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Saturday, July 12, 2008 | The bonuses and extra compensation collected by the president and other employees of a city of San Diego redevelopment department could run afoul of Internal Revenue Service regulations governing nonprofit organizations, experts said.
A number of nonprofit specialists called the Southeastern Economic Development Corp.’s bonus program unusual and said the way the agency pays its executive’s salary and employee bonuses could, if found to be tax law violations, result in fines to employees and board members and even cost the organization its nonprofit status altogether.
“They are certainly setting themselves up for real problems at some point,” said Bill Ramseyer, a Pasadena attorney who specializes in nonprofit organization.
A voiceofsandiego.org story, based on SEDC tax filings, this week revealed a clandestine system of bonuses and extra compensation that were unknown to the City Council and SEDC board, which both ultimately approve the agency’s budget. Subsequently, SEDC President Carolyn Y. Smith and board Chairman Artie M. “Chip” Owen said the chairman is solely responsible for setting Smith’s annual salary, though they pledged to change that 14-year-old practice.
The IRS has in recent years put a greater focus on excessive nonprofit compensation and requires nonprofit organizations to handle employee compensation transparently, document the process and ensure that the process is free of conflicts of interest.
Experts said the following issues could run the organization afoul of the IRS: the existence at SEDC of bonuses not tied to incentives; the fact that one individual rather than the board of directors or at least a board committee sets the president’s salary; and a board’s chairman business ties to a local developer.
An IRS spokesman said he couldn’t speak about any specific cases and there were no public indications that the IRS is investigating SEDC.
SEDC officials said the agency offers holiday bonuses, “acknowledgement” payments based solely on tenure and an annual lump sum payment that it calls a cost of living allotment. The agency also allows employees to periodically cash out unused vacation and sick days. Smith said last month that those payments are all contingent on the agency receiving sufficient tax revenue to pay for them.
The most serious problem, Ramseyer said, is that SEDC offers bonuses that aren’t tied to employee performance. Nonprofit bonus programs must be tied to performance and be used as an incentive, he said. Money can’t simply be distributed to employees because it’s there.
“If it’s just a Christmas bonus, if it doesn’t increase the incentive for the employee, that’s just a straight gift of nonprofit funds,” he said.
He called the SEDC bonuses a “classic example of nonprofit abuse” and said they violate the most fundamental rules governing nonprofits.
The potential penalty is the loss of an organization’s tax-exempt status, Ramseyer said.
The IRS violations are only relevant to SEDC because its structure is atypical for a government agency.
SEDC uses tax money to revitalize southeastern San Diego through beautification projects, the purchase of land on behalf of the city, and the subsidization of private commercial and residential development.
SEDC doesn’t fall directly under City Hall’s bureaucracy. Like its downtown counterpart, Centre City Development Corp., it is structured as a nonprofit agency with its own board appointed by the mayor. However, its major decisions, such as its budget and development agreements, must ultimately be approved by the City Council.
Unlike most nonprofits, SEDC’s funds do not come from outside donations but rather directly from tax funds.
SEDC officials didn’t respond to interview requests for this story. Corporate counsel Regina Petty said she would research the issues at a later time.
At CCDC downtown, Chief Financial Officer Frank Alessi calls the unique combination of government and nonprofit a “hybrid.”
“It confuses the hell out of the financial advisors,” Alessi said.
The IRS requires nonprofit organizations to use data from comparable for-profit and nonprofit organizations when setting executive compensation to guard against paying excessive salaries. It also requires organizations to document their pay decisions, make them transparent, and ensure that those in charge of making the decisions are free of conflicts.
It is a violation of the law for nonprofits to overpay their executive officers, Ramseyer said.
Linda Lampkin, research director at the Economic Research Institute, a company that surveys nonprofit salaries, said the IRS wants the most amount of money to go to the public good. “The money’s not to be used for personal gain for anyone involved in it. Thus, they have these rules,” she said.
A majority of SEDC board members and the City Council said they didn’t know about the bonuses, and Smith said a long-standing set of formulas was used to calculate a number of the extra payments, such as how long an employee had been at the agency.
In a previous interview, she said that the more than $100,000 she received in bonuses and extra compensation over the last four years was contained in SEDC’s budget and was therefore approved by the agency’s board of directors.
The budgets contain vague allotments for such things as bonuses and miscellaneous salary and wages, but don’t spell out the details of the bonus programs, such as how the money is distributed and to whom. Smith, who records show was the largest recipient of the bonuses among SEDC’s top officials, said she ultimately had control over how the money was dispersed.
“The IRS doesn’t particularly care for the situation where a powerful employee like the president sets their own compensation,” Ramseyer said. “That’s a violation of IRS policy at the very least.”
Smith and Owen, the SEDC chairman, said Owen has sole authority over setting her annual salary.
That also is unusual, the experts said. The compensation should be set by the board or a subcommittee of the board, Lampkin said.
“I don’t consider that the appropriate delegation of the board’s responsibility,” Ramseyer said. “In any case they have a responsibility to know what the numbers are.”
It is unclear what process Smith and Owen, as well as previous SEDC chairpersons, have undertaken in setting Smith’s salary, what document exists and what comparable salaries were used to arrive at her total compensation. The process doesn’t appear to have been done in any public setting.
Owen’s relationship with a developer that has a development agreement with SEDC also raises the questions of whether the setting of Smith’s salary is conflict-free, the experts said. Told of Owen’s relationship with the developer, Lampkin said, “I don’t have an official opinion on it, but I think it would be something that an IRS investigator would want to investigate.”
Bob Ottenhoff, president and CEO of GuideStar, a nonprofit research organization, said the IRS is going to determine that an organization has made a reasonable decision on executive pay if it can demonstrate documentation, the absence of a conflict and transparency.
If not, the IRS can impose an excise tax of 25 percent on any compensation that is determined to be excessive. If the employee doesn’t return the excess compensation to the nonprofit organization, the IRS can impose an additional 200 percent tax, according to GuideStar. Managers deemed responsible for approving the transactions can also be fined 10 percent of the excess benefit.
“When you’re a nonprofit you have certain advantages, you have contributions that are tax free. The price for that is playing by the rules that nonprofits play by, which is that they are set up for the public good,” Lampkin said.