Periodically, the topic of nonprofit executive compensation arises. As a CPA working with healthcare organizations, I am often involved in structuring, reviewing and reporting on compensation plans for our clients.
On July 5, 2011, an article written by M. B. Pell was published in The Atlanta Journal Constitution addressing the topic of chief executive compensation at several tax-exempt, Atlanta area hospitals. In that article, a former state Department of Community Health Commissioner expressed an opinion that when a tax-exempt hospital’s CEO has a salary rivaling that of corporate executives, the charitable work [of such hospitals] is obscured by the pursuit of profit. The individual is quoted as saying [about high CEO salaries], “I think it makes a statement about what their priorities are, and I think that’s the bigger issue. It displays a lack of sensitivity for the communities they serve.” I disagree.
Tax-exempt organizations do not have shareholders in the traditional sense of the term. Generally, a tax-exempt entity is incorporated as a non-stock company. A tax-exempt hospital is governed by a board of directors which is required to include independent community leaders. Any excess earnings of such an organization must be reinvested into the entity rather than distributed to owners. Tax-exempt hospitals reinvest their earnings into improvements in healthcare services which may include new clinical programs, equipment, facilities, personnel and technology.
Congress and the Internal Revenue Service have adopted a number of rules that require nonprofit organizations to monitor compensation and other business practices. Tax-exempt organizations that pay excessive compensation to individuals may lose their tax-exempt status. Individuals that receive excessive compensation are subject personally to excise taxes that can total more than twice the amount of an excess payment. The members of the board that approve any such excessive payments may also be subject to excise taxes for authorizing such payments.
IRS regulations provide guidance with respect to setting the compensation of any individual that has substantial influence over the affairs of the entity. These regulations indicate that a tax-exempt organization should have an authorized body comprised of members acting free from any conflict of interest approve in advance the compensation arrangement in question using appropriate market data and document such approval in a timely manner. These regulations specifically address the issue of appropriate comparable market data and indicate that relevant data includes compensation paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions, and permit the use of compensation surveys compiled by independent firms. Sufficient market data is readily available to benchmark executive compensation at fair value.
Nonprofit hospitals are highly regulated, complex organizations. Many large Atlanta hospitals have annual operating revenues nearing or in excess of one billion dollars and employ 4,000 or more employees. The skills needed to effectively run such organizations are great. One of the primary skills these executives need is the vision to ensure that the hospital is financially viable for generations to come. In this era of decreased funding of public health programs, pressure on hospital revenues from managed care plans and increased competition from alternative healthcare providers, strong strategic vision is required. Hospital executives earn their pay, as do physicians, nurses and other employees. In my opinion, it would be unwise to arbitrarily set limits on compensation to obtain the skilled leaders needed to run such complex organizations.
Tax-exempt organizations have a duty to ensure their executives are paid at fair value within the framework of IRS guidance. The public should also recognize the need to pay for the talent required to ensure their community hospital will be operational tomorrow.