Salk 2012- Compensating Trustees

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Addresses fixing and defending the compensation of private foundation trustees and managers.

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Salk 2012- Compensating Trustees

  1. 1. Setting and DefendingTrustee/Manager Compensation Edwin K. Hunter Hunter, Hunter & Sonnier March 14, 2012 Salk Institute’s Private Foundation Trustees’ Tax & Management Seminar
  2. 2. 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 Institutes Private Foundation Trustees Seminar
  3. 3. 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 Institutes Private Foundation Trustees Seminar
  4. 4. 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 Institutes Private Foundation Trustees Seminar
  5. 5. 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 Institutes Private Foundation Trustees Seminar
  6. 6. 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 Institutes Private Foundation Trustees Seminar
  7. 7. The Private Foundation game is changing rapidly!• Foundation assets 600,000,000 growing Non-Charitable Use Assets Current Dollars (thousands) 500,000,000• Rising PF charitable asset ratios 400,000,000• Program-Related Investments 300,000,000• Grant effectiveness 200,000,000 metrics• More trustee control 100,000,000 over investment strategies 0 2000 2002 2004 2006 1984 1986 1988 1990 1992 1994 1996 1998 40th Annual Salk Institutes Private Foundation Trustees Seminar
  8. 8. The Private Foundation game is changing rapidly!• Foundation assets growing• Rising PF charitable PSC asset ratios• Program-Related Blurred Investments Lines OF• Grant effectiveness metrics PF• More trustee control over investment strategies 40th Annual Salk Institutes Private Foundation Trustees Seminar
  9. 9. 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 Institutes Private Foundation Trustees Seminar
  10. 10. The Foundation Center’s PRI Read 40th Annual Salk Institutes Private Foundation Trustees Seminar
  11. 11. 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 Institutes Private Foundation Trustees Seminar
  12. 12. The Private Foundation game is changing rapidly!• Foundation assets growing Evolution of Default Investment• Rising PF charitable Standard asset ratios• Program-Related Ordinary Investments As If Your Safe List MPT Own Prudence• Grant effectiveness metrics• More trustee control over investment strategies 40th Annual Salk Institutes Private Foundation Trustees Seminar
  13. 13. The Private Foundation game is changing rapidly! Rapidly Vanishing Misconceptions1. Non-compensated trustees enjoy reduced exposure to liabilities for poor investments2. A trustee who parrots his personal investments in selecting the trust’s assets has strengthened his defenses3. Trustees can net trust breach gains against trust breach loses4. A fast trip to the bottom is okay if more or less everyone finds the bottom eventually5. No harm, no foul – where a risky investment eventually recovers value6. A trustee with everything in F.D.I.C. insured C.D.s can sleep soundly7. Acting on a broker’s professional advice automatically protects the trustee8. Portfolio diversification simply reflects the old adage “don’t put all your eggs in one basket” 40th Annual Salk Institutes Private Foundation Trustees Seminar
  14. 14. 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 40th Annual Salk Institutes Private paid to professionals Foundation Trustees Seminar
  15. 15. CompStatsCOF’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 Institutes Private Foundation Trustees Seminar
  16. 16. CompStats Our Stratified PF Universe40th Annual Salk Institutes Private Foundation Trustees Seminar
  17. 17. CompStats 990Reported Comp Expenditures 40th Annual Salk Institutes Private Foundation Trustees Seminar
  18. 18. CompStats Reported Comp (000) by PF Size PF Size <100,000 <Million140,000 <10 Million <50 Million120,000 <100 Million Larger100,00080,00060,00040,00020,000 0 1993 1995 1997 1999 2001 1994 1996 1998 2000 2002 40th Annual Salk Institutes Private Foundation Trustees Seminar
  19. 19. CompStats Poorly Designed Studies Fail to Identify Variables Courtesy of Randal40th Annual Salk Institutes Private Monroe Foundation Trustees Seminar
  20. 20. Statutory Constraints • Reg. §1.501(c)(3)-1(c)(2)• Private inurement • PF operated for other• Private benefit than charitable purpose• Taxable • A minimal amount expenditures forfeits exempt status• Self-dealing • Applies only to individuals• State fiduciary law whose relationship with• Minimum payouts an organization offers• Net investment them an opportunity to income excise tax make use of the organizations income or assets for personal gain 40th Annual Salk Institutes Private Foundation Trustees Seminar
  21. 21. Statutory Constraints • Must be more than• Private inurement incidental to forfeit• Private benefit exempt status• Taxable • Applies to outsiders, but expenditures foundation manager could• Self-dealing possibly fall within• State fiduciary law purview• Minimum payouts• Net investment income excise tax 40th Annual Salk Institutes Private Foundation Trustees Seminar
  22. 22. Statutory Constraints • IRC §4945• Private inurement • Treas. Reg. § 53.4945-6(b)(2)• Private benefit • Avoided by demonstrating• Taxable compensation paid in good expenditures faith belief that they were• Self-dealing – reasonable• State fiduciary – consistent with ordinary law business care and prudence• Minimum payouts • Fact and circumstances issue• Net investment • Objective proof of subjective belief income excise tax Annual Salk Institutes Private 40th Foundation Trustees Seminar
  23. 23. Statutory Constraints• Private inurement • IRC §4941(d)(1)(D)• Private benefit • IRC §4941(d)(2)(E) exception• Taxable – Personal services expenditures – Reasonable, not excessive• Self-dealing – Necessary to carryout exempt function• State fiduciary law • Resolved by objective proof of an objective fact, cf.• Minimum payouts taxable expenditure• Net investment • Treas. Reg. §53.4941(e)- income excise tax 1(e)(1)(I)- continuing transaction with penalty in each year or partial year, Fabonacci process 40th Annual Salk Institutes Private Foundation Trustees Seminar
  24. 24. Statutory Constraints• Private inurement • Related to IRC §508• Private benefit – Mandatory insertion of TRA 69 provisions in governing• Taxable instrument expenditures – Effort to mobilize AGs• Self-dealing • General obligation- put the• State fiduciary principals interest ahead of law your own• Minimum payouts• Net investment income excise tax 40th Annual Salk Institutes Private Foundation Trustees Seminar
  25. 25. Statutory Constraints• Private inurement • IRC §4942• Private benefit • IRC §4942(g)- qualified• Taxable distributions include expenditures reasonable and necessary• Self-dealing administrative expense• State fiduciary • Thus, compensation disallowed law as reasonable may subject PF to excise tax for failing to• Minimum payouts meet the 5% requirement if• Net investment there is no carry forward and income excise tax management plays close to the line 40th Annual Salk Institutes Private Foundation Trustees Seminar
  26. 26. Statutory Constraints• Private inurement • IRC §4940• Private benefit • Net Investment Income tax• Taxable base equals gross investment expenditures income and capital gain net• Self-dealing income reduced by investment deductions• State fiduciary law • IRC §4940(c)(3)(A)- “...there• Minimum payouts shall be allowed as a deduction• Net investment all the ordinary and necessary income excise tax 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 Institutes Private Foundation Trustees Seminar
  27. 27. 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 Institutes Private Foundation Trustees Seminar
  28. 28. 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 Institutes Private Foundation Trustees Seminar
  29. 29. 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 Institutes Private Foundation Trustees Seminar
  30. 30. The IRS Positions IRM Guidance to AuditorsPt 4, Ch 35, Sect 2-“Audit Techiques for BusinessReturns”- “The examiner should take into accountsuch factors as: nature of duties, background andexperience, knowledge of the business, size ofthe business, individuals contribution to profitmaking, time devoted, economic conditions ingeneral, and locally, character and amount ofresponsibility, time of year compensation isdetermined, whether alleged compensation is inreality, in whole or in part, payment for a businessor assets acquired, the amount paid by similarsize businesses in the same area to equallyqualified employeesAnnual Salk Institutes Private 40th for similar services, etc.” Foundation Trustees Seminar
  31. 31. IRC §162 Jurisprudence Kennedy, Jr. vs. Comr, 671 F.2d 167 (6th Cir. 1982)a. Employee qualificationsb. Nature, extent and scope of workc. Size and complexity of the businessd. Comparison of pay with others of similar gross and net incomee. Prevailing general economic conditionsf. Prevailing rates of compensation for comparable positionsg. Salary policy towards other employees 40th Annual Salk Institutes Private Foundation Trustees Seminar
  32. 32. IRC §162 Jurisprudence Kennedy, Jr. vs. Comr, 671 F.2d 167 (6th Cir. 1982)h. The amount of compensation paid to theparticular employee in previous yearsi. The success of the employee’s effortsj. Profitability of the businessk. 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 sizel. Unusual capability of employeesm. Bonuses not paid in the ratio of stock holdings 40th Annual Salk Institutes Private Foundation Trustees Seminar
  33. 33. 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 Institutes Private Foundation Trustees Seminar
  34. 34. Setting Defendable Compensation Contingent Arrangement EO Jurisprudence• People of God Community v. Com’r, 75 T.C. 127 (1980), organizations 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 compensationInstitutestheir efforts.” 40th Annual Salk for Private Foundation Trustees Seminar
  35. 35. 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 Institutes Private Foundation Trustees Seminar
  36. 36. 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 Institutes Private Foundation Trustees Seminar
  37. 37. Setting Defendable Compensation Moving Towards the Pixels Administration Formulating Job Investment Discription Direct Portfolio Staffing Supervision Setting Management Ascertainment Risk-Return Policy Measuring Performance Investment Review Selecting Hiring Portfolio Performance Managers Communication Tax & Other Compliance & Replacing Morale Managers Function Defining/Updating Mission Soliciting Proposals Setting Grant Guidelines Developing Mission Oriented Expertise Ascertaining “Client” Needs Developing and Deploying PRI Skills Communicating with “Clients” & Serving on “Client” Boards Community Relations 40th Annual Salk Institutes Private Charitable Mission Foundation Trustees Seminar
  38. 38. 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 Institutes Private Foundation Trustees Seminar
  39. 39. 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 Institutes Private Foundation Trustees Seminar
  40. 40. 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 Institutes Private Foundation Trustees Seminar
  41. 41. Setting Defendable Compensation Acquire the Opinion of a Comp ExpertEmbrace Avoid1. Engage expert before 1. Hiring expert after audit fixing compensation notice2. Expert with Qualified 2. Algorithm-statistical Appraiser character form studies3. Experts relied on by 3. Hired guns who general parties to transactions work in litigation context4. Experts accepted by a 4. Academics with no court variety of courts or deposition history5. Experts who interview 5. Experts who decline site trustees and managers visits and interviews6. Solid credentials 6. Jacks of all trades 40th Annual Salk Institutes Private Foundation Trustees Seminar
  42. 42. A webcomic of romance, sarcasm, math, and language Southern Half40th Annual Salk Institutes Private Foundation Trustees Seminar

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