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Legal Memorandum: Excess Benefit Transaction under I.R.C. 4958

Issue: Under federal law, what are the potential penalties for participating in an ‘excess benefit’ transaction under I.R.C. 4958?

Area of Law: Tax Law
Keywords: Excess benefit transaction; Participation; Potential penalties
Jurisdiction: Federal
Cited Cases: None
Cited Statutes: I.R.C. 4958, 4963(e), §§ 4962, 4963, §§ 4961(a), 4962(a); Treas. Reg. § 53.4958‑7(a), § 53.4958‑7(c), § 53.4958‑7(b)(4), § 53.4958‑7(e), § 53.4958‑1(a), § 53.4958‑1(d)(1); I.R.C. §§ 4961(a), 4962(a)
Date: 05/01/2005

The penalties for being involved in an excess benefit transaction can be extremely severe, and section 4958 empowers the IRS to require correction and to impose significant sanctions for excess benefit transactions.  The IRS attempts to correct the excess benefit transaction and place the exempt organization in a financial position similar to that in which it would have been “if the disqualified person were dealing under the highest fiduciary standards.”[1]  A disqualified person may correct the excess benefit by making a payment in cash or cash equivalents equal to the correction amount plus interest.[2]  If the excess benefit involved the transfer of specific property, the disqualified person may return the property, if the exempt organization agrees, along with any additional cash payment necessary to equal the correction amount.[3]  If the exempt organization no longer exists, the disqualified person must still correct the excess benefit transaction by paying the correction amount to another qualified organization.[4] The IRS is working on creating a voluntary compliance program for section 4958 issues that could include safe harbors and specific procedures for organizations to self-correct excess benefits.[5] 

In addition to requiring the correction, the IRS may impose a penalty on the disqualified person equal to 25 percent of the excess benefit; and, if the amount owed is not paid within the taxable period, the IRS may impose an additional tax equal to 200 percent of the excess benefit.[6]  If a disqualified person completes the correction of an excess benefit transaction within […]

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