Expansion on §4958 (the "Intermediate Sanctions" Rule)
Since the mid-1990s a rule addressed at the problem of improper
payments to certain individuals has been in effect. This rule
is sometimes referred to as the "intermediate sanctions"
rule. Before this rule about the only sanction the Internal
Revenue Service had when a §501(c)(3) improperly transferred assets
to a private interest was to revoke its exemption. In many
cases this was believed to be too extreme. The new rule provides
a sanction between doing nothing and revoking an organizations
This rule, prescribed under §4958 of the
Code, imposes a tax on "disqualified
persons" on the "excess benefit"
they have received from an "excess benefit
transaction." A tax is also imposed
upon board members who approved the transaction
knowing it was an excess benefit
transaction. An excess benefit transaction
is one in which a disqualified person receives
more from a §501(c)(3) organization than she
provides to the organization.
Thus, if a § 501(c)(3) nonprofit organization provides its executive
director with a compensation package that is far higher than that
received by other persons in comparable organizations in the same
geographical area who are performing services comparable to those
performed by the executive director, it may be found that the executive
director has been paid an unreasonable or excessive compensation
and a tax may be imposed on the executive director under §4958 of
the Code. Generally the tax will be on the amount of the compensation
package that was excessive. In some cases a tax will also
be imposed upon members of the board of the nonprofit who approved
the compensation package. An excessive compensation payment
is called an "excess benefit transaction" under §4958.
As will be explained below, payment of excessive compensation is
just one kind of excess benefit transaction. For anyone reviewing
a filers Form 990 to determine what it reveals about the filers
performance, it will be of obvious interest to learn that the filer
has engaged in an excess benefit transaction. Line 89b in
Part VI on page 5 asks whether the filer engaged in any excess benefit
transaction during the year (or whether it became aware of any excess
benefit transaction for a prior year). If the filer answers
the question "Yes," it must attach a statement explaining
each such transaction. See Item #7. Consequently, if
the reader of a filers Form 990 is troubled about the possibility
that the filer may be paying too high salaries, she will want to
look at Line 89b. This expansion elaborates on §4958 and excess
Here is an example. Suppose a §501(c)(3) organization pays
its executive director $500,000 when the compensation for persons
in comparable positions in the same geographical area is $300,000.
The executive director would be a disqualified person who received
an excess benefit of $200,000. A tax of 25% would be imposed
on the excess benefit (viz., $50,000). If the executive director
did not return the $200,000 to her organization on the earliest
of the date she was notified of the tax or the date when the 25%
tax was assessed, she would be subject to a second-tier tax of 200%
(viz., $400,000). Each board member who approved the compensation
knowing it was an excess benefit transaction would be subject to
a tax of 10% ($20,000). There would be no second-tier tax
on board members.
A "disqualified person" is defined as any person who
is in a position to exercise substantial influence over the affairs
of the organization. The Treasury Regulations under §4958
define disqualified persons as including (1) board members, (2)
presidents, chief executive officers or chief operating officers,
(3) treasurers and chief financial officers, and (4) those others
who facts and circumstances tend to show have substantial influence
over the affairs of the organization. It seems clear that
key employees would be disqualified persons under §4958.
What constitutes excessive or unreasonable
compensation? For this question the
Temporary Treasury Regulations under §4958 are
helpful. Here is what they say about
The value of services is the amount that would ordinarily be
paid for like services by like enterprises (whether taxable or
tax-exempt) under like circumstances (i.e., reasonable compensation).
Treas. Regs. §53.4958-4(b)(1)(ii).
Thus, generally speaking, to determine whether
someones compensation is reasonable a
comparison should be made of the compensation
being paid to persons doing similar jobs in
similar enterprises in the same geographical
If compensation is listed at Part V which appears to a reader to
be so high as to raise some question as to whether it might be excessive,
as will be discussed below, it is likely that the filer may have
developed some documentation supporting the compensations
reasonableness in order to comply with safe-harbor provisions of
the § 4858 regulations. A reader could request to see this
documentation. It is unlikely that the organization would
comply with her request. It would not be legally required
to. But such failure to comply in itself may be significant
to the reader. Under the § 4958 Treasury Regulations, compensation
arrangements between an organization and a disqualified person are
presumed to be reasonable if the following conditions are satisfied.
First, the board or a committee of the board has approved in advance
the compensation. Second, the governing body awarding the
compensation relied upon data as to comparable salaries. And
third, the board adequately documented the basis for its compensation
award. Thus, as suggested, documentation supporting the compensations
reasonableness may be available.
A reader of the Form 990 may be interested in
compensation information generally and not only
to determine whether a filer has paid anyone
excessively. For example, a reader may be
canvassing a number of similar organizations to
learn what they are paying their respective
executive directors. This has become an easy task
now that organizations' Forms 990 are available
on the Internet. Furthermore, if any one or more
of these organizations had prepared the
documentation just described and were willing to
share it with others, it would be very helpful
for this inquiry.
The payment of excessive compensation is not the only type of excess
benefit transaction. Any payment by a § 501(c)(3) nonprofit
to a disqualified person in which the nonprofit organization gets
back from the disqualified person less in value than it paid the
disqualified person would be an excess business transaction.
Thus, many self-dealing transactions between board members and the
nonprofits on whose board they sit may be excess benefit transactions.
For example, if a board member sells a building to his nonprofit
for $700,000 whose fair market value at the time of sale was only
$400,000, this would be an excess benefit transaction and presumably
a tax would be imposed on the $300,000 excess benefit. Self-dealing
transactions are discussed at #8.
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