You Take High Road, I’ll Take the Low Road – and Neither One is Reasonable

Earlier today, my co-blogger Darryll Jones scooped me posted about the recent Chronicle on Philanthropy article on private foundation salaries.  Executive comp is a topic that’s a bit near and dear to my heart at the moment, as I just placed an article on the topic (look for “The Fallacies Behind the Excise Tax on ‘Excessive’ Charity Compensation”  in the Loyola University-Chicago Law Journal, Vol. 56, Issue 1, forthcoming!)  In that article, I’m in the odd position of advocating for the repeal of Code Section 4960, the excise tax on “excessive” compensation.  It’s hard defending $1.0 million plus charity salaries, but I guess someone has to do it.

Actually, ultimately what I wanted to defend – and to this extent I think Darryll and I might be in agreement, at least in some part – is that high does not equal unreasonable.  And, its corollary, low doesn’t equal reasonable, either.   Section 4960 reinforces the erroneous idea that $1.0 million is some kind of bright line test for what is excessive.   The reality is that $1.0 million is pretty arbitrary and not really related to regulating compensation at all, except to the extent it follows the competely failed model of the $1.0 million public company deduction limit in Section 162(m).

The real problem here is that we just can’t get comfortable with the idea that sometimes high IS reasonable.   We can’t seem to get over the troublesome notion that we’ve all bought into –  that people should be paid less for working for a charity.  “Donative labor theory” is pernious and forces charities to underpay, under hire, and under train, to the detriment of the sector.  Nonprofits that underpay and therefore have low expense ratios are rewarded and encouraged to keep cutting – just look at the atttention paid in the Chronicle article about expense to distribution ratios.    More regulators, more media coverage, and more donor anger isn’t helpful when all it does is reinforce the notion that low overhead is unreservedly and objectively good – even if it means a complete erosion of nonprofit capacity.

Oh, and by the way, plenty of excessive compensation occurs at levels below $1.0 million.  I’d venture a guess that more actually happens at that lower level.  Institutions that pay high salaries at least have the infrastructure to put the rebuttable presumption window dressing on (or its 4941 analog, for private foundations) and pay for compensation surveys.   There is at least a nod to reasonablness on the high end, while the IRS’ own studies show that there is a signficant lack of compliance with even the rebuttable presumption procedures across the sector.  In that study, the IRS fund that only about half of the organizations examined even attempted to meet all three prongs of the rebuttable presumption under Section 4958.  

The real problem, of course, is definiing reasonableness in terms of comparables when the entire market – nonprofit and for profit – feels off when we aren’t sure what we are exactly buying with these compensation packages.   The problem is worse for nonprofits, where the ultimate measure of value – shareholder profits – isn’t a thing.   So how do we measure successful administration in a meaningful way that isn’t a percentage of distributions?

Frustratedly, eww