Recently, some of the most popular questions among executive directors/CEOs or their compensation committees have been about the most appropriate peer group selection methodology, according to WTW’s executive compensation analyses. These questions led us to carefully consider what constitutes appropriate data for comparability under Internal Revenue Code Section 4958.
A key aspect of the comparability analysis is accurately sizing an organization. Depending on the mission and business strategy, size may be defined in a variety of ways, including operating budget, revenue or assets.
Once the size criteria are established, questions often arise regarding which financial statements should be used to determine the anchor point for measuring the range of comparably sized peers. Organizations must decide whether to include their related or affiliate organizations in the financials to identify an appropriate peer group.
To determine whether an organization is controlled for this purpose, we recommend first relying on an evaluation of the entities’ relationships; specifically, whether there is common control through board of director crossover between entities. In short, if a majority of the board members of one organization also serve on the board of another organization, this overlap can indicate a common control. This is particularly evident when these shared directors have significant influence over the strategic decisions of both entities.
Additionally, organizations must report controlled entities on their Forms 990. If a disclosure does not exist, we assume they are not controlled for purposes of sizing the peer group.
Once an organization is properly sized, the range around the scoping anchor points helps define the proper peer group. This critical step may be overlooked, but it is essential to ensure market competitive pay for disqualified persons and a defensible pay program from the IRS’ perspective.
The IRS has been actively enforcing regulations on excessive compensation for tax-exempt organizations. Additionally, IRC Section 4960 requires tax-exempt organizations that pay more than $1 million to certain covered employees to pay an excise tax on the overage. Thus, the overage needs to be justifiable based on defensible market pay analyses. IRS enforcement and general good governance underscore the importance of accurately determining and justifying compensation levels to avoid potential penalties.
