The Tax Court held that a taxpayer who was the CEO and a member of the board of directors of a tax-exempt organization engaged in excess benefit transactions that were not corrected within the required period. As a result, the taxpayer was subject to the 25% Sec. 4958(a)(1) tax imposed on the receipt of the excess benefits and the 200% Sec. 4958(b) tax for failure to correct the transactions in a timely manner.
Facts: In 2003, Joan Farr founded the Association for Honest Attorneys (AHA) in Kansas as a Sec. 501(c)(3) tax-exempt organization. During 2010, 2011, and 2012, while a member of AHA's board of directors and its CEO, she used the AHA's checking account to make cash withdrawals and purchases from department stores, grocery stores, home improvement stores, and various other places totaling $6,964 in 2010, $27,233 in 2011, and $5,299 in 2012. The taxpayer did not report any income from the AHA on her individual returns for those years.
For tax years 2010, 2011, and 2012, the AHA filed tax returns as a Sec. 501(c)(3) organization and not as a private foundation. In 2015, the IRS sent a notice to the AHA that it was revoking the organization's tax-exempt status effective Jan. 1, 2010. The IRS also sent the taxpayer a notice of deficiency for 2010, 2011, and 2012 with an assessment of $9,874 for engaging in excess benefit transactions with the AHA in those years and an additional tax assessment for those years of $78,991 for failing to correct the transactions in a timely manner. The taxpayer petitioned the Tax Court for relief.
Issues: Under Sec. 4958(a)(1), a disqualified person who benefits from an excess benefit transaction with an applicable tax-exempt organization is subject to a tax equal to 25% of the excess benefit. A disqualified person includes any person in a position to exercise substantial influence over the affairs of the applicable tax-exempt organization during a five-year period ending on the date of the applicable transaction. Board members, the CEO, the COO, the CFO, and the treasurer of an organization, among others, generally are disqualified persons.
An excess benefit transaction is any transaction where a disqualified person receives an economic benefit from the tax-exempt organization with a value greater than the value provided by that person to the organization. Applicable tax-exempt organizations include Sec. 501(c)(3) tax-exempt organizations but do not include private foundations.
In addition to the Sec. 4958(a)(1) 25% tax, under Sec. 4958(b), a disqualified person receiving an excess benefit is subject to a tax equal to 200% of the excess benefit, unless the excess benefit transaction is corrected during the taxable period, defined as beginning on the date of the transaction and ending on the earlier of the date of mailing of a notice of deficiency or the date of the assessment of the 25% tax. A disqualified person can correct the transaction by paying the organization an amount equal to the excess benefit plus interest.
The taxpayer conceded that the AHA was an applicable tax-exempt organization and that she was a disqualified person. However, the taxpayer did not agree with the IRS that the purchases and cash withdrawals were excess benefit transactions. She contended that they were made for a business or an exempt purpose of the AHA, were compensation for her services rendered to the AHA, or were repayments by the AHA of loans she had previously made to the organization.
Holding: The court found Farr's testimony and evidence supporting her contention were not reliable, credible, or persuasive. Therefore, the court held that the purchases and cash withdrawals were excess benefit transactions subject to the 25% tax. The court also found that she had not corrected those transactions within the taxable period; therefore, Farr was also subject to the 200% tax.
- Farr, T.C. Memo. 2018-2
— By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.