If you are involved in the management of any tax exempt organization,
you need to get informed about some rules that can impose serious penalties
on the people who volunteer to serve on the board or who work (part time
or full time) in a management capacity.
For many years, the people who administer private foundations have been
subject to a variety of penalties and excise taxes on prohibited transactions.
These rules did not apply to public charities. Instead, when a publicly
supported charity was found to engage in similar self dealing transactions,
the only option available to the IRS was to remove the entity’s exempt
status. To cure that problem, the IRS convinced the Congress to apply similar
penalty rules on any self dealing transactions between any “disqualified
person” and the public charity.
Commerce Clearing House (a tax reference publisher) describes the law
as follows.
“Penalty excise taxes may now be imposed as an intermediate
sanction when a Code Section 501(c)(3) or 501(c)(4) organization engages
in an ‘excess benefit transaction’. These excise taxes are imposed on ‘disqualified
persons’ who improperly benefit from the transactions and on organization
managers who knowingly participate in the transactions.” [Taxpayer
Bill of Rights 2; Law and Explanation, Commerce Clearing House, 1-800-835-5224]
A “disqualified person” includes any person who is in a position to exercise
substantial authority over an organization’s affairs, regardless of their
official title. Generally, that would include directors, officers or trustees,
members of their families and any entities in which they own a 35% or greater
interest - for up to five years after the alleged excess benefit transaction
occurs.
For this purpose, an “excess benefit transaction” is any transaction
in which the value of the economic benefits (consideration) received by
the charity are not equal to the value of the benefits given. According
to an article in the January, 1997 Journal of Accountancy by Arthur
Cassill and Susan Anderson,
“If a charity gives its directors (or other person with
substantial authority) a compensation package greater than that of directors
of charities of comparable size, the director will be subject to a penalty
tax ...(and) any of the charity’s managers who agreed to the package knowing
it was excessive will also be subject to penalty taxes.”
The presumption seems to be that if the compensation package is more than
the average for comparable charities, it must be an excess benefit to the
director or other managers of the charity. In the first place, this could
prevent any charity from offering an above average compensation package
to attract an officer/manager to work for the charity. In addition, it
will make it nearly impossible for charities to compete with for profit
organizations for talent, but there appears to be an out for the charity.
If the charity has an independent review board to examine new compensation
agreements (and certain property transactions), the penalties can be avoided.
Speaking of penalties, they are certainly severe enough to get your
attention. The first “tier” penalty is 25% of the excess benefit. Any organization
managers who are found to have been aware of the transaction will be subject
to a penalty of 10% of the excess benefit - with a maximum of $10,000.
If the same kind of penalty is assessed again, the “second tier” penalty
will be 200% of the excess benefits received.
If your charity hasn’t looked into this yet, this would probably be
a good time to start. You should begin with IRC Section 4958. Some background
on this matter would be in the 1996 Taxpayer Bill of Rights 2. Your exempt
organization tax advisor should be able to get you the details.