Fixed Payments May Avoid Unreasonable Compensation at Nonprofits Reviewed by Momizat on . Internal Revenue Code § 4958 imposes excise taxes on the excessive portion of compensation paid by a non-profit organization. Excise taxes must be paid by “disq Internal Revenue Code § 4958 imposes excise taxes on the excessive portion of compensation paid by a non-profit organization. Excise taxes must be paid by “disq Rating: 0
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Fixed Payments May Avoid Unreasonable Compensation at Nonprofits

Internal Revenue Code § 4958 imposes excise taxes on the excessive portion of compensation paid by a non-profit organization. Excise taxes must be paid by “disqualified persons” who receive unreasonable compensation as well as by the individuals who approve it. Despite the “excise tax” label, these taxes are generally considered to be a severe form of penalty. In considering whether compensation is unreasonable, it is important to determine whether any part of the compensation qualifies as a “fixed payment.” This article discusses the excise tax, when the “reasonableness” test relates back and what is considered a “fixed payment.”

Fixed Payments May Avoid Unreasonable Compensation at Nonprofits

Internal Revenue Code § 4958 imposes excise taxes on the excessive portion of compensation paid by a non-profit organization. Excise taxes must be paid by “disqualified persons” who receive unreasonable compensation as well as by the individuals who approve it. Despite the “excise tax” label, these taxes are generally considered to be a severe form of penalty.

In considering whether compensation is unreasonable, it is important to determine whether any part of the compensation qualifies as a “fixed payment.”  

Internal Revenue Service (“IRS”) Regulation § 53.4958-4(a)(3)(ii) explains which payments or benefits are fixed payments. It says, “fixed payment means an amount of cash or other property specified in the contract or determined by a fixed formula specified in the contract, which is to be paid or transferred in exchange for the provision of specified services or property.” Fixed payments are distinguished because the property or the amount of cash is not subject to management’s discretion after the terms of a contract have been set. The amounts of such payments may be determined by a formula “provided that no person exercises discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus).”

As such, the term “fixed payment” could include a certain amount of cryptocurrency or an investment such as the future cash value of a life insurance policy after the employer commits to putting a certain amount into the policy each year.

Regulation § 53.4958-4(b)(2) addresses the timing of reasonableness determinations. Regulation § 53.4958-4(b)(2)(i) says, “The facts and circumstances to be taken into consideration in determining reasonableness of a fixed payment (within the meaning of paragraph (a)(3)(ii) of this section) are those existing on the date the parties enter into the contract pursuant to which the payment is made.”  

Regulation § 53.4958-4(b)(2)(iii) includes examples to “illustrate the timing of the reasonableness determination.” In the examples, H is the employee and G is the employer. 

In the first example, a disqualified person enters a multi-year employment contract that provides for payment of a salary and provision of specific benefits pursuant to a qualified pension plan and an accident and health plan. The example says, “The contract provides that H’s salary will be adjusted by the increase in the Consumer Price Index (CPI) for the prior year. The contributions G makes to the qualified pension plan are equal to the maximum amount G is permitted to contribute under the rules applicable to qualified plans. Under these facts, all items comprising H’s total compensation are treated as fixed payments within the meaning of paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of H’s compensation is determined based on the circumstances existing at the time G and H entered into the employment contract.”  

The second example involves the transfer of a car’s title to an employee under the condition that, if the employee fails to complete a certain number of years of service, title to the car will be forfeited back to the employer. It says, “Although ultimate vesting of title to the car is contingent on H continuing to work for G for x years, the amount of property to be vested (i.e., the type of car) is specified in the contract, and no person exercises discretion regarding the type of property or whether H will retain title to the property at the time of vesting. Under these facts, the car is a fixed payment within the meaning of paragraph (a)(3)(ii) of this section. Therefore, the reasonableness of H’s compensation, including the value of the car, is determined based on the circumstances existing at the time G and H enter into the employment contract.”

Based on the IRS regulations, the current value of an amount paid currently may not be a consideration. Instead, the timing of the reasonableness determination may be back when the compensation terms were established.

Severance pay often falls under the definition of fixed payment. For example, an employment contract may state that the employee will be paid a certain percentage of his or her base salary for a certain period following termination of employment. To determine the reasonableness of the severance, you may need to look back to the facts that existed and were known when the agreement was reached. Those facts may include the severance terms typically offered by similar organizations to similar employees at that time. The key facts may also include the anticipated value of any restrictive covenants that extend beyond termination of the individual’s employment. Common restrictions address nondisclosure of confidential or proprietary information, non-competition, and non-solicitation of employees.

The excise taxes under § 4958 are not limited to compensation paid to employees. They also apply to amounts paid to independent contractors who are disqualified persons. Section 4958(f) defines this term to include, among others, “any person who was, at any time during the five-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization.”

A similar rule applies to deductible compensation expense paid by for-profit entities. Regulation § 1.162-7(b)(3) says, “The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.”


Stephen D. Kirkland, CPA, CMC, CFF, is a compensation consultant with Atlantic Executive Consulting, LLC. He serves as an expert witness in cases involving potentially unreasonable compensation.

Mr. Kirkland can be contacted at (803) 724-1414 or through ReasonableComp.biz, at Stephen.Kirkland@AECG.biz.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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