Tax Reform Redefines ‘Reasonable’ Compensation For Nonprofit Execs

Steven Porter, December 20, 2017

Excise tax on salaries above $1 million could make competing for top talent even more expensive for nonprofit healthcare organizations.

One provision in the GOP’s tax reform bill—which is headed to President Donald Trump’s desk for a signature after the House passed the final version Wednesday morning in a 224-201 vote—will penalize nonprofit healthcare organizations that pay executives seven-figure salaries.

The measure, which imposes a 21% excise tax on compensation above $1 million for each of the five highest-paid employees of a nonprofit organization, promises to overhaul the way large hospitals and health systems compete for top talent. Compensation paid to licensed medical professionals for the performance of medical services is exempt.

Related: How 4 Healthcare Measures Weathered Tax Bill Reconciliation

It’s relatively common for the top executives of large healthcare nonprofits to make more than $1 million in a given tax year, as a HealthLeaders Media review of recent Form 990 filings with the Internal Revenue Service confirms. Moving forward, those organizations will have to recalibrate their financial priorities.

“It’s going to be a mess to begin with because I suspect most of those executives have employment contracts, and the organization is bound by contract to pay them,” says Gregory B. Lam, JD, managing partner of Copilevitz & Canter’s Kansas City office.

Beyond the hurdles related to existing contracts, affected organizations will likely do one of two things, Lam tells HealthLeaders Media. Either they will pay less and risk losing highly qualified executives to for-profit competitors who can pay more, he says, or they will continue to pay top dollar and incorporate the excise tax into their budgets.

“Or they’ll do a combination of those sorts of things so they try to create a balance yet at the same time not lose talent to the for-profit sector,” Lam adds.

Earlier this month, the National Council of Nonprofits published analysis of the proposed excise tax, which appeared in both the House and Senate version of the bill, suggesting that the change would “bring nonprofit pay rules in line with the for-profit cap on compensation.”

Nonprofit Quarterly’s Michael Wyland echoed that sentiment after the conference committee’s report.

“This change would bring nonprofit salary taxation in line with longstanding tax policy governing for-profit corporations,” Wyland wrote.

What’s ‘Reasonable’?

This excise tax is significant not only because it adds an expense to nonprofit payrolls but also because it renovates the structures that have guarded against excessive compensation for the past two decades.

“It obviously doesn’t preclude payment of that level of compensation, but it changes the historical rules for compensating principles of an exempt organization,” Lam says. “Those rules were always couched in terms of ‘reasonable’ compensation.”

Steven Porter

Steven Porter is editor at HealthLeaders Media.

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