It’s been more than six months since Gov. Cuomo’s Executive Order 38 (EO38), which changed how the state’s nonprofits can allocate certain resources, took effect, and for some organizations, grappling with the regulation has been a challenge.

But according to David M. Rottkamp and Anita L. Pelletier, there are best practices for navigating the new rules that may help to cut through the confusion. The two shared tips on becoming compliant with the order at the Foundation for Accounting Education’s Nonprofit Conference on Jan. 16.

EO38 set caps on how much nonprofit organizations that receive funding from the state government can compensate their executives (directors, trustees, officers or key employees, as defined on Form 990) and spend on administrative costs. In general, if a nonprofit organization gets more than $500,000 from the state government and at least 30 percent of their revenues over a two-year period, they cannot pay their executives more than $199,000 a year, and can devote no more than 25 percent of their resources towards administrative expenses. While the regulation sounds simple, it can actually get rather complex, as suggested by its sheer length, said Rottkamp, chair of the NYSSCPA’s Not-for-Profit Committee.

“It’s 174 pages long, double sided, so it’s good reading material when you’re on the beach somewhere in the Caribbean,” he joked.

Not every type of nonprofit organization is included in the regulation. Pelletier noted that, for executive compensation, exemptions include government units, people who provide childcare services under social services law, and professionals who are partners or shareholders of S corporations that provide services individually, which she said leaves out some practitioners like physicians.

According to Pelletier, there is the possibility that someone could occupy a dual capacity, seeming to both fit and not fit in the exempt category—for example, someone who is both a hospital’s executive director and its director of nursing or clinical services. How would an organization go about negotiating this?

“You can allocate their salary between the two positions,” she said. “So if they spend 50 percent in administration and 50 percent in their capacity as nursing director, and they make $300,000, [it would be] $150,000 and $150,000 … they’re under the cap.”

Still, Rottkamp warned that, when executing such a split, organizations must pay particular attention to funding sources, specifically how much comes from the state and how much comes from other sources, lest they draw the attention of government auditors.

“That allocation should be hand in hand with your general ledger and financials, as well as what goes on your cost reporting and contract reporting,” he said.

Another exception to this executive order is if the cap would put compensation to less than the 75th percentile of comparable organizations, which can be determined through an approved compensation survey, Pelletier said. To determine whether an organization fits this exemption, she said that organizations can use an existing industry survey, or even commission their own. However, she cautioned that if an organization wants to create its own survey, it needs to include reasonably similar organizations from the same sector. The comparison organizations need to be the same size, in terms of revenue, assets and budgets, be in the same general physical location where services are rendered and include similar executives, in order to be a true “apples to apples” comparison.

“If you’ve got a brand new executive working only a few years, you can’t compare [his or her] salary to what a 20 year veteran is earning and receiving because that is not comparing comparable information,” she said.

Reading the fine print

Pelletier stressed that all of these exemptions will only apply if an organization uses non-state funds to pay any compensation over $199,000. Moreover, because these exemptions are so strict, she also stressed the importance of documenting as much as possible. If an organization is trying to justify an exemption, she said, there needs to be supporting documentation justifying that exemption.

“Don’t just pull those contracts out of thin air, you really need to do due diligence and review whether an allocation is reasonable or not,” she said.

Rottkamp said that, a lot of the time, compensation questions are decided during executive sessions at board meetings, where people seldom take any notes.

“You’ve got to reiterate to your clients that when you go into executive session someone has to maintain documentation of that conversation, of who was in the room, what the discussion points were, what materials were used, and all deliberation points that went on,” he said.

The administrative expenses provision of the executive order, similarly, has exemptions. Pelletier said that program expenses are exempt, though what is and is not a program expense can sometimes be a matter of judgment. For example, said Pelletier, the salary and benefits of IT personnel might seem like they’re connected to administrative functions, but at the same time they can also provide support for program activities. Office supplies can have a similar ambiguity. Rottkamp added that legal expenses can also occupy a gray area, as it could mean working on program issues in addition to providing legal support for the administration. Much like with compensation, eligibility for exemptions starts with making sure resources are properly allocated and documented.

“You need documentation to include how you allocated it and why you allocated it,” Pelletier, said.

Rottkamp added that there are some types of expenses that are exempted entirely from this rule, including capital expenses, property rentals, mortgage or maintenance, tax payments, equipment rental, depreciation of interest expenses, and salaries and benefits of research staff. Also excluded are “nonrecurring or unanticipated expenses greater than $10,000.”

“For example, if you have an unanticipated lawsuit and can’t allocate it to program services, and if it’s more than $10,000 and not covered by insurance, you could exclude that from the calculation of limitation,” Rottkamp said. “So they did put a safety net there for organizations that have unanticipated expenses.”

More about EO38 is available in the January Tax Stringer article, Executive Compensation Limits under NYS Executive Order #38.