IRS intermediate sanctions for nonprofit health providers and executives

Nonprofit health care providers must comply with tax laws governing executive compensation by paying executives what they are reasonably and competitively worth. If executive compensation benefits are excessive, both the particular executive and the managers involved in the transaction for the nonprofit health care provider could be subject to excise taxes.

Executive compensation is viewed broadly and includes not only wages, but also the value of certain fringe benefits.

Penalties for excess executive benefits

In case of violation, the executive, called the disqualified person with "substantial influence over the affairs of the organization" (and certain family members), is usually liable for a penalty tax of one-quarter of the excess benefit above what would have been reasonable. This tax is what is referred to as the intermediate sanction.

The executive must also correct the excess benefit within the applicable taxable period, meaning pay back the value of that part of compensation considered excessive, or an additional tax of 200 percent of the excess benefit may be assessed.

Any organization manager who participated in hiring the executive at an unreasonable compensation level and did so knowingly, willfully and without reasonable cause is normally liable for 10 percent of the excess benefit, capped at $20,000. Covered managers include officers, directors and trustees, and employees with similar power.

Potentially, depending on the circumstances, the IRS could seek to revoke the organization's tax-exempt status.

The rebuttable presumption in intermediate sanction cases

A nonprofit health organization must conduct the executive recruitment process with extreme care because if three procedures are followed, the IRS grants a legal presumption that the compensation package is reasonable:

  • The package is preapproved by authorized individuals of the organization who are without conflicts of interest.
  • The authorized individuals obtained and considered compensation data from similar organizations that hired executives with comparable qualifications and talents.
  • The deliberations and considerations used to make the compensation decision are carefully documented in detailed writing at the time.

If the organization obtains the presumption of reasonable compensation, the IRS can only overcome it with sufficient contrary evidence.

This is only a broad overview of intermediate sanctions. The IRS website contains helpful information about the topic.

This is an extremely important matter for nonprofit boards, which must compete to hire executives from within the pool of highly qualified individuals who can help fulfill the charitable missions of such health care organizations. The need to attract the best talent possible by offering attractive executive compensation packages must be balanced with the legal requirements of remaining nonprofit and complying with the IRS intermediate sanctions rules.

Because of the complexity of these laws and severity of negative consequences for noncompliance, it is essential for both health care executives negotiating employment contracts and for the nonprofit organizations seeking to hire talented, capable executives that legal counsel be on board to provide legal advice and proper guidance.

A lawyer will assist with gathering the data needed to understand what a compliant and reasonable executive compensation package looks like under the circumstances as well as negotiate, draft and review employment contracts.

Should the IRS question the hiring and compensation transaction, an attorney should be brought on board as early as possible to communicate with the agency on behalf of the client and begin negotiations with the IRS, if appropriate.

From offices in Pawling and Carmel, New York, the health law attorneys of Daniels Porco & Lusardi, LLP, represent both not-for-profit health care organization employers and executive medical professionals in intermediate sanctions matters in Hudson Valley, throughout New York State and in Connecticut.