IRS to Hospital Executives and Boards: You're doing what we told you to do, but we're not sure we're happy

As we noted on our website, in February 2009, the IRS released the Final Report on its Non-Profit Hospital Study. The study, and the bulk of the report, focused on the "community benefit" provided by the hospitals, but also addressed executive compensation, through questions on a questionnaire sent to over 500 hospitals and a more detailed examination of the executive compensation practices of 20 hospitals.

And this is where it gets interesting: The "Intermediate Sanctions" process, which imposes penalties for excess executive compensation (on both the executive and the board) is something for which the IRS sought legal authority from Congress back in the 1990s, to give it an enforcement tool less drastic than revoking an organization's tax exemption. As many if not most of our readers know, the IRS regulations for Intermediate Sanctions enable the hospital or other non-profit to establish a "safe harbor" (called the "rebuttable presumption" in the regs) by following certain procedures: an independent governing body, use of appropriate comparability data, and proper documentation of the compensation decision.

And what did the IRS study find? According the Executive Summary, "nearly all" the compensation amounts examined were established in accordance with the rebuttable presumption regs and were "within the range of reasonable compensation."

But is the IRS satisfied? Apparently not, and perhaps this means that the extensive adverse publicity regarding executive compensation in areas of the economy far removed from non-profit hospitals (and, we should add, involving pay levels far beyond those of hospital CEOs) is making itself felt in the IRS Exempt Organizations section. The Executive Summary's acknowledgement of general compliance by the examined hospitals is grudgingly prefaced "[A]lthough many of the compensation amounts reported may appear high to some . . ." (and who are those "some"?). But more revealing is a talk given in January, before the Report was issued, by Steven Miller, the IRS Commissioner for Tax Exempt and Governing Entities. Commissioner Miller, too, acknowledges that the study found general compliance with the IRS regulations for setting executive compensation, but he, too, says that the unidentified "some" will think the compensation of top management is high - and not just "may" but "will." One paragraph later, he focuses on the 20 hospitals selected for detailed examination in the study and while again acknowledging their executive compensation was reasonable "under the current standard," and "permissible under current law,"he then says "but (it) was pretty high" and "I wonder how it will be perceived in the court of public opinion." We've added the italics because this says to us that a very key person at the IRS is looking at public opinion on executive compensation on nonprofit hospitals - as he reads that public opinion - and not only looking at it, but saying he agrees with it, and that the "current" rules may not be with us forever.

Incidentally, the report contains many interesting statistics about hospitals' executive compensation practices, including such issues as who sets the compensation (the board, a compensation committee, etc.) , and the tools used (such as compensation consultants, published surveys, and internet research). In particular, the Executive Summary of the Report notes the "widespread use" of compensation consultants and comparability data in setting executive compensation. Perhaps not surprisingly, the sophistication and detail of the process tended to increase with revenue size.