The IRS has released new guidance on excess benefit transactions (EBTs). So-called disqualified persons and organization managers who engage in such transactions with nonprofits face stiff excise taxes — also known as intermediate sanctions — under Section 4958 of the Internal Revenue Code. But not every transaction between disqualified persons and nonprofits is prohibited. Here’s what you need to know.
What’s an EBT?
An EBT generally is any transaction in which a nonprofit (other than a private foundation) pro- vides an economic benefit to a disqualified person that exceeds the value of the consideration received in exchange for the benefit. “Consideration” might include, for example, the performance of services. Although EBTs often involve unreasonable employment compensation, a variety of other transactions also can fall into the definition.
Disqualified persons include those:
- In a position to exercise substantial influence over the organization’s affairs,
- A disqualified person’s family members,
- 35% controlled entities (generally, entities in which disqualified persons have a 35% or greater stake),
- Persons involved with a related supporting organization,
- Donors or donor advisors involved in a transaction with a donor-advised fund (DAF), or
- Investment advisors to a DAF sponsoring organization.
A disqualified person who engages in an EBT is liable for an excise tax equal to 25% of the excess benefit. If the transaction isn’t timely corrected after the tax is imposed, an additional excise tax of 200% of the excess benefit is imposed. An organization manager found to have knowingly participated in an EBT could incur an excise tax equal to 10% of the excess benefit, up to $20,000.
Is there a rebuttable presumption?
Tax regulations provide a route for an organization to establish a “rebuttable presumption” that a certain transaction with a disqualified person isn’t an EBT. A rebuttable presumption is a legal principle that assumes something to be true unless proven otherwise. The requirements for such a presumption provide a roadmap for how organizations should handle transactions with disqualified people.
The regulations presume fair market value in arrangements involving employment compensation, the transfer of property or the right to use property. To start, the organization’s authorized body (for example, the board of directors or a board committee) must be composed entirely of individuals without a conflict of interest regarding a transaction.
The authorized body must approve the compensation arrangement or property transfer terms in advance. Additionally, the authorized body must obtain and rely on appropriate data as to comparability before making its determination. For example, it can use an independent compensation survey for functionally comparable positions or an independent appraisal of the property being transferred.
It must also adequately and “concurrently” document the basis for its determination as it was making the determination. This includes the transaction’s terms, approval date and who voted, as well as comparability data relied on and how it was obtained. Concurrent documentation means it’s prepared by the later of:
- The next meeting of the authorized body, or
- 60 days after the authorized body’s final action on the matter.
The comparability data is particularly important. If the above requirements are satisfied, the IRS can rebut the presumption only by developing sufficient contrary evidence to rebut the relevance of the data.
Is there help for small organizations?
Although small nonprofits may find the prospect of obtaining adequate comparability data daunting, IRS regulations provide some relief to nonprofits with annual gross receipts of less than $1 million. Your authorized body will be deemed to have appropriate data if yours details compensation paid for similar services by three comparable organizations in your community or similar ones.
Annual gross receipts are your average gross receipts during the three prior taxable years. But you must aggregate annual gross receipts of all organizations if your nonprofit is controlled by or controls another entity.
Don’t risk it
The potential repercussions of an EBT go beyond the financial costs for the disqualified persons and organization managers involved. Your nonprofit also could suffer bad publicity and reputational damage that harms your ability to raise funds. Consult with your CPA before entering any transactions with disqualified persons to avoid prohibited transactions.
TREAD CAREFULLY WITH THESE TRANSACTIONS
So when does an excess benefit transaction (EBT) occur? The new IRS guidance on EBTs identifies examples of transactions between a tax-exempt organization and disqualified person that could raise Section 4958 issues. These include:
- An organization’s payment of personal expenses for a disqualified person or family members,
- A disqualified person’s use of the organization’s vehicles or real property for personal reasons,
- A disqualified person’s lease of property to the organization for rent,
- Loans between the organization and a disqualified person (in either direction),
- Payments to a for-profit corporation owned by a disqualified person,
- Revenue-sharing arrangements, and
- An organization’s transfer of assets to or from a for-profit organization controlled by a disqualified person.
The IRS stresses that the above list isn’t all-inclusive. It’s a safe bet, though, that any such transactions will pique the interest of an IRS auditor.