Intermediate Sanctions on NPO Executive: Unreasonable Compensation Can Bring an Unexpected Tax Liability

By Kuhn, Nancy Ortmeyer | Journal of Accountancy, November 2001 | Go to article overview

Intermediate Sanctions on NPO Executive: Unreasonable Compensation Can Bring an Unexpected Tax Liability


Kuhn, Nancy Ortmeyer, Journal of Accountancy


A relatively recent tax on executives in the charitable sector is getting attention due to vigorous IRS enforcement and extensive new Treasury regulations issued in January 2001. This tax, sometimes referred to as an intermediate sanction (the ultimate being revocation of the NPO's exempt status), is imposed on executives whose compensation the IRS considers excessive. CPAs--and the NPO executives they advise--must plan carefully to avoid the tax. The law targets not only top executives but also their family members and family-controlled entities if any receive excess benefits.

Congress had passed IRC section 4958 as part of the Taxpayer Bill of Rights 2 and made it retroactive for transactions on or after September 14, 1995. The rules gave the IRS a tool to regulate the activities of exempt organizations--with or without revoking the organization's exempt status. CPAs should understand section 4958 and the new regulations to help guard against unexpected tax liability for NPO executives--the targeted taxpayers. (While NPOs themselves have no liability under section 4958, they are subject to other penalties.)

STATUTORY DEFINITIONS

Section 4958 imposes an excise tax on excess benefits received by a "disqualified person"--anyone in a position to exercise substantial influence over a qualifying organization's affairs. IRC section 501(c)(3) or 501(c)(4) entities are considered "qualifying organizations." Section 4958 does not apply to individuals employed by private foundations; executives of such organizations are already subject to similar IRC section 4941 self-dealing penalties.

There is a five-year look-back period starting with the transaction date. This means the IRS can look back five years from the date the executive received the excess benefit and impose the tax if he or she was a disqualified person at any time during this period. The term disqualified person can apply to that person's immediate family as well as to family-controlled entities. (The law defines control as 35% of the total combined voting power.) Congress clearly did not want executives to divert benefits to family members by way of family-controlled businesses or trusts. Independent contractors, including advisers, do not fall within these rules since they presumably do not hold positions of influence in the organization.

A parallel five-year look-back rule applies in determining qualifying organizations. If an entity was a section 501(c)(3) or (c)(4) organization at any time within the five years before the transaction date, section 4958(e) considers it a qualifying organization.

An excess benefit is one a disqualified person receives that exceeds the value of the benefit the organization gets in return, including the value of services he or she performs. For example, the IRS would consider an executive with a salary and benefits greater than those of comparable executives performing comparable work at similar organizations to be in receipt of an excess benefit subject to the section 4958 excise tax.

The legislative history shows that when valuing compensation, NPOs and their executives can use either for-profit or nonprofit comparables. In a footnote to the committee report accompanying the 1996 legislation, the House of Representatives said that "an individual need not necessarily accept reduced compensation merely because he or she renders services to a tax-exempt, as opposed to a taxable, organization." The 2001 regulations also specify executives can use for-profit comparables.

THE BINDING CONTRACT EXCEPTION

A transitional rule in the 1996 legislation allows an executive to continue receiving excess benefits when there is a long-standing affiliation between a disqualified person and the organization. Congress included this exception for written contracts that were binding on September 13, 1995, and, at all times thereafter, up to and including the transaction date.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Intermediate Sanctions on NPO Executive: Unreasonable Compensation Can Bring an Unexpected Tax Liability
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.