organization's compensation program. Another important consideration in structuring an effective variable pay plan is the determination of the size of the award opportunity. The award amount must be examined from several perspectives. The award must be large enough to have some meaning or value to the recipient and be commensurate with the event/performance being rewarded. However, it should not be excessive on its own account or produce an unreasonable amount of total compensation when added to all the other compensation and benefits the individual receives. Competitive compensation information from published surveys and other pay data sources (Form 990s filed by other organizations) can provide helpful information about the prevalence and award amounts offered by other organizations. This can be a valuable context for assessing the competitiveness of an organization's overall compensation for key positions and also offer helpful analysis of the amounts of bonuses/incentives paid as well as information about the plans upon which they are based. Governance for variable pay plans should be assigned to the independent members of the organization's board or compensation committee of the board, if one has been established. A formal description of the plan should be drafted including its purpose, role in the organization's overall compensation program, eligibility requirements for participants, plan terms and conditions. Incentive plan details should be approved by the board early in the year along with any incentive bonus awards paid under the plan. It is important that no plan participant is engaged in any aspect of the oversight of the plan. Plans should be regularly reviewed to ensure that they continue to fulfill their intended purpose as well as continue to support the organization's desired position in relation to competitive pay levels and practices. Communication with individuals eligible for participation in variable pay plans should clearly explain the purpose, terms and conditions applicable to any award opportunity or a payment made under the plan. This is essential for ensuring that the plan accomplishes its intended objective. A well-designed bonus or incentive plan could be a valuable addition to your organization's compensation program. By thoughtfully addressing the issues we've discussed here, those who may have been skeptical about the use of bonus or incentive plans may discover a way to enhance their compensation program's alignment with and, in support of, the organization's mission. ---------- Michelle M. Cain, CPA is a partner with Mengel, Metzger, Barr & Co. LLP. She can be reached at Mcain@mmb-co.com. Published: Tue, Jun 5, 2012