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Compensation What You Don’t Know May Cost You

Payroll compliance may not seem like a concerning issue to your organization. You have hired an outside payroll provider. That provider diligently pays employees every two weeks, remits payroll taxes, and files all necessary returns. However, unless you inform the payroll provider of all types of compensation, you may be underreporting.

For W-2 reporting purposes, non-cash benefits not expressly excluded from wages by the Internal Revenue Code need to be evaluated for inclusion on the employees’ Form W-2. Some common examples include company automobiles, housing allowances, employee-owned life insurance policies, gift cards, and social club dues. If these types of compensation are missed, payroll taxes will be underreported. The penalty for failure to deposit payroll taxes timely can be steep- from two to fifteen percent of the underreported liability.

Correctly capturing compensation on the W-2 is just one concern for your organization. The W-2 is the starting point for reporting compensation of top officials and key employees on the Form 990. The Form 990 will also include a break out of non-taxable benefits, including health insurance and employer contributions to retirement plans, among other things. Further, the governance questions within the Form 990 also ask if the process for reviewing compensation of top officials include review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision of a compensation package. In other words, the compensation needs to be reasonable under rebuttable presumption criteria.

Forming a compensation committee is one way to minimize any potential issues with reasonable compensation. Some options to assist the committee with determining the reasonableness of compensation include reviewing the Form 990 of other similar organizations, reviewing compensation surveys or studies, or hiring an independent compensation consultant. While not an exhaustive list, here are a few key questions for the compensation committee to consider:

  • Is the individual instrumental to the success of the organization?
  • Does the employee possess knowledge that would be difficult to replace?
  • Do general economic conditions support the level of compensation?
  • Does the compensation conform to the organization’s basic salary policy?
  • Was the compensation determined under an arm’s length transaction?

If this is overwhelming for your organization, you are not alone. Compensation can be a difficult area to navigate for exempt organizations of all sizes. Please do not hesitate to contact us for additional information specific to your organization.

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