We Did What?! Now What? – Nonprofit Organizations And Excess Benefit Transactions

This Freeman Law Insights blog provides an overview of the excess benefit transaction rules of 26 U.S.C. § 4958 and corresponding Treasury Regulations, 26 C.F.R. § 4958-1, et. seq.

Excess Benefit Transaction. Under the Internal Revenue Code, an excess benefit is the amount by which the value of the economic benefit provided by a tax-exempt organization directly or indirectly to or for the use of a “disqualified person” (i.e., a control person, director, officer, etc.) exceeds the value of the consideration, including the performance of services, received by the organization for providing such benefit.

Taxes Triggered. The Internal Revenue Code imposes a tax equal to 25% of the excess benefit on each excess benefit transaction. That 25% tax “shall be paid by” the disqualified person. In addition, the Code imposes a tax equal to 200% of the excess benefit in any case in which the 25% tax is imposed and the transaction is not corrected within the applicable taxable period. Thus, the amount of excess in an excess benefit transaction can trigger excise taxes assessed against the disqualified person who benefits from the transaction up to 225% of the excess involved.

Taxes Assessed Against the Organization’s Manager(s). The organization’s managers (i.e., those serving on the governing board or otherwise approving the transaction, as applicable) who knowingly participate in the approval of, or who acquiesce by silence to such a transaction can be assessed with an excise tax of up to 10% (up to $20,000) of the excess. The term “knowing” includes actual knowledge of and/or negligently failing to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.

Reasonable Cause. The managers may avoid the excise taxes under section 4958 of the Code if their participation is due to “reasonable cause,” meaning the manager exercised responsibility on behalf of the organization with ordinary business care and prudence.
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