Magazine article The CPA Journal

Intermediate Sanctions for "Excess Benefit Transactions"

Magazine article The CPA Journal

Intermediate Sanctions for "Excess Benefit Transactions"

Article excerpt

Federal intermediate tax sanctions became law on July 30, 1996, when President Clinton signed the Taxpayer Bill of Rights 2.

This legislation is likely to change the manner in which many tax-exempt organizations approach business transactions with corporate "insiders."

Penalty excise taxes may now be imposed as an intermediate sanction when an IRC section 501(c)(3) or 501(c)(4) organization engages in an "excess benefit transaction." In such an event, these excise taxes are imposed on "disqualified persons" receiving the excess benefit and on organization managers who knowingly participate in the transactions. The penalty is imposed upon the participating individuals, but not upon the exempt organization itself. Private foundations are not subject to these sanctions but remain subject to their existing regime under current law.

The committee report indicates that intermediate sanctions for excess benefit transactions are expected to be the sole sanction imposed, unless the excess benefit is significant enough to question whether the organization functions as a tax-exempt organization. Accordingly, revocation of the organization's taxexempt status, with or without accompanying excise taxes, is not a consideration except in the most extreme cases.

Excess Benefit Transaction

An "excess benefit transaction" is any transaction in which an economic benefit is provided directly or indirectly to a "disqualified person" and that benefit exceeds the value of the consideration (including performance of services) received by the organization. This would include the following types of transactions and financial arrangements: a) A "disqualified person" (i.e., an insider) engages in a nonfair-market-value transaction directly or indirectly with the tax-exempt organization; b) A "disqualified person" receives unreasonable compensation from the tax-exempt organization; or c) To the extent provided in Treasury Department regulations, a "disqualified person" receives payment based on the income of the organization in an arrangement that violates the private inurement prohibition.

The IRS will apply existing tax law standards in determining reasonableness of compensation and fair market value. In determining whether compensation is reasonable, the committee report suggests that the parties to a transaction can rely on a rebuttable presumption of reasonableness for a compensation package that was approved by an independent board or committee

1) composed of persons unrelated to and not controlled by the disqualified persons, 2) that relied on appropriate comparability data, and

3) that adequately documented the basis for its determination.

A rebuttable presumption would also result as to the reasonableness of the valuation of property transferred between an organization and a disqualified person if the transfer is approved by an independent board that uses appropriate comparability data.

Therefore, if these three criteria are met, compensation arrangements, for example, will have the benefit of a rebuttable presumption of reasonableness. Accordingly, intermediate sanctions cannot be imposed unless the IRS demonstrates sufficient contrary evidence to rebut the presumption.

Therefore, where appropriate, all compensation arrangements and decisions, as well as "insider transactions," should be approved in advance by an independent board or committee, using the best available relevant comparability data, and the boards should thoroughly document the basis for their determination. …

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