[ Intermediate Sanctions & Rebuttable Presumption of Reasonableness ]
On August 10, 2004, the IRS announced a new enforcement effort, entitled the Tax Exempt Compensation Enforcement Project, in order to identify and halt abuses by tax-exempt organizations that pay excessive compensation and benefits to their officers and other insiders. State Attorneys General are also stepping up audits of tax-exempt organizations in the post-9/11 environment. New penalties apply to individuals, rather than organizations, under IRC Section 4958, also known as "Intermediate Sanctions."

Who and How Much
Organization managers, which include officers and board members, can be held personably liable for excessive compensation. The board members or other executives in a position to authorize compensation decisions are also held liable for 10% of the excise amount up to $10,000 for each occurrence. The individual with excessive compensation, the Disqualified Person, is required to:
  • Pay back the excess benefit
  • Pay interest on the excess benefit
  • Pay an excise tax equal to 25% of the excess for each occurrence
  • Pay a 200% excise tax on the excess if not paid within 90 days of notice
Proactive Steps
In order to defend against personal or organizational penalty, the Department of the Treasury suggests proper due diligence in making compensation decisions. This due diligence includes:
  • Define a compensation philosophy and/or strategy
  • Hire an independent compensation expert to advise the organization
  • Record the decision-making, dissent, and vote regarding executive compensation decisions
  • Record the data and process used to reach the compensation decision
Rebuttable Presumption of Reasonableness
The Department of the Treasury has provided guidelines for a Rebuttable Presumption of Reasonableness regarding Excessive Compensation and Corporate Governance in setting compensation levels. Specifically, for organizations with more than $1 million in revenues, there are safe harbor guidelines that shift the burden of proof to the IRS. The following guidance is summarized from section 4958(a):

An organization manger is not considered "knowing" if the organization manager relies on a reasoned written opinion of an Independent Expert who: hold themselves out to the public as compensation consultants; perform valuations on a regular basis; are qualified to make valuations; and include a written opinion.

The Organization must take reasonable care in determining executive compensation and document: compensation terms; comparability data and how it was obtained; and who debated and voted to approve compensation.

Current comparability data must be used to determine executive compensation. This data should include similarly situated organizations (both taxable and tax-exempt) for functionally comparable positions. Data sources should include: current compensation surveys compiled by an independent firm and consist of similar services in geographic area.

In summary, an organization and its board members should:
  1. Hire an independent compensation expert who uses appropriate and professional guidelines for determining competitive compensation levels
  2. Document the data and process utilized by the compensation expert (usually provided by the consultant in the form of a report)
  3. Follow the advice provided by the expert
  4. Record the discussion and dissent of the vote on compensation
  5. Retain the board minutes and the compensation report

About the Author
Rodney A. Cottrell is the current President of Corporate Compensation Partners, LLC and EHResearch Data Services, LLC. Concentrating only in compensation issues, Rodney is considered an expert in the areas of executive pay, sales compensation, incentive plans, employee compensation, FLSA, compensation and benefit surveys, and compensation technology. He provides international compensation consulting to clients in multiple industries across the United States and is a frequent lecturer and guest speaker at colleges and corporate events.

Rodney A. Cottrell, CEBS, CCP, CMS, MSHRM, SPHR
Corporate Compensation Partners, LLC
(724) 934-0800
[ Reality Check: US Wage Gains As Planned, Despite Inflation ]
May 18 / 14:18 EDT
By Claudia Hirsch

NEW YORK, May 18 (MNI) - Gasoline and food price inflation have not translated into higher-than-expected U.S. salary increases so far this year, as still-cautious employers seek to control outlays even as their own commerce and prospects firm, according to compensation consultants.

Consultants said the planned, modest growth in wage increases heading into 2011 is holding. Raises were seen hovering around 3% this year, up from about 2.5% or below in 2010. That gas and grocery inflation has virtually erased pay increases so far this year hasn't entered the equation, but some experts said if prices continue to speed upward they could affect pay negotiations in the second half of the year. Health benefit costs press ever higher for both employees and employers, but the percentage of these outlays borne by workers appears to be leveling out, at least for now, human resources consultants said.

Dan Moynihan, a principal with Hay Group, a global management consulting firm headquartered in Philadelphia, said that even though capital investments and a return to hiring are beginning to work their way back into budgets, better-than-expected salary increases are not.

"Although prices of gas and food have been rising, fixed salaries are remaining constant," Moynihan said. "We're not seeing much movement away from budgets. Any increases will have to come from variable pay."

Salary rises this year are amounting to about 2.9% or 3.0% for rank-and-file and executives alike, he said.

He said that sustained increases in consumer prices may put more pressure on wage growth in the second half as employers start contemplating 2012 budgets.

Moynihan said employers are relying less on fixed pay than before and turning instead to variable compensation, like bonuses, profit sharing and team-based rewards. Such discretionary performance-based rewards are now extending below executive levels to managers, directors and high-level professionals, he said.

He said hiring is kicking up across the board, even in the retail sector. In some cases, hiring has exceeded budgets a little, juiced by better business in general.

"With every client we're speaking to right now we're seeing an acceleration in hiring," Moynihan said. Layoffs are apparently over.

Health benefit costs continue to rise, he said. The employee's share of those outlays has more or less maxed out at 70% of premia for family coverage, he said, but added that "employers are always pushing a little bit more of that cost to the employees." Several clients have recently told him they're through with re-designing benefits packages and switching insurance carriers to control costs, because workers tend to view these changes as a "take-away." Instead, these companies plan to shift next year's benefits cost increases directly to employees, he said.

Jim Hudner, managing director of Pearl Meyer & Partners, a New York-based compensation consulting firm with offices nationwide, said both salary increases and hiring budgets remain conservative.

"While employers are continuing to be optimistic about prospects in the next year or so, they remain somewhat cautious about stretching too far with new hires and with increases to payroll costs," he said. "Based on what we're seeing, we wouldn't expect a significant change in the projection of high-two's (percent salary increases) for the balance of this year."

Political upheaval in the Middle East, oil supply concerns and fast-rising energy and food prices all have employers putting "the reins on more advances both in employment and (salary) increase levels," Hudner said. Instead, they're focusing on holding on to high performers through as much differentiation as possible in salary-increase and discretionary-bonus levels, he said.

"We're seeing organizations looking more closely at the use of variable pay, both in terms of amounts and those that would be eligible for such rewards," he said. Individuals with salaries in the $60,000 to $75,000 range are often now eligible for such incentives, but even this progress is as planned. Employers are not ready for significant changes to pay programs, particularly while the economy's recovery is so measured, he said.

Josh Wilson, an Atlanta-based partner with Mercer, a leading global human resources consulting firm headquartered in New York, said the 2011 salary-increase cycle, which peaked in March and April, missed some of the biggest recent leaps in gas and grocery prices. Raises for 2012, however, may begin to address bruised household budgets.

"A few months ago, people would have predicted 2.9% or 3.0% merit increases in 2012," Wilson said. "Given what's going on with inflation, it wouldn't surprise me if the number ticked up a little bit, maybe to 3.1% or 3.2%, but I wouldn't expect anything dramatic."

The consumer, he said, "bears more of the brunt of inflation, at least earlier, than companies do,"

In hotter industries, like pharmaceutical, energy and healthcare, average salary bumps are coming in a hair above the norm, at 3.0% or 3.1%, Wilson said. Across many sectors, employers are eager to retain their best talent and are extending raises to 6% or 7% of annual base pay when necessary, offsetting that with low or no increases for weaker performers, he said. A few years ago, the weakest typically saw a 3% increase and the strongest received a 5% raise.

Wilson also said that many companies are successfully passing on their higher raw-materials costs to customers, so that they can meet or exceed their planned payouts of bonuses and other incentives. But Wilson said that for non-management employees, salary increases are more meaningful than discretionary rewards.

When hiring, he said, starting salaries for top talent are nudging a bit higher than forecast.

"Hiring is happening slower than economists would have predicted on a nationwide basis, yet every company will tell you they're looking for strong performers and can't find them."

A compensation consultant in southwestern Pennsylvania whose clients are mostly in manufacturing and financial services said inflationary pressures are keeping a lid on employee costs, even if these employers are able to pass higher commodity costs along to their customers.

"A lot of the gains received in economic confidence have been going out in fuel costs and aren't being provided to employees as base-pay increases," said Rodney Cottrell, president of Corporate Compensation Partners, a boutique consultancy in Sewickley, Penn., just outside Pittsburgh. "The bottom line is that the budget still rules."

Even so, salary-increase budgets are approaching 3.0% to 3.2% again, up from zero to 2% during the recession, when static wages were quite common, Cottrell said.

"Wage freezes have gone away," he said. "One employer here took the extra step of after-the-fact pay increases."

But he expects employers to remain resistant to reflecting inflation in salary-increase budgets even in 2012. And with the inexorable rise in health benefit costs, he said, "real wages are going backwards, and they have for years." Even though the employee's share of benefits outlays appears to have steadied at a maximum of 70%, dollar increases continue. Unless employers carefully re-design their healthcare benefits packages, insurance costs are rising some 16% or 17% annually, and they have been for some time, he said.

On job creation, Cottrell said that outside of telecommunications and information technology, he's not seeing much beyond replacement hires.

"Manufacturing orders are up, and all of the signals are there, but there's just not a huge rush to add costs yet," he said, and added that companies are still more comfortable sitting on their expanding cash reserves.

Gordon Pavy, collective bargain director at the AFL-CIO, the Washington-based federation of 56 labor unions, said inflation isn't playing out in contract talks so far this year, but that may change in the summer and fall, when negotiations are slated for telecom giant Verizon and for automakers.

"Right now, first-year wage increases are at a very low point," Pavy said. "A lot are coming in at less than 2%. Some have freezes with increases in the out years." Raises are typically heftier in the second and third years of collective bargaining agreements. Some first-year base pay freezes have been accompanied by one-time lump-sum payments, which limit employers' fixed overhead, he said.

"If the economy doesn't point toward a double dip and shows some strength in the second quarter, I'm hopeful there'll be a return to more normal wage increases in the summer and fall - closer to 2.5% and 3%," he said.

For now, healthcare costs are the primary issue at the bargaining table, not wage increases, Pavy said. The union-employee burden appears to be limited to 20% to 25% in total, including paycheck contributions, co-payments and deductibles.

"We're still hopeful that the healthcare cost curve is going to start bending in our favor," as a result of the health insurance reform of 2010, he said.

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