salk 2012- compensating trustees
TRANSCRIPT
Setting and Defending Trustee/Manager Compensation
Edwin K. Hunter Hunter, Hunter & Sonnier
March 14, 2012 Salk Institute’s Private Foundation Trustees’
Tax & Management Seminar
Why pay at all? Egalitarian Answer
• Restricting board membership to those who can afford to work for nothing leads to an elitist organization.
• Imagine Congress composed of nothing but volunteers.
• Even successful families have members with financial difficulties that need compensation for their time.
40th Annual Salk Institute's Private Foundation Trustees Seminar
Why pay at all?
Market Driven Answer
• If incentives did not improve performance, businesses would pay a pittance to all of their employees.
• Illa nanscisceris cui solvis
40th Annual Salk Institute's Private Foundation Trustees Seminar
Why pay at all?
Pragmatic Answer • Many prioritize their
attention, time and energy… pro bono frequently finds the action stack bottom
• Treasury cited a notorious “inadequate oversight by volunteer boards of directors” when seeking intermediate sanctions for publicly-supported charities
• Even a tiny PF check can generate a healthy feeling of guilt… the dollar bill in the letter including a survey
40th Annual Salk Institute's Private Foundation Trustees Seminar
Why pay at all?
Political Answer
• A public perception of benefits flowing to those running private foundations blackens philanthropy’s image and leads to adverse legislation
• Or perhaps the public would be most impressed by getting the work done?
40th Annual Salk Institute's Private Foundation Trustees Seminar
Why pay at all?
Envious Answer
• Most publicly supported charities have voluntary boards… PFs should not differ
• Recall supra Treasury’s position on the need for intermediate sanctions because of ineffective public boards?
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
• Foundation assets growing
• Rising PF charitable asset ratios
• Program-Related Investments
• Grant effectiveness metrics
• More trustee control over investment strategies 0
100,000,000
200,000,000
300,000,000
400,000,000
500,000,000
600,000,000
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Non-Charitable Use Assets Current Dollars (thousands)
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
• Foundation assets growing
• Rising PF charitable asset ratios
• Program-Related Investments
• Grant effectiveness metrics
• More trustee control over investment strategies
BlurredLinesPF O
F
PSC
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
• Foundation assets growing
• Rising PF charitable asset ratios
• Program-Related Investments
• Grant effectiveness metrics
• More trustee control over investment strategies
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Foundation Center’s PRI Read
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
• Foundation assets growing
• Rising PF charitable asset ratios
• Program-Related Investments
• Grant effectiveness metrics
• More trustee control over investment strategies
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
• Foundation assets growing
• Rising PF charitable asset ratios
• Program-Related Investments
• Grant effectiveness metrics
• More trustee control over investment strategies
Evolution of Default Investment Standard
Safe ListOrdinary Prudence
As If Your Own MPT
40th Annual Salk Institute's Private Foundation Trustees Seminar
The Private Foundation game is changing rapidly!
Rapidly Vanishing Misconceptions 1. Non-compensated trustees enjoy reduced exposure to
liabilities for poor investments 2. A trustee who parrots his personal investments in selecting
the trust’s assets has strengthened his defenses 3. Trustees can net trust breach gains against trust breach loses 4. A fast trip to the bottom is okay if more or less everyone
finds the bottom eventually 5. No harm, no foul – where a risky investment eventually
recovers value 6. A trustee with everything in F.D.I.C. insured C.D.s can sleep
soundly 7. Acting on a broker’s professional advice automatically protects
the trustee 8. Portfolio diversification simply reflects the old adage “don’t
put all your eggs in one basket”
40th Annual Salk Institute's Private Foundation Trustees Seminar
CompStats Axe Grinders?
• COF & ASF Studies – Tiny sample
• COF <600 • ASF <400
– Self-selected – COF aggregates
community and public foundations with PFs
• Ambiguous unclear how respondents addressed – Travel & conferences – Liability insurance – Grant matching – Discretionary grants – Non-trustee fees
paid to professionals
40th Annual Salk Institute's Private Foundation Trustees Seminar
CompStats COF’s Median Fee Pronouncement
• Another tiny sample biased by self-selection
• Based on a median 12 person board
• Averages in the responding CFs and Publicly Supported Foundations
• Averages in zeros to produce a median
40th Annual Salk Institute's Private Foundation Trustees Seminar
CompStats Our Stratified PF Universe
40th Annual Salk Institute's Private Foundation Trustees Seminar
990 CompStats Reported Comp Expenditures
40th Annual Salk Institute's Private Foundation Trustees Seminar
19931994199519961997199819992000200120020
20,000
40,000
60,000
80,000
100,000
120,000
140,000
PF Size
<100,000
<Million
<10 Million
<50 Million
<100 Million
Larger
CompStats Reported Comp (000) by PF Size
40th Annual Salk Institute's Private Foundation Trustees Seminar
CompStats Poorly Designed Studies Fail to Identify Variables
40th Annual Salk Institute's Private Foundation Trustees Seminar
Courtesy of Randal Monroe
Statutory Constraints
• Private inurement • Private benefit • Taxable
expenditures • Self-dealing • State fiduciary law • Minimum payouts • Net investment
income excise tax
• Reg. §1.501(c)(3)-1(c)(2) • PF operated for other
than charitable purpose • A minimal amount
forfeits exempt status • Applies only to individuals
whose relationship with an organization offers them an opportunity to make use of the organization's income or assets for personal gain
40th Annual Salk Institute's Private Foundation Trustees Seminar
Statutory Constraints
• Private inurement
• Private benefit
• Taxable expenditures
• Self-dealing
• State fiduciary law
• Minimum payouts
• Net investment income excise tax
• Must be more than incidental to forfeit exempt status
• Applies to outsiders, but foundation manager could possibly fall within purview
40th Annual Salk Institute's Private Foundation Trustees Seminar
Statutory Constraints
• Private inurement
• Private benefit
• Taxable expenditures
• Self-dealing
• State fiduciary law
• Minimum payouts
• Net investment income excise tax
• IRC §4945
• Treas. Reg. § 53.4945-6(b)(2)
• Avoided by demonstrating compensation paid in good faith belief that they were – reasonable
– consistent with ordinary business care and prudence
• Fact and circumstances issue
• Objective proof of subjective belief
40th Annual Salk Institute's Private Foundation Trustees Seminar
Statutory Constraints • Private inurement • Private benefit • Taxable
expenditures • Self-dealing • State fiduciary
law • Minimum payouts • Net investment
income excise tax
• IRC §4941(d)(1)(D) • IRC §4941(d)(2)(E) exception
– Personal services – Reasonable, not excessive – Necessary to carryout exempt
function
• Resolved by objective proof of an objective fact, cf. taxable expenditure
• Treas. Reg. §53.4941(e)-1(e)(1)(I)- continuing transaction with penalty in each year or partial year, Fabonacci process 40th Annual Salk Institute's Private
Foundation Trustees Seminar
Statutory Constraints • Private inurement
• Private benefit
• Taxable expenditures
• Self-dealing
• State fiduciary law
• Minimum payouts
• Net investment income excise tax
• Related to IRC §508 – Mandatory insertion of TRA 69
provisions in governing instrument
– Effort to mobilize AGs
• General obligation- put the principals interest ahead of your own
40th Annual Salk Institute's Private Foundation Trustees Seminar
Statutory Constraints • Private inurement
• Private benefit
• Taxable expenditures
• Self-dealing
• State fiduciary law
• Minimum payouts
• Net investment income excise tax
• IRC §4942
• IRC §4942(g)- qualified distributions include reasonable and necessary administrative expense
• Thus, compensation disallowed as reasonable may subject PF to excise tax for failing to meet the 5% requirement if there is no carry forward and management plays close to the line
40th Annual Salk Institute's Private
Foundation Trustees Seminar
Statutory Constraints • Private inurement • Private benefit • Taxable
expenditures • Self-dealing • State fiduciary law • Minimum payouts • Net investment
income excise tax
• IRC §4940 • Net Investment Income tax
base equals gross investment income and capital gain net income reduced by investment deductions
• IRC §4940(c)(3)(A)- “...there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income....”
40th Annual Salk Institute's Private Foundation Trustees Seminar
The IRS Positions • Litigation of PF compensation issues relatively
uncommon • The sparse jurisprudence for the most part
features egregious facts • In general, disclosed data from Forms 990-PF
and 4720 show a low level of self-dealing penalties imposed for compensation issue
• “Facts and Circumstances” usually bars rulings- Rev. Proc. 2011-3, 2011-1 I.R.B. 111
• But, positions are nonetheless on the table, in large measure as a result of the for-profit compensation jurisprudence
40th Annual Salk Institute's Private Foundation Trustees Seminar
The IRS Positions For-Profit Concepts Accepted
• Pension for directors past personal services not self-dealing if not excessive-Rev. Rul. 74-591, 1974-2 C.B. 385
• Premiums for split-dollar for trustee permit excepted under IRC §4941(d)(2)(E) if total compensation not excessive- PLR 9539016
• Deferred compensation permitted as well- but distribution benefit on cash basis only
40th Annual Salk Institute's Private Foundation Trustees Seminar
The IRS Positions Reliance on Unvetted Conclusions
• TAM 9008001- total directors’ compensation >75% than COF average for foundations of its size – ≈1:2.4 compensation to grant ratio – agony, worry, stress, and humiliation
justification rejected – 40X expectation justification
rejected – Build-up method employed
• Kermit Fischer consistently cited – $4 to $5 per $1,000 of foundation
assets, plus 5% of foundation income.” – Claim that most foundations use
formula – Witness failed every qualified
appraiser test – Bank trust officer 40th Annual Salk Institute's Private
Foundation Trustees Seminar
The IRS Positions IRM Guidance to Auditors
Pt 4, Ch 35, Sect 2-“Audit Techiques for Business Returns”- “The examiner should take into account such factors as: nature of duties, background and experience, knowledge of the business, size of the business, individual's contribution to profit making, time devoted, economic conditions in general, and locally, character and amount of responsibility, time of year compensation is determined, whether alleged compensation is in reality, in whole or in part, payment for a business or assets acquired, the amount paid by similar size businesses in the same area to equally qualified employees for similar services, etc.”
40th Annual Salk Institute's Private Foundation Trustees Seminar
IRC §162 Jurisprudence Kennedy, Jr. vs. Comr, 671 F.2d 167 (6th Cir. 1982)
a. Employee qualifications b. Nature, extent and scope of work c. Size and complexity of the business d. Comparison of pay with others of
similar gross and net income e. Prevailing general economic conditions f. Prevailing rates of compensation for
comparable positions g. Salary policy towards other employees
40th Annual Salk Institute's Private Foundation Trustees Seminar
IRC §162 Jurisprudence Kennedy, Jr. vs. Comr, 671 F.2d 167 (6th Cir. 1982)
h. The amount of compensation paid to the particular employee in previous years i. The success of the employee’s efforts j. Profitability of the business k. Absence of the usual fringe benefits such
as a pension or profit sharing plan, stock options, etc. which are available to executives of other companies of comparable size
l. Unusual capability of employees m. Bonuses not paid in the ratio of stock
holdings 40th Annual Salk Institute's Private
Foundation Trustees Seminar
Setting Defendable Compensation Starting the Process
• Formal process in resolution or by-laws
• First step – Recommendation from
the chief executive – Compensation
committee report – Study from a
compensation consultant
– Resolution in a regular board meeting
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Contingent Arrangement EO Jurisprudence
• People of God Community v. Com’r, 75 T.C. 127 (1980), organization's net earnings inured to the benefit of private individuals where compensation based on a percentage of EO’s gross receipts with no upper limit, burden on tax payer to establish reasonableness
• World Family Corp. v. Comr., 81 T.C. 958 (1983)- exempt from taxation under §§501(a) and 501(c)(3) despite fund raisers receiving a percentage of contributions, stating “(t)he law places no duty on individuals operating charitable organizations to donate their services; they are entitled to reasonable compensation for their efforts.”
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Potential Conditions for Augmented Pay
Portfolio performance
Measured philanthropic results
Objectives achieved Obtaining a degree or
certification
Completion of a project within budget, such as • Installation of new accounting
system
• Construction of foundation facilities
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Reductionist Get Better Results
Break down and document the trustee’s task into its elements
Crude reduction might be Investments
Grants
Administration
Dig deeper
By my Park City Neighbor, Prof. Helga Kolb
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Moving Towards the Pixels
Function
Administration Investment
Charitable Mission
Tax & Other Compliance
DirectPortfolio
Management
Hiring
Formulating JobDiscription
StaffingAscertainment
Supervision
Communication&
Morale
SelectingPortfolioManagers
MeasuringInvestment
Performance
SettingRisk-Return
Policy
ReplacingManagers
Setting Grant GuidelinesSoliciting ProposalsDefining/Updating Mission
Ascertaining “Client” NeedsDeveloping Mission Oriented Expertise
Communicating with “Clients”&
Serving on “Client” Boards
Developing and Deploying PRI Skills
Community Relations
PerformanceReview
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Document Trustee Activity
• Periodic practice, perhaps every 5 years unless significant change has occurred
• Sampling is acceptable, but use common sense
• Maybe 25% of the board • Maybe during a calendar quarter • Don’t forget travel, attendance at
conferences, grantee functions, continuing education, monitoring investment advisor results, studying investment opportunities, reading articles and books, serving on other non-profit boards as a de facto representative of the foundation, education and study specific to program-related investments such as monitoring the activities of the PRI
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation Document Trustee Qualifications & Accomplishments
• Degrees and certifications • Professional compensation rates • Awards and recognitions • Experience and special
qualifications in areas supported by the foundation – e.g. experience and study specific to
area homeless issues – e.g. scientific/medical training for
research PRI proposals – e.g. years of site visits with particular
grantees – e.g. publications and presentations on
topics related to charitable mission
• Investment experience and success
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation
Isolate Direct Charitable Activities
• More non-operating foundations now choose direct action
• PRI’s take more care, monitoring and expertise than direct grants
• Ratio of charitable to investment assets climbing and usually require significant attention
40th Annual Salk Institute's Private Foundation Trustees Seminar
Setting Defendable Compensation
Acquire the Opinion of a Comp Expert
Embrace
1. Engage expert before fixing compensation
2. Expert with Qualified Appraiser character
3. Experts relied on by parties to transactions
4. Experts accepted by a variety of courts
5. Experts who interview trustees and managers
6. Solid credentials
Avoid
1. Hiring expert after audit notice
2. Algorithm-statistical form studies
3. Hired guns who general work in litigation context
4. Academics with no court or deposition history
5. Experts who decline site visits and interviews
6. Jacks of all trades 40th Annual Salk Institute's Private
Foundation Trustees Seminar
Southern Half
A webcomic of romance, sarcasm, math, and language
40th Annual Salk Institute's Private Foundation Trustees Seminar