Executive Departures: How Good is the Goodbye?
By Michael Conover
Like their for-profit counterparts, tax-exempt organizations routinely encounter situations involving the departure of a senior level executive. These situations range from celebratory endings of successful careers to disappointing departures after things don’t work out. The circumstances surrounding them can vary greatly, but departures almost inevitably involve some consideration of compensation/benefit issues.
In the midst of these situations, boards or individuals charged with overseeing or negotiating the particulars of a departing executive’s separation arrangement may sometimes fail to recognize that the compensation and benefits offered are covered by the IRS Intermediate Sanctions’ excess benefit provisions or other IRS constraints on the types of compensation and benefit transactions allowed in a tax-exempt organization. In addition, enhanced disclosure requirements and the general public’s outrage over excessive executive pay further heighten the potential repercussions from a separation arrangement.
Accordingly, a generous retirement arrangement bestowed upon an executive in recognition of years of service – and perhaps to make up for years of being underpaid – could present problems for the recipient and the organization rather than fulfill the original best intentions. Potentially more troublesome are the large payments representing months or years of compensation, continuation of top-shelf benefit coverage, etc. offered to an executive when things don’t work out.
The Intermediate Sanctions provisions have prompted many tax-exempt organizations to realize the benefits of a more formal approach to management of executive compensation and benefits (i.e., the presumption of reasonableness). Accordingly, information and advice about competitive practices, independent compensation committees, and thorough documentation of the entire governance/administrative process associated with leadership compensation have become a regular occurrence in these organizations.
In addition to supporting their compliance efforts, many organizations have also learned more about the unique issues associated with compensation and benefit practices for tax-exempt organizations (e.g., excise tax/penalties imposed on excess benefit transactions, incentive plan issues, restrictions on retirement/deferred compensation plans, etc.). Board members from the for-profit sector often had not been aware of these issues. And finally, some organizations have also discovered ways to improve the competitiveness and effectiveness of their pay and benefit programs.
Despite increased sophistication of their ongoing compensation and benefit programs for executives, some tax-exempt organizations fail to realize a need for similar prudence in structuring their separation arrangements – or fail to do so until the very late stages when it is sometimes very difficult to undo or withdraw earlier commitments. The risk goes well beyond unrealized expectations. Examples seen over the years include tax-free consulting fees; lump sum severance payment of two years’ compensation; and huge contributions/deferred compensation in the final three or four years of employment to achieve a nice retirement income and/or make up for low compensation over the years.
Tax-exempt organizations would be well advised to ensure that these aspects of executive departures are considered and incorporated in their compensation governance and administrative process:
Public Disclosure – sometimes even the most reasonable compensation/benefit arrangements attract negative comments because the rationale or actual arrangement requires a disclosure of a value in a particular year that is unusually large or out of proportion with respect to historical levels, other executives, etc. In these and sometimes more aggressive arrangements, media coverage may do little to help or may aggravate public perception. Outside advisors familiar with disclosure requirements can provide helpful insight on the form and timing of information that will become available in public filings.
Intermediate Sanctions – in the event the IRS successfully identifies an excess benefit, the recipient faces significant excess tax penalties (20% to 200%) along with a requirement for repayment (with interest) of the excess amount. In addition, board members and other staff that were associated with the excess benefit may be subject to penalties (10% of the excess up to $10,000). Proposed departure arrangements (e.g., retirement, severance, etc.) can be subjected to competitive analysis in just the same way that compensation and benefits practices are analyzed. Therefore, developing proposed departure arrangements with the benefit of this competitive data, along with thoughtful/documented deliberation of the compensation committee, can be of great value in helping the organization secure the presumption of reasonableness.
Allowable Compensation & Benefit – an organization should make sure that retirement plans/contributions, other types of benefits or funding vehicles are allowable for use as well as understand the pros/cons and costs (known and unknown) that may be associated with the approach(es) in question. Again, knowledgeable outside advisors like BDO can be of extraordinary value in assisting an organization to structure a sound arrangement.
Tax-exempt organizations would do well to ensure that the compensation committee is appropriately involved as departure arrangements are being formulated. The time spent to develop severance guidelines or plan retirement benefits in light of these considerations will go a long way in helping to ensure the organization’s desires for its departure arrangements are as successful as possible for all concerned.