Public charities and social welfare organizations are subject to numerous rules and regulations affecting much of their day-to-day operations. The Internal Revenue Code limits what those organizations can do, with whom they may be involved and who may benefit from their dealings.
One major limitation is that the charities cannot arrange their operations to benefit private individuals (especially organization insiders). Under the code, the only penalty for improper insider dealings was revocation of the organizations tax-exempt statusa penalty deemed overly drastic if the violation was inadvertent or minor, and often therefore not enforced.
To remedy this situation, in 1996 Congress enacted code section 4958, which established penalty taxes (known as intermediate sanctions) that could be assessed against exempt organizations for improper dealings (called excess benefit transactions) with organization insiders (those considered disqualified persons).
The tax under section 4958 is twofold: (1) the disqualified person who received the benefit is subject to a 25% tax on the excess benefit and (2) if the benefit is not repaid within a specified period, that disqualified person is subject to a subsequent 200% tax.
In general, a disqualified person is someone who can exercise substantial influence over an organizations affairs, including
- Voting members of the organizations governing body.
- Those with the powers or responsibilities of the organizations president, CEO, COO, CFO or treasurer.
- Any individual (regardless of title) who has or shares ultimate responsibility for managing the organizations financial assets or who has authority to sign drafts or direct transfers of funds.
Two categories of individuals or entities will never be considered as having substantial influence:
- Other exempt charitable organizations.
- Any employee who receives total compensation of less than $80,000, is not in one of the disqualified person categories and is not a substantial contributor to the organization.
Those who are not specifically included or excluded are evaluated under a facts and circumstances test to determine whether they have substantial influence.
An excess benefit transaction is a transaction in which a disqualified person receives (directly or indirectly) an economic benefit if its value exceeds the consideration paid.
Certain benefits are not considered excess:
- Reasonable expenses for members attending meetings of an organizations governing body.
- The economic benefit a disqualified person receives solely as a member of the organization if that benefit is provided to the public for an annual membership fee of $75 or less.
- Economic benefits a disqualified person receives solely as a member of a charitable class that the organization intends to benefit.
In addition, certain revenue-sharing arrangements may be excess benefit transactionsdepending on the relationship between the size or amount of the benefit provided and the quality and quantity of services provided or depending on the ability of the recipient of the compensation to control the activities generating the revenues on which compensation is based.
For a discussion of intermediate sanctions and other current developments, see the Tax Clinic, by Edward Sair, in the March 1999 issue of The Tax Adviser .
Nicholas Fiore, editor
The Tax Adviser