IRS plan imperils `phantom' options
Not-for-profit hospitals and other tax-exempt organizations that want to offer deferred compensation programs for their top executives would have fewer choices under proposed regulations issued last week by the Internal Revenue Service.
The regulations are designed to eliminate tax advantages of mutual fund option programs, also known as "phantom" stock option plans, which have emerged in the past four years or so. The proposed regulations would require such options to be taxed when they are granted unless there's a "substantial risk of forfeiture" if the executive changes jobs or fails to meet other requirements. Even with a forfeiture risk, options would have to be exercised all at once, increasing the tax burden on the recipient.
To remain competitive with investor-owned companies in recruitment and retention, not-for-profit hospitals will have to rely more on alternatives such as jointly owned life insurance policies, supplemental executive retirement plans and account-based plans similar to 401(k)s that do impose a risk of forfeiture, experts said.
The crackdown comes as some not-for-profit healthcare leaders complain that it's becoming more difficult to attract and retain executive talent, particularly when for-profit companies can offer huge performance bonuses and stock options. For-profits also have more flexibility to offer deals that allow their executives to minimize tax liability by receiving compensation over years after they retire.
Not-for-profits "are already at a competitive disadvantage, and to get hit with this... that's tough," said Ralph DeJong, chairman of the health law department at Gardner, Carton & Douglas in Chicago.
John Self, a Tyler, Texas-based healthcare recruiter, noted that the IRS has approved some not-for-profit hospital gain-sharing arrangements with physicians, which he said "would be more contrary to the not-for-profit tradition."
Self said not-for-profits can't increase cash compensation without concerns about public appearance and the legal prohibition on private inurement. "They're going to lose one more strategy to provide competitive compensation packages," he said.
James Nelson, managing director at Clark Bardes Healthcare Group, a Minneapolis-based healthcare executive compensation consulting firm, estimated that 100 to 200 hospitals and health systems adopted the strategy, which was marketed by major accounting firms.
Nelson said his firm did not recommend options programs because they represented an "aggressive" interpretation of the tax code and other strategies have proven more effective.
Public comments on the proposed regulations are due Aug. 7, and a public hearing is scheduled Aug. 28. There is no deadline for the issuance of final regulations.