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Intermediate Sanctions: Why You Should Be Concerned about Excess Benefit Transactions and How You Can Avoid Them

Intermediate Sanctions: Why You Should Be Concerned about Excess Benefit Transactions and How You Can Avoid Them. Jeffrey S. Tenenbaum Matthew T. Journy March 9, 2010. Intermediate Sanctions What are intermediate sanctions? How can they affect me and my organization?

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Intermediate Sanctions: Why You Should Be Concerned about Excess Benefit Transactions and How You Can Avoid Them

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  1. Intermediate Sanctions: Why You Should Be Concerned about Excess Benefit Transactions and How You Can Avoid Them Jeffrey S. Tenenbaum Matthew T. JournyMarch 9, 2010

  2. Intermediate Sanctions • What are intermediate sanctions? • How can they affect me and my organization? • What type of transactions give rise to intermediate sanctions? • Who may be subject to intermediate sanctions? • What are the penalties? • Why should I be concerned? • What can I do to avoid intermediate sanctions? © 2010 Venable LLP. All Rights Reserved.

  3. What are Intermediate Sanctions? • Internal Revenue Code (“Code”) section 4958 allows the Internal Revenue Service (“Service”) to impose penalties on “disqualified persons” who participate in or approve “excess benefit transactions.” • These penalties are commonly referred to as intermediate sanctions. • Similar to “private inurement” concept. © 2010 Venable LLP. All Rights Reserved.

  4. How Can Intermediate Sanctions Affect My Organization? • Intermediate Sanctions may be imposed in lieu of revocation: • Prior to implementation of 4958, the sole sanction that the Service could impose on organizations that engaged in private inurement was revocation. • With Code section 4958, the Service now has the ability to penalize each of the individuals who received impermissible benefits while continuing to recognize the organization’s tax-exempt status. © 2010 Venable LLP. All Rights Reserved.

  5. What Type of Transactions Give Rise to Intermediate Sanctions? • Intermediate sanctions may be imposed on “excess benefit transactions” • Code section 4958(c)(1)(A)defines an “excess benefit transaction” as any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to any disqualified person, if the value of the economic benefit provided exceeds the value of the consideration that the organization received for providing the benefit. © 2010 Venable LLP. All Rights Reserved.

  6. What Type of Transactions Give Rise to Intermediate Sanctions? • Common situations that may result in “excess benefit transactions” include: • Compensation; • Payments for services provided to the organization (e.g., back-office service providers); • Purchase of property by the organization or the sale of property to a disqualified person; and • Provision of certain fringe benefits (which may be “automatic” excess benefits). © 2010 Venable LLP. All Rights Reserved.

  7. Who May be Subject to Intermediate Sanctions? • Not all tax-exempt organizations are subject to Code section 4958. • Section 4958(e) provides that only “applicable tax-exempt organizations” are subject to the provisions of 4958. • Applicable tax-exempt organizations include: • Organizations exempt from tax under Code sections 501(c)(3) and 501(c)(4); and • Organizations that were exempt from tax under Code sections 501(c)(3) and 501(c)(4) at anytime during the 5-year period ending on the date of the transaction. © 2010 Venable LLP. All Rights Reserved.

  8. Who May be Subject to Intermediate Sanctions? • The Code section 4958 penalties may only be imposed on disqualified persons. • Section 4958(f) generally defines the term “disqualified person” to include: • Any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization; • Family members of individuals who are in a position to exercise substantial influence; • A 35-percent controlled entity; • Any person who is described above with respect to a supporting organization of the applicable tax-exempt organization; and • Certain donors and donor advisors with respect to donor advised funds. © 2010 Venable LLP. All Rights Reserved.

  9. Who May be Subject to Intermediate Sanctions? • Treas. Reg. Section 53.4958-3(c) lists specific persons who are in a position to exercise substantial influence, including: • Voting Members of the organization’s governing body; • President, CEO, COO; and • Treasurer and CFO. © 2010 Venable LLP. All Rights Reserved.

  10. Who May be Subject to Intermediate Sanctions? • Treas. Reg. section 53.4958-3(e) provides a facts-and-circumstances test for determining if other individuals who are not listed are in a position to exercise substantial influence. • Facts tending to show substantial influence include: • The individual who founded the organization; • The individual is a substantial contributor; • The individual's compensation is based on the organization’s revenues; • The individual has or shares authority to control a substantial portion of the organization’s expenditures; and • The person manages a discrete segment of the organization's activities. © 2010 Venable LLP. All Rights Reserved.

  11. What are the Penalties? • There are two types of penalties for entering into an excess benefit transaction: • Penalties on the disqualified person receiving the benefit; and • Penalties on organization managers who approved the benefit. © 2010 Venable LLP. All Rights Reserved.

  12. What are the Penalties? • Penalty for receipt of an excessive benefit: • Return the value of the excessive benefit to the organization; and • An excise tax of either: • 25% of the value of the excessive benefit if the benefit is returned to the organization prior to the issuance of a notice of deficiency by the Service, or • 200% of the value of the excessive benefit if the benefit is returned after the Service issues the notice of deficiency. © 2010 Venable LLP. All Rights Reserved.

  13. What are the Penalties? • Penalty on organization managers for approval of an excessive benefit transaction: • Section 4958(a)(2) imposes a 10% tax on any organization manager that knowingly approves an excess benefit transaction. © 2010 Venable LLP. All Rights Reserved.

  14. What are the Penalties? • Example: • Board approves the purchase of property from a disqualified person. The property’s fmv is $2,000 and the purchase price is $6,000. • The disqualified person may: • Be required to return $4,000 to the organization, and • Pay either $1,000 or $8,000 to the organization depending on the date that the excessive benefit is returned. • The total penalty would be either $5,000 or $12,000. • Each board member who approved the transaction may be required to pay an excise tax of $400. © 2010 Venable LLP. All Rights Reserved.

  15. Why Do You Need to be Aware of Intermediate Sanctions? • For many years the Service has been reluctant to impose intermediate sanctions, though this has changed in the last year. • In the last year we have seen the Service assess intermediate sanctions in more examinations than during the previous 5 years combined. • During a recent conversation with an attorney from IRS Office of Chief Counsel, we were told that the Service is developing cases for intermediate sanctions and that the Service will pursue these cases aggressively in court. © 2010 Venable LLP. All Rights Reserved.

  16. What Can You Do to Avoid Intermediate Sanctions? • Use caution when entering into transactions with disqualified persons. • Develop, implement, and follow a conflict of interest policy that prevents board members and organization executives from participating in decisions that impact them financially. • Require board approval and documentation of transactions before any payments are made. © 2010 Venable LLP. All Rights Reserved.

  17. What Can You Do to Avoid Intermediate Sanctions? • Establish the rebuttable presumption of reasonableness. • Under section 53.4958-6 of the regulations, if the organization takes certain precautions in approving a transaction, there is a “rebuttable presumption” that the transaction is at fair market value. • To establish the rebuttable presumption: • The transaction must be approved in advance by disinterested members of the organization's governing body; • The governing body must obtain and rely on valid comparability data in approving the transaction; and • The governing body must contemporaneously document its decision and the reason for its decision. © 2010 Venable LLP. All Rights Reserved.

  18. Jeffrey S. Tenenbaum 575 7th Street NW Washington, DC 20004 (202) 344-8138 jstenenbaum@venable.com Matthew T. Journy 575 7th Street NW Washington, DC 20004 (202) 344-4589 mjourny@venable.com Questions? © 2010 Venable LLP. All Rights Reserved.

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