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Legal Memorandum: Taxes on Excess Benefit Transactions

Issue: How can tax-exempt organizations avoid taxation issues regarding compensation and benefit packages?

Area of Law: Tax Law
Keywords: Excess benefit transactions; Tax-exempt organizations
Jurisdiction: Federal
Cited Cases: None
Cited Statutes: IRC Section 4958; section 501(c)(3), section 501(c)(4)
Date: 05/01/2006

PLAYING IT SAFE – AVOIDING INTERMEDIATE SANCTIONS IN EXEMPT ORGANIZATIONS

ABSTRACT

The Internal Revenue Service (“IRS”) has stepped up its scrutiny of compensation packages and benefits in tax‑exempt organizations and is using IRC Section 4958 to sanction “disqualified persons” and organizational managers, rather than the organizations, for excess benefit transactions.  In 2002, the IRS issued final regulations that attempted to clarify several ambiguous provisions in the temporary regulations related to intermediate sanctions.  In addition, Tax Court rulings, IRS technical advice memoranda, and several private letter rulings address some recurring issues related to intermediate sanctions.   This article outlines how section 4958 works, describes the potential pitfalls for exempt organizations, including the problems created by loans to disqualified persons and other forms of possibly excessive compensation, and discusses how exempt organizations should respond in light of the final regulations, the Tax Court’s decision in Caracci v. Commissioner, 118 T.C. No. 25 (2002), and the other IRS rulings and memoranda.

INTRODUCTION

Tax-exempt organizations must be aware of the dangers that may arise from excess benefit transactions and the increased regulatory scrutiny.  When Congress passed the Taxpayer Bill of Rights 2 on January 30, 1996, it significantly changed the laws governing exempt organizations by adding section 4958 to the Internal Revenue Code.  Before section 4958, when the Internal Revenue Service (“IRS”) determined that a private person had benefited from an improper transaction with an exempt organization, it could only revoke the organization’s exempt status as a sanction.  Pursuant to […]

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