[Federal Register Volume 63, Number 149 (Tuesday, August 4, 1998)]
[Proposed Rules]
[Pages 41486-41506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20419]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 53 and 301
[REG-246256-96]
RIN 1545-AV60
Failure by Certain Charitable Organizations To Meet Certain
Qualification Requirements; Taxes on Excess Benefit Transactions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to the
excise taxes on excess benefit transactions under section 4958 of the
Internal Revenue Code (Code), as well as certain amendments and
additions to existing Income Tax Regulations affected by section 4958.
Section 4958 was enacted in section 1311 of the Taxpayer Bill of Rights
2. Section 4958 generally is effective for transactions occurring on or
after September 14, 1995. Section 4958 imposes excise taxes on
transactions that provide excess economic benefits to disqualified
persons of public charities and social welfare organizations. The
proposed regulations clarify certain definitions and rules contained in
section 4958.
DATES: Written comments and requests for a teleconference must be
received by November 2, 1998.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-246256-96), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (REG-246256-96),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Phyllis D.
Haney of the Office of Associate Chief Counsel (Employee Benefits and
Exempt Organizations), (202) 622-4290; concerning submissions, LaNita
VanDyke, (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). Comments on the collections of information should be
sent to the Office of Management and Budget, Attn: Desk Officer for the
Department of Treasury, Office of Information and Regulatory Affairs,
Washington, DC 20503, with copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.
Comments on the collection of information should be received by October
5, 1998. Comments are specifically requested concerning:
Whether the proposed collections of information are necessary
for the proper performance of the functions of the Internal Revenue
Service, including whether the information will have practical
utility;
The accuracy of the estimated burden associated with the
proposed collections of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collections of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of service to provide information.
[[Page 41487]]
The collections of information in this proposed regulation are in 26
CFR 53.4958-6(a)(2), 53.4958-6(a)(3), 53.4958-6(d)(2), and 53.4958-
6(d)(3). This information is required for an applicable tax-exempt
organization to avail itself of a rebuttable presumption that payments
under a compensation arrangement between the organization and a
disqualified person are reasonable, or a transfer of property, right to
use property, or any other benefit or privilege between the
organization and a disqualified person is at fair market value. This
information will be used by the organization's governing body, or
committee thereof, to document the basis for its determination that
compensation was reasonable or any other benefit was at fair market
value. The collections of information are required to obtain the
benefit of this rebuttable presumption of reasonableness. The likely
recordkeepers are nonprofit institutions.
Estimated total annual recordkeeping burden: 910,083 hours.
The estimated annual burden per recordkeeper varies from 3 hours to
308 hours, depending on individual circumstances, with an estimated
weighted average of 6 hours, 3 minutes.
Estimated number of recordkeepers: 150,427.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document provides rules regarding section 4958 excise taxes on
excess benefit transactions. Section 4958 was added to the Code by the
Taxpayer Bill of Rights 2, Public Law 104-168 (110 Stat. 1452), enacted
July 30, 1996. The section 4958 excise taxes generally apply to excess
benefit transactions occurring on or after September 14, 1995. They do
not apply, however, to any benefit arising from a transaction pursuant
to any written contract that was binding on September 13, 1995, and
continued in force through the time of the transaction.
An excess benefit transaction subject to tax under section 4958 is
any transaction in which an economic benefit provided by an applicable
tax-exempt organization to, or for the use of, any disqualified person
exceeds the value of consideration received by the organization in
exchange for the benefit. An excess benefit transaction also includes
certain revenue-sharing transactions. An applicable tax-exempt
organization is any organization described in section 501(c)(3) (except
private foundations) or section 501(c)(4) at the time of the excess
benefit transaction or at any time during the five-year period ending
on the date of the transaction. The excess benefit is generally the
excess of the value of the benefit provided to a disqualified person
over the value of the consideration received by the organization.
A disqualified person is any person who was, at any time during the
5-year period ending on the date of the excess benefit transaction, in
a position to exercise substantial influence over the affairs of the
organization. A disqualified person also includes any family member of
a person described in the preceding sentence or any entity in which at
least 35 percent of the control or beneficial interest is held by such
a person.
There are three taxes under section 4958. Disqualified persons are
liable for the first two taxes, which are imposed as follows: Pursuant
to section 4958(a)(1), a tax of 25 percent of the excess benefit must
be paid by any disqualified person who benefits from an excess benefit
transaction with an applicable tax-exempt organization. Pursuant to
section 4958(b), a tax of 200 percent of the excess benefit must be
paid by any disqualified person who benefits from an excess benefit
transaction if that transaction is not corrected before the earlier of
either the date a deficiency notice is mailed with respect to the 25
percent tax or the date the 25 percent tax is assessed.
Certain organization managers are liable for the third tax, which
is imposed as follows: Pursuant to section 4958(a)(2), a tax of 10
percent of the excess benefit must be paid by any organization manager
who participates in an excess benefit transaction knowingly, willfully,
and without reasonable cause. An organization manager is an officer,
director, or trustee of the organization, or any individual having
powers or responsibilities similar to those of an officer, director, or
trustee. The tax that must be paid by participating organization
managers for any one excess benefit transaction cannot exceed $10,000.
The IRS notified the general public of the new section 4958 excise
taxes in Notice 96-46 (1996-2 C.B. 112). Notice 96-46 also solicited
comments to be used in drafting these proposed regulations.
Comments Received Pursuant to Notice 96-46
In response to its request for comments in Notice 96-46, the IRS
received 28 comment letters addressing a variety of topics pertaining
to section 4958. Some general comments requested that in applying the
section 4958 excise taxes the IRS avoid creating administrative burdens
on the vast majority of charities and only scrutinize a narrowly
targeted group of charities prone to abuse the inurement prohibition.
Most comments, however, focused on specific definitions or other
statutory language in section 4958. A brief summary of the most
frequently made suggestions follows. All of the comments were given
consideration in preparing these proposed regulations.
Commentators made suggestions regarding the definition of
disqualified person, including applying a facts and circumstances test
that annunciates only general principles; using a test that does not
treat all of an organization's officers as necessarily being
disqualified persons; deferring to an organization's own internal good-
faith identification of disqualified persons; treating certain donors
as disqualified persons under standards similar to those for private
foundation substantial contributors; clarifying that a donor is not in
a position to exercise substantial influence over the affairs of an
organization solely by reason of having made a large donation;
including as disqualified persons those persons who provide advice and
consultation to organizations regarding potential excess benefit
transactions; providing that a person does not become a disqualified
person with respect to a transaction as a result of the transaction
(thus a person who negotiated a compensation arrangement in good faith
before entering into an employment relationship would not become a
disqualified person by virtue of the negotiation); and excluding
certain independent contractors from disqualified person status.
Commentators on the tax to be paid by organization managers who
participate in an excess benefit transaction knowingly, willfully, and
without reasonable cause suggested the following: defining organization
manager narrowly; using the principles of the regulations under
sections 4946 and 4955 in defining organization
[[Page 41488]]
manager; excluding in-house counsel and independent contractors
(attorneys, accountants, etc.) from the definition; using an
organization's bylaws as the source of determining whether an
individual is an officer, director, or trustee; excluding managers who
voted against an excess benefit transaction from joint and several
liability for any 10% tax associated with the transaction; using the
definitions in current section 4946 private foundation regulations for
knowing, willful, and reasonable cause; allowing managers to rely on
advice of legal counsel to prove their participation in a transaction
was due to reasonable cause, and expanding the category of persons
qualified to render opinions with this effect. Although the proposed
regulations provide that only advice of counsel in a reasoned written
legal opinion protects organization managers in this regard, the IRS
invites further comments on this topic. The IRS also requests that such
comments address whether, to be consistent on this point, other
regulations (e.g., Sec. 53.4941 and Sec. 53.4945) should be amended as
well.
Numerous comments were received on determining reasonable
compensation for services and fair market value in sale or exchange
transactions. Commentators asked the IRS to use existing law standards
under section 162 for determining reasonable compensation and to
provide special standards for new organizations in the start-up phase
of operations. With respect to compensation, some commentators also
requested objective standards or charts of reasonable compensation
amounts; others requested that the regulations not impose strict dollar
limitations on what would constitute reasonable compensation.
Several commentators made suggestions regarding the requirement
that an organization must demonstrate its intent to treat economic
benefits as compensation in order to treat the benefit as being
provided in exchange for services. These suggestions included using a
facts and circumstances test to determine whether an organization
clearly indicated its intent to treat a benefit as compensation;
considering certain small amounts inadvertently not included in a
disqualified person's reported compensation as de minimis and not
triggering section 4958 taxes; and allowing a reasonable cause
exception under which items that were not reported as compensation
could still be treated as provided in exchange for services.
A number of commentators requested that the definition of an excess
benefit transaction exclude the provision of certain types of benefits
to a disqualified person. These benefits included economic benefits
made available to the general public on at least as favorable a basis;
economic benefits that are de minimis fringe benefits under section
132; reimbursements for expenses of administration of an organization;
and incidental benefits.
Commentators provided a wide range of suggestions on the subject of
which revenue-sharing arrangements should constitute excess benefit
transactions. Suggestions included incorporating existing IRS
unpublished guidance in a safe harbor rule; using the principles of
Rev. Rul. 69-383 (1969-2 C.B. 113), to determine whether a particular
plan of compensation results in prohibited inurement or private
benefit; limiting the category of revenue-sharing arrangements that
constitute excess benefit transactions to arrangements based on the
organization's revenues only; and applying regulations on revenue-
sharing arrangements prospectively, with transition rules for existing
arrangements.
Many comments were received on the rebuttable presumption of
reasonableness that is described in the legislative history as arising
when a board of directors approves certain compensation arrangements or
other transactions. The following suggestions were submitted in
multiple comments: that the presumption apply when an applicable
organization's board approves general guidelines for entering into
transactions with disqualified persons rather than voting on each
individual transaction; that the regulations require a determination of
reasonableness at the time the organization makes a payment to a
disqualified person; that the presumption apply when approval is given
by a compensation committee that is not composed exclusively of
directors or trustees; that the board or committee be considered
independent if members recuse themselves when they have conflicts of
interest; that the regulations clarify whether a joint compensation
committee composed of representatives from several affiliated
organizations would be a committee of each of the respective boards;
that the regulations allow an organization's board to delegate the
responsibility for setting compensation to an independent committee;
that the regulations use examples to define what is an independent firm
that can produce salary surveys that will serve as appropriate data on
comparability; that the regulations clarify that the rebuttable
presumption is a safe harbor and no negative inference should be drawn
if an organization does not avail itself of that safe harbor; and that
the regulations clarify that compensation outside the range of
comparables is not per se unreasonable. Some church representatives
submitted comments noting that the religious beliefs of some churches
and some state laws regarding churches prevent churches from
benefitting from the rebuttable presumption of reasonableness because
of the identity of the parties required to approve compensation
arrangements or other transactions. While these proposed regulations do
not provide a special exception for churches from the requirements that
must be met to give rise to the rebuttable presumption, they do provide
churches with a special rule stating that the procedures of section
7611 will be used in initiating and conducting any inquiry or
examination into whether an excess benefit transaction has occurred
between a church and a disqualified person. For purposes of this rule,
the reasonable belief required to initiate a church tax inquiry is
satisfied if there is a reasonable belief that a section 4958 tax is
due from a disqualified person with respect to a transaction involving
a church.
Several comments were received on the relationship between
revocation of tax-exempt status and the taxes imposed under section
4958, recommending that the regulations follow the legislative history
on this question. The IRS intends to exercise its administrative
discretion in enforcing the requirements of sections 4958, 501(c)(3)
and 501(c)(4) in accordance with the direction given in the legislative
history. The legislative history specifically provides that the IRS may
still revoke the tax-exempt status of an organization for violating the
inurement proscription, with or without imposition of section 4958
excise taxes. It further provides that, in practice, the excise taxes
imposed by section 4958 will be the sole sanction imposed in those
cases in which the excess benefit does not rise to a level where it
calls into question whether, on the whole, the organization functions
as a charitable or other tax-exempt organization. In determining
whether an excess benefit transaction rises to such a level, factors
relating to the organization's general pattern of compliance with the
requirements of section 501(c)(3) or (4) and other applicable Federal
and State laws will be taken into account. These factors would include
whether the organization has been involved in repeated excess benefit
transactions; the size and scope
[[Page 41489]]
of the excess benefit transaction; whether, after concluding that it
has been party to an excess benefit transaction, the organization has
implemented safeguards to prevent future recurrences; and whether there
was compliance with other applicable laws. The IRS intends to publish
the factors that it will consider in exercising its administrative
discretion in guidance issued in conjunction with the issuance of final
regulations under section 4958.
Explanation of Provisions
Overview
This document contains proposed regulations that add new
regulations under section 4958, and that amend and add to existing
Income Tax and Excise Tax Regulations under sections 4963, 6213, 6501,
7422, and 7611. The explanation of these proposed regulations is
grouped into two parts: the substantive section 4958 regulations, and
regulations under the provisions amended to reflect various effects of
the enactment of section 4958 on abatement, Tax Court petitions,
statute of limitations, refund actions, and church tax inquiries and
examinations. The proposed Sec. 53.4958 regulations are described in
more detail in this preamble under Section I, Taxes on excess benefit
transactions, immediately below. The proposed amendments and additions
to regulations under various procedural and administrative provisions
affected by the enactment of section 4958 are described in Section II,
Amendment of regulations under various procedural and administrative
provisions, below.
I. Taxes on Excess Benefit Transactions
The proposed regulations describe the three taxes imposed under
section 4958 on excess benefit transactions between an applicable tax-
exempt organization and a disqualified person. Two of the taxes are
paid by certain disqualified persons who benefit economically from a
transaction, and the other tax is paid by certain organization managers
who participate in the transaction knowingly, willfully, and without
reasonable cause.
A disqualified person who receives an excess benefit from a
transaction is liable for a tax equal to 25 percent of the excess
benefit. If the excess benefit is not corrected within the taxable
period, that disqualified person is then liable for a tax of 200
percent of the excess benefit. Taxable period is defined as the period
beginning on the date the transaction occurs and ending on the earlier
of the date of mailing a notice of deficiency for the 25 percent tax or
the date on which the 25 percent tax is assessed.
Correction is defined in the proposed regulations as undoing the
excess benefit to the extent possible, and taking any additional
measures necessary to place the organization in a financial position
not worse than that in which it would be if the disqualified person had
been dealing under the highest fiduciary standards. Correction of the
excess benefit occurs if the disqualified person repays the applicable
tax-exempt organization an amount of money equal to the excess benefit,
plus any additional amount needed to compensate the organization for
the loss of the use of the money or other property during the period
commencing on the date the excess benefit transaction occurs and ending
on the date the excess benefit is corrected. Correction may also be
accomplished, in certain circumstances, by returning property to the
organization and taking any additional steps necessary to make the
organization whole. If the excess benefit transaction consists of the
payment of compensation for services under a contract that has not been
completed, termination of the employment or independent contractor
relationship between the organization and the disqualified person is
not required in order to correct. However, the terms of any ongoing
compensation arrangement may need to be modified to avoid future excess
benefit transactions. If the excess benefit is corrected within the
correction period, then under the rules of section 4961 the 200 percent
tax under section 4958(b) is not assessed. If the excess benefit is
corrected within the correction period and it is established to the
satisfaction of the Secretary that the excess benefit transaction was
due to reasonable cause and not to willful neglect, then under the
rules of section 4962 the 25 percent tax under section 4958(a)(1) will
be abated.
Each organization manager who participated in the excess benefit
transaction, knowing that it was such a transaction, unless such
participation was not willful and was due to reasonable cause, is
liable for a tax equal to 10 percent of the excess benefit, not to
exceed an aggregate amount of $10,000 with respect to any one excess
benefit transaction. An organization manager is, with respect to any
applicable tax-exempt organization, any officer, director, or trustee
of such organization, or any individual having powers or
responsibilities similar to those of officers, directors, or trustees
of the organization. Independent contractors, acting in a capacity as
attorneys, accountants, and investment managers and advisors, are not
officers. Any person who has authority merely to recommend particular
administrative or policy decisions, but not to implement them without
approval of a superior, is not an officer. An individual who is not an
officer, director, or trustee, yet serves on a committee of the
governing body of an applicable tax-exempt organization that is
invoking the rebuttable presumption of reasonableness (described later
in this section) based on the committee's action, however, is an
organization manager for purposes of the 10 percent tax.
The definitions provided in the proposed regulations for the terms
participation, knowing, willful, and due to reasonable cause with
respect to organization managers for section 4958 purposes parallel the
definitions of those terms used with respect to foundation managers in
the section 4941 regulations. If an organization manager, after full
disclosure of the factual situation to legal counsel (including in-
house counsel) relies on the advice of such counsel expressed in a
reasoned written legal opinion that a transaction is not an excess
benefit transaction under section 4958, that manager's participation in
such transaction will ordinarily not be considered knowing or willful,
and will ordinarily be considered due to reasonable cause, even if the
transaction is subsequently held to be an excess benefit transaction.
With respect to any specific excess benefit transaction, if more
than one person is liable for any of the taxes imposed by section 4958,
all persons with respect to whom a particular tax is imposed are
jointly and severally liable for that tax. For instance, if more than
one disqualified person benefits from the same transaction, all the
benefitting disqualified persons are jointly and severally liable for
the respective section 4958(a)(1) or (b) taxes on that transaction.
Where an organization manager also receives an excess benefit from an
excess benefit transaction, the manager may be liable for both taxes
imposed by section 4958(a).
Except as otherwise provided in the proposed regulations, a
transaction occurs on the date on which a disqualified person receives
an economic benefit from the applicable tax-exempt organization for
federal income tax purposes. In the case of payment of deferred
compensation, the transaction occurs on the date the deferred
compensation is earned and vested.
The proposed regulations cross-reference sections 6501(e)(3) and
6501(l) and the regulations thereunder, as
[[Page 41490]]
amended, for statute of limitations rules for section 4958 excise
taxes. Thus, the statute of limitations for imposition of tax under
section 4958 generally begins to run as of the date the applicable tax-
exempt organization files its return (Form 990) for the year in which
the excess benefit transaction occurred.
The proposed regulations provide that the taxes imposed on excess
benefit transactions apply to transactions occurring on or after
September 14, 1995. However, these taxes do not apply to a transaction
pursuant to a written contract that was binding on September 13, 1995,
and at all times thereafter before the transaction occurred. A written
binding contract that is terminable or subject to cancellation by the
applicable tax-exempt organization without the disqualified person's
consent is treated as a new contract as of the date that any such
termination or cancellation, if made, would be effective. If a binding
written contract is materially modified (including situations in which
the contract is amended to extend its term or to increase the amount of
compensation payable to the disqualified person), it is treated as a
new contract entered into as of the date of the material modification.
Definition of Applicable Tax-Exempt Organization
The proposed regulations generally define an applicable tax-exempt
organization as any organization that, without regard to any excess
benefit, is or would have been described in sections 501(c)(3) or (4)
and exempt from tax under section 501(a) at any time during a five-year
period ending on the date of an excess benefit transaction (the
lookback period). In the specific case of any transaction occurring
before September 14, 2000, the lookback period begins on September 14,
1995, and ends on the date of the transaction.
To be described in section 501(c)(3) for purposes of section 4958,
an organization must meet the requirements of section 508 (subject to
any applicable exceptions provided by that section). A private
foundation as defined in section 509(a) is not an applicable tax-exempt
organization for section 4958 purposes. An organization that has
applied for and received recognition of exemption as an organization
described in section 501(c)(4) is an applicable tax-exempt organization
for section 4958 purposes. In addition, an organization that has sought
to take advantage of section 501(c)(4) status by filing an application
for recognition of exemption under section 501(c)(4) with the IRS,
filing an information return as a section 501(c)(4) organization under
the Code or regulations promulgated thereunder, or otherwise holding
itself out as being described in section 501(c)(4), is an applicable
tax-exempt organization for section 4958 purposes.
A foreign organization that receives substantially all of its
support from sources outside of the United States is not an applicable
tax-exempt organization for section 4958 purposes. Section 4948(b)
generally states that chapter 42 taxes, including section 4958 taxes on
excess benefit transactions, do not apply to any foreign organization
that has received substantially all of its support from sources outside
the United States.
Definition of Disqualified Person
The proposed regulations define a disqualified person as a person
who, with respect to any transaction with an applicable tax-exempt
organization, at any time during a five-year period beginning after
September 13, 1995, and ending on the date of such transaction, was in
a position to exercise substantial influence over the affairs of the
organization. Certain persons are statutorily defined to be
disqualified persons under section 4958(f), including certain family
members of disqualified persons (spouse, brothers or sisters (by whole
or half blood), spouses of brothers or sisters (by whole or half
blood), ancestors, children, grandchildren, great grandchildren, and
spouses of children, grandchildren, and great grandchildren), and 35
percent controlled entities (a corporation in which a disqualified
person owns more than 35 percent of the combined voting power; a
partnership in which a disqualified person owns more than 35 percent of
the profits interest; or a trust or estate in which a disqualified
person owns more than 35 percent of the beneficial interest).
The proposed regulations specifically identify certain persons as
having substantial influence over the affairs of an applicable tax-
exempt organization. These specified persons include any individual who
serves as a voting member on the governing body of the organization;
any individual or individuals who have the power or responsibilities of
the president, chief executive officer or chief operating officer of an
organization; any individual or individuals who have the power or
responsibilities of treasurer or chief financial officer of an
organization; and any person who has a material financial interest in
certain provider-sponsored organizations in which a hospital that is an
applicable tax-exempt organization participates.
The proposed regulations deem two categories of persons not to have
substantial influence over the affairs of an applicable tax-exempt
organization. The first category comprises other applicable tax-exempt
organizations described in section 501(c)(3). The second category
comprises any employee who, for the taxable year in which the benefits
are provided, receives economic benefits, directly or indirectly from
the organization, of less than the amount of compensation referenced
for a highly compensated employee in section 414(q)(1)(B)(i), who is
not a statutorily-defined disqualified person and not specifically
identified by the regulations as having substantial influence, and is
not a substantial contributor to the organization within the meaning of
section 507(d)(2).
The proposed regulations provide that except as specified in the
categories set forth in the statute or the preceding parts of the
regulation, the determination of whether a person has substantial
influence over the affairs of an organization is based on all relevant
facts and circumstances. A person who has managerial control over a
discrete segment of an organization may nonetheless be in a position to
exercise substantial influence over the affairs of the entire
organization. Facts and circumstances tending to show that a person has
substantial influence over the affairs of an organization include, but
are not limited to, the following: that the person founded the
organization; that the person is a substantial contributor (within the
meaning of section 507(d)(2)) to the organization; that the person's
compensation is based on revenues derived from activities of the
organization that the person controls; that the person has authority to
control or determine a significant portion of the organization's
capital expenditures, operating budget, or compensation for employees;
that the person has managerial authority or serves as a key advisor to
a person with managerial authority; or that the person owns a
controlling interest in a corporation, partnership, or trust that is a
disqualified person.
Facts and circumstances tending to show that a person does not have
substantial influence over the affairs of an organization include but
are not limited to, the following: that the person has taken a bona
fide vow of poverty as an employee, agent, or on behalf of a religious
organization; that the person is an independent contractor, such as an
attorney, accountant, or investment manager or advisor, acting in that
capacity, unless the person is acting in
[[Page 41491]]
that capacity with respect to a transaction from which the person might
economically benefit either directly or indirectly (aside from fees
received for the professional services rendered); and that any
preferential treatment a person receives based on the size of that
person's donation is also offered to any other donor making a
comparable contribution as part of a solicitation intended to attract a
substantial number of contributions.
In the case of multiple organizations affiliated by common control
or governing documents, the determination of whether a person does or
does not have substantial influence will be made separately for each
applicable tax-exempt organization.
Excess Benefit Transaction
The proposed regulations state that an excess benefit transaction
is any transaction in which an economic benefit is provided by an
applicable tax-exempt organization directly or indirectly to, or for
the use of, any disqualified person if the value of the economic
benefit provided exceeds the value of the consideration (including the
performance of services) received for providing such benefit. An excess
benefit transaction also includes certain revenue-sharing transactions
(described later in this section). A benefit can be provided indirectly
if it is provided through one or more entities controlled by or
affiliated with the applicable tax-exempt organization.
Certain economic benefits provided by an applicable tax-exempt
organization to a disqualified person are disregarded for purposes of
section 4958. These include paying reasonable expenses for members of
the governing body of an applicable tax-exempt organization to attend
meetings of the governing body of the organization, not including
expenses for luxury travel or spousal travel; an economic benefit
provided to a disqualified person that the disqualified person receives
solely as a member of, or volunteer for, the organization, if the
benefit is provided to members of the public in exchange for a
membership fee of $75 or less per year; and an economic benefit
provided to a disqualified person that the disqualified person receives
solely as a member of a charitable class the applicable tax-exempt
organization intends to benefit.
The proposed regulations provide that the payment of a premium for
an insurance policy providing liability insurance to a disqualified
person to cover any taxes imposed under this section or indemnification
of a disqualified person for such taxes by an applicable tax-exempt
organization is not an excess benefit transaction if the premium or the
indemnification is treated as compensation to the disqualified person
when paid, and the total compensation paid to the disqualified person
is reasonable.
The proposed regulations provide that if the amount of the economic
benefit provided by the applicable tax-exempt organization exceeds the
fair market value of the consideration, the excess is the excess
benefit on which tax is imposed by section 4958. Rules concerning the
excess benefit in certain revenue-sharing transactions are described
later in this section. The fair market value of property is the price
at which property or the right to use property would change hands
between a willing buyer and a willing seller, neither being under any
compulsion to buy, sell, or transfer property or the right to use
property, and both having reasonable knowledge of relevant facts.
Compensation
Compensation for the performance of services is reasonable only if
it is an amount that would ordinarily be paid for like services by like
enterprises under like circumstances. Generally, the circumstances to
be taken into consideration are those existing at the date when the
contract for services was made. However, where reasonableness of
compensation cannot be determined based on circumstances existing at
the date when the contract for services was made, then that
determination is made based on all facts and circumstances, up to and
including circumstances as of the date of payment. In no event shall
circumstances existing at the date when the contract is questioned be
considered in making a determination of the reasonableness of
compensation. A written binding contract that is terminable or subject
to cancellation by the applicable tax-exempt organization without the
disqualified person's consent is treated as a new contract as of the
date that any such termination or cancellation, if made, would be
effective. If a binding written contract is materially modified (which
includes amending the contract to extend its term or increase the
amount of compensation payable to the disqualified person), it is
treated as a new contract entered into as of the date of the material
modification. Examples illustrate whether the reasonableness of
compensation can be determined based on circumstances existing at the
time a contract for the performance of services was made. In accordance
with the legislative history, the fact that a State or local
legislative or agency body has authorized or approved a particular
compensation package paid to a disqualified person is not determinative
of the reasonableness of compensation paid for purposes of section 4958
excise taxes. Under the proposed regulations, the fact that a
particular compensation package is authorized or approved by a court
also is not determinative of the reasonableness of compensation paid to
a disqualified person.
Compensation for purposes of section 4958 includes all items of
compensation provided by an applicable tax-exempt organization in
exchange for the performance of services by a disqualified person.
These items of compensation include, but are not limited to, all forms
of cash and noncash compensation, including salary, fees, bonuses, and
severance payments paid, and all forms of deferred compensation that is
earned and vested, whether or not funded, and whether or not paid under
a deferred compensation plan that is a qualified plan under section
401(a). If deferred compensation for services performed in multiple
prior years vests in a later year, then that compensation is attributed
to the years in which the services were performed. Compensation also
includes the amount of premiums paid for liability or any other
insurance coverage, as well as any payment or reimbursement by the
organization of charges, expenses, fees, or taxes not covered
ultimately by the insurance coverage; all other benefits, whether or
not included in income for tax purposes, including payments to welfare
benefit plans on behalf of the disqualified persons, such as plans
providing medical, dental, life insurance, severance pay, and
disability benefits, and both taxable and nontaxable fringe benefits
(other than working condition fringe benefits described in section
132(d) and de minimis fringe benefits described in section 132(e)),
including expense allowances or reimbursements or foregone interest on
loans that the recipient must report as income on his separate income
tax return; and any economic benefit provided by the applicable tax-
exempt organization directly or indirectly through another entity,
owned, controlled by or affiliated with the applicable tax-exempt
organization, whether such other entity is taxable or tax-exempt.
An economic benefit that an applicable tax-exempt organization
provides to, or for the use, of a disqualified person is not treated as
consideration for the performance of services unless the organization
clearly indicates its intent to treat the benefit as compensation when
the benefit is paid.
[[Page 41492]]
An applicable tax-exempt organization will be treated as having
intended to provide an economic benefit as compensation for services
only if it provides clear and convincing evidence of having that intent
when the benefit was paid. An applicable tax-exempt organization can
provide clear and convincing evidence of such intent by reporting the
economic benefit as compensation on original or amended federal tax
information returns with respect to the payment (e.g., Form W-2 or
1099) or with respect to the organization (e.g., Form 990), filed
before the commencement of an IRS examination in which the reporting of
the benefit is questioned. For purposes of section 4958 and these
proposed regulations, an IRS examination of an applicable tax-exempt
organization has commenced if the organization has received written
notification from the Exempt Organizations Division of an impending
Exempt Organizations examination, or written notification of an
impending referral for an Exempt Organizations examination, and also
includes having been under an Exempt Organizations examination that is
now in Appeals or in litigation for issues raised in an Exempt
Organizations examination of the period in which the excess benefit
transaction occurred. Reporting of an economic benefit to provide clear
and convincing evidence of intent is also accomplished if the recipient
disqualified person reports the benefit as income on the person's Form
1040 for the year in which the benefit is received. If the amount of an
economic benefit paid to a disqualified person is not reported and
should have been reported on any information return issued by the
applicable tax-exempt organization, and the failure to report was due
to reasonable cause as defined under section 6724 regulations, then the
organization is deemed to satisfy the clear and convincing evidence
requirement. To show that its failure to report an economic benefit
that should have been reported on an information return was due to
reasonable cause, the applicable tax-exempt organization must establish
that there are significant mitigating factors with respect to its
failure to report, or the failure arose from events beyond the
organization's control, and the organization acted in a responsible
manner both before and after the failure occurred. If an organization
fails to provide clear and convincing evidence that it intended to
provide an economic benefit as compensation for services when paid, any
services provided by the disqualified person will not be treated as
provided in consideration for the economic benefit.
Transaction in Which Amount of Economic Benefit Determined in Whole or
in Part by the Revenues of One or More Activities of the Organization
The proposed regulations apply a facts and circumstances test to
assess whether a transaction in which the amount of an economic benefit
provided by an applicable tax-exempt organization to or for the use of
a disqualified person is determined in whole or in part by the revenues
of one or more activities of the applicable tax-exempt organization
(revenue-sharing transaction) results in inurement, and therefore
constitutes an excess benefit transaction. A revenue-sharing
transaction may constitute an excess benefit transaction regardless of
whether the economic benefit provided to the disqualified person
exceeds the fair market value of the consideration provided in return
if, at any point, it permits a disqualified person to receive
additional compensation without providing proportional benefits that
contribute to the organization's accomplishment of its exempt purpose.
If the economic benefit is provided as compensation for services,
relevant facts and circumstances include, but are not limited to, the
relationship between the size of the benefit provided and the quality
and quantity of the services provided, as well as the ability of the
party receiving the compensation to control the activities generating
the revenues on which the compensation is based.
The type of revenue-sharing transaction described in the proposed
regulations constitutes an excess benefit transaction if it occurs on
or after the date of publication of final regulations. The excess
benefit in such a transaction consists of the entire economic benefit
provided. Any revenue-sharing transaction occurring after September 13,
1995, may still constitute an excess benefit transaction if the
economic benefit provided to the disqualified person exceeds the fair
market value of the consideration provided in return. Before the date
of publication of final regulations, however, the excess benefit shall
consist only of that portion of the economic benefit that exceeds the
fair market value of the consideration provided in return. Examples are
provided of revenue-sharing transactions that do and do not constitute
excess benefit transactions.
Rebuttable Presumption That Transaction Is Not an Excess Benefit
Transaction
The proposed regulations provide that a compensation arrangement
between an applicable tax-exempt organization and a disqualified person
is presumed to be reasonable, and a transfer of property, a right to
use property, or any other benefit or privilege between an applicable
tax-exempt organization and a disqualified person is presumed to be at
fair market value, if three conditions are satisfied. The three
conditions are as follows: (1) the compensation arrangement or terms of
transfer are approved by the organization's governing body or a
committee of the governing body composed entirely of individuals who do
not have a conflict of interest with respect to the arrangement or
transaction; (2) the governing body, or committee thereof, obtained and
relied upon appropriate data as to comparability prior to making its
determination; and (3) the governing body or committee adequately
documented the basis for its determination concurrently with making
that determination. The presumption established by satisfying these
three requirements may be rebutted by additional information showing
that the compensation was not reasonable or that the transfer was not
at fair market value.
To the extent permitted under local law, the governing body of an
applicable tax-exempt organization may authorize other parties to act
on its behalf by following specified procedures that satisfy the three
requirements for invoking the rebuttable presumption of reasonableness.
An arrangement or transaction that is subsequently approved by the
board's designee or designees in accordance with those procedures shall
be subject to the rebuttable presumption even though the governing body
does not vote separately on the specific arrangement or transaction.
With respect to the first requirement, the proposed regulations
provide that the governing body is the board of directors, board of
trustees, or equivalent controlling body of the applicable tax-exempt
organization. A committee of the governing body may be composed of any
individuals permitted under state law to serve on such a committee, and
may act on behalf of the governing body to the extent permitted by
state law. However, any members of such a committee who are not members
of the governing body are deemed to be organization managers for
purposes of the tax imposed by section 4958(a)(2) if
[[Page 41493]]
the organization is invoking the rebuttable presumption based on the
actions of the committee. A person is not included on an organization's
governing body or committee thereof when the governing body or
committee is reviewing a transaction if that person meets with the
other members only to answer questions, and otherwise recuses himself
from the meeting and is not present during debate and voting on the
transaction or compensation arrangement.
The proposed regulations provide that a member of the governing
body, or committee thereof, does not have a conflict of interest with
respect to a compensation arrangement or transaction if the member is
not the disqualified person and is not related to any disqualified
person participating in or economically benefitting from the
compensation arrangement or transaction; is not in an employment
relationship subject to the direction or control of any disqualified
person participating in or economically benefitting from the
compensation arrangement or transaction; is not receiving compensation
or other payments subject to approval by any disqualified person
participating in or economically benefitting from the compensation
arrangement or transaction; has no material financial interest affected
by the compensation arrangement or transaction; and, as prescribed in
the legislative history, does not approve a transaction providing
economic benefits to any disqualified person participating in the
compensation arrangement or transaction, who in turn has approved or
will approve a transaction providing economic benefits to the member.
An arrangement or transaction has not been approved by a committee of a
governing body if, under the governing documents of the organization or
state law, the committee's decision must be ratified by the full
governing body in order to become effective.
With respect to the second requirement for the rebuttable
presumption of reasonableness, the proposed regulations provide that a
governing body or committee has appropriate data on comparability if,
given the knowledge and expertise of its members, it has information
sufficient to determine whether a compensation arrangement will result
in the payment of reasonable compensation or a transaction will be for
fair market value. Relevant information includes, but is not limited
to, compensation levels paid by similarly situated organizations, both
taxable and tax-exempt, for functionally comparable positions; the
availability of similar services in the geographic area of the
applicable tax-exempt organization; independent compensation surveys
compiled by independent firms; actual written offers from similar
institutions competing for the services of the disqualified person; and
independent appraisals of the value of property that the applicable
tax-exempt organization intends to purchase from, or sell or provide to
the disqualified person.
A special rule is provided for organizations with annual gross
receipts of less than $1 million. Under this rule, when the governing
body reviews compensation arrangements, it will be considered to have
appropriate data as to comparability if it has data on compensation
paid by five comparable organizations in the same or similar
communities for similar services. No inference is intended with respect
to whether circumstances falling outside this safe harbor will meet the
requirements with respect to the collection of appropriate data.
For purposes of the third requirement of the rebuttable presumption
of reasonableness under the proposed regulations, to be documented
adequately, the written or electronic records of the governing body or
committee must note the terms of the transaction that was approved and
the date it was approved; the members of the governing body or
committee who were present during debate on the transaction or
arrangement that was approved and those who voted on it; the
comparability data obtained and relied upon by the committee and how
the data was obtained; and the actions taken with respect to
consideration of the transaction by anyone who is otherwise a member of
the governing body or committee but who had a conflict of interest with
respect to the transaction or arrangement. If the governing body or
committee determines that reasonable compensation for a specific
arrangement or fair market value in a specific transaction is higher or
lower than the range of comparable data obtained, the governing body or
committee must record the basis for its determination. For a decision
to be documented concurrently, records must be prepared by the next
meeting of the governing body or committee occurring after the final
action or actions of the governing body or committee are taken. Records
must be reviewed and approved by the governing body or committee as
reasonable, accurate and complete within a reasonable time period
thereafter.
If reasonableness of the compensation cannot be determined based on
circumstances existing at the date when a contract for services was
made, then the rebuttable presumption cannot arise until circumstances
exist so that reasonableness of compensation can be determined, and the
three requirements for the presumption subsequently are satisfied.
The fact that a transaction between an applicable tax-exempt
organization and a disqualified person is not subject to the
presumption described in this section shall not create any inference
that the transaction is an excess benefit transaction. Neither shall
the fact that a transaction qualifies for the presumption exempt or
relieve any person from compliance with any federal or state law
imposing any obligation, duty, responsibility, or other standard of
conduct with respect to the operation or administration of any
applicable tax-exempt organization. The rebuttable presumption applies
to all payments made or transactions completed in accordance with a
contract provided that the three requirements of the rebuttable
presumption were met at the time the contract was agreed upon.
Special Rules
The proposed regulations provide that the excise taxes imposed by
section 4958 do not affect the substantive statutory standards for tax
exemption under sections 501(c)(3) or (4). Organizations are described
in those sections only if no part of their net earnings inure to the
benefit of any private shareholder or individual.
The proposed regulations provide that the procedures of section
7611 will be used in initiating and conducting any inquiry or
examination into whether an excess benefit transaction has occurred
between a church and a disqualified person. For purposes of this rule,
the reasonable belief required to initiate a church tax inquiry is
satisfied if there is a reasonable belief that a section 4958 tax is
due from a disqualified person with respect to a transaction involving
a church. Any additional procedures that apply when determining whether
disqualified persons are liable for taxes as a result of transactions
with organizations other than churches will apply when determining
whether disqualified persons are liable for taxes as a result of
transactions with churches.
II. Amendment of Regulations Under Various Procedural and
Administrative Provisions
The proposed regulations amend the section 4963 regulations to
include section 4958 taxes in the list of taxes subject to abatement
under sections
[[Page 41494]]
4961 and 4962; amend the section 6213 regulations to suspend the time
period for filing a Tax Court petition for the time allowed by the
Commissioner to correct a section 4958 transaction; amend the section
6501 regulations to allow the filing of an information return by an
applicable tax-exempt organization to begin the three-year limitation
on assessment and collection for section 4958 taxes (or six years if an
organization failed to disclose an item); amend the section 7422
regulations to apply existing rules for refund proceedings to section
4958 taxes; and amend section 7611 regulations to cross-reference the
rules governing the interaction between section 4958 and section 7611
in these proposed regulations.
Except as otherwise specified in the text of the final regulations,
these regulations will be effective upon publication of the final
regulations in the Federal Register. Taxpayers may rely on these
proposed regulations for guidance pending the issuance of final
regulations. If, and to the extent, future guidance is more restrictive
than the guidance in these proposed regulations, the future guidance
will be applied without retroactive effect.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required.
An initial regulatory flexibility analysis has been prepared as
required for the collection of information in this notice of proposed
rulemaking under 5 U.S.C. 603. The analysis follows:
Initial Regulatory Flexibility Analysis
These proposed regulations clarifying section 4958 of the Code
(Taxes on excess benefit transactions) may have an impact on small
organizations if those organizations avail themselves of the rebuttable
presumption of reasonableness described in the regulations (26 C.F.R.
53.4958-6(a)(2), 53.4958-6(a)(3), 53.4958-6(d)(2), and 53.4958-
6(d)(3)). The rebuttable presumption is being considered because the
legislative history of section 4958 (H. REP. 104-506 at 56-7, March 28,
1996) stated that parties to a transaction should be entitled to rely
on such a rebuttable presumption that a compensation arrangement or a
property transaction between certain organizations and disqualified
persons of the organizations is reasonable or at fair market value. The
legislative history further instructed the Secretary of the Treasury
and the IRS to issue guidance in connection with the standard for
establishing reasonable compensation or fair market value that
incorporates this presumption.
The objective for the rebuttable presumption is to allow
organizations that satisfy the three requirements to presume that
compensation arrangements and property transactions entered into with
disqualified persons pursuant to satisfaction of those requirements are
reasonable or at fair market value. In such cases, the section 4958
excise taxes can be imposed only if the IRS develops sufficient
contrary evidence to rebut the probative value of the evidence put
forth by the parties to the transaction. The legal basis for the
proposed rule is Code sections 4958 and 7805.
The proposed rule affects organizations described in sections
501(c)(3) and (4) (applicable tax-exempt organizations). Some
applicable tax-exempt organizations may be small organizations, defined
in 5 U.S.C. 601(4) as any not-for-profit enterprise which is
independently owned and operated and is not dominant in its field.
The proposed recordkeeping burden entails obtaining and relying on
appropriate comparability data and documenting the basis of an
organization's determination that compensation is reasonable, or a
property transfer (or transfer of the right to use property) is at fair
market value. These actions are necessary to meet two of the
requirements specified in the legislative history for obtaining the
rebuttable presumption of reasonableness. The skills necessary for
these actions are of the type required for obtaining and considering
comparability data, and for documenting the membership and actions of
the governing board or relevant committee of the organization.
Applicable tax-exempt organizations that are small entities of the
class that files Form 990-EZ (i.e., those with gross receipts of less
than $100,000 and assets of less than $250,000) are unlikely to
undertake fulfilling the requirements of the rebuttable presumption of
reasonableness, and therefore will not be affected by the recordkeeping
burden. All other classes of applicable tax-exempt organizations that
file Form 990, up to organizations with assets of $50 million, are
likely to be small organizations that avail themselves of the
rebuttable presumption of reasonableness. These classes range from
organizations with assets of $100,000 to $50 million. The proposed rule
currently contains a less burdensome safe harbor for one of the
requirements (obtaining comparability data on compensation) for
organizations with annual gross receipts of less than $1 million. The
IRS is not aware of any other relevant federal rules which may
duplicate, overlap, or conflict with the proposed rule. A less
burdensome alternative for small organizations would be to exempt those
entities from the requirements for establishing the rebuttable
presumption of reasonableness. However, it is not consistent with the
statute to allow organizations to rely on this presumption without
satisfying some conditions. Satisfaction of the requirements as
outlined in the legislative history leads to a benefit, but failure to
satisfy them does not necessarily lead to a penalty. A more burdensome
alternative would be to require all applicable tax-exempt organizations
under Code section 4958 to satisfy the three requirements of the
rebuttable presumption of reasonableness under all circumstances.
Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying. A
teleconference public hearing may be scheduled if requested in writing
by a person wishing to testify outside the Washington, DC area who
timely submits written comments. A request for a hearing by video
conference was made on April 7, 1998, by the Taxation Section of the
Los Angeles County Bar Association. If a teleconference public hearing
is scheduled, notice of the date, time, place, and remote
teleconference sites for the hearing will be published in the Federal
Register.
In addition to several areas mentioned earlier in this preamble,
specific comments are requested with respect to certain issues raised
by these proposed regulations. Concerning the relationship between
revocation of tax-exempt status and the taxes imposed under section
4958, comments are invited to be considered in preparing guidance
outlining the factors the IRS will consider in exercising its
administrative discretion in accordance with the legislative history.
Comments are also requested with regard to the rule under
[[Page 41495]]
which an economic benefit provided to, or for the use of, a
disqualified person will not be treated as consideration for the
performance of services absent the clear indication of the
organization's intent to treat the benefit as compensation when the
benefit is paid. Specifically, comments are requested on appropriate
ways of applying this rule that will not create an unnecessary burden
on affected organizations. Additionally, comments are requested with
respect to the effect of the proposed regulations on different
compensation arrangements, including revenue-based compensation,
deferred compensation, and the use of options as compensation.
Drafting Information
The principal author of these regulations is Phyllis D. Haney,
Office of Associate Chief Counsel (Employee Benefits and Exempt
Organizations). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 53
Excise taxes, Foundations, Investments, Lobbying, Reporting and
recordkeeping requirements, Trusts and trustees.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR Parts 53 and 301 are proposed to be amended as
follows:
PART 53--FOUNDATION AND SIMILAR EXCISE TAXES
Paragraph 1. The authority citation for part 53 continues to read
as follows:
Authority: 26 U.S.C. 7805.
Par. 2. Sections 53.4958-0 through 53.4958-7 are added to read as
follows:
Sec. 53.4958-0 Table of contents.
This section lists the captions contained in Secs. 53.4958-1
through 53.4958-7.
Sec. 53.4958-1 Taxes on excess benefit transactions.
(a) In general.
(b) Excess benefit defined.
(c) Taxes paid by disqualified person.
(1) Initial tax.
(2) Additional tax on disqualified person.
(i) In general.
(ii) Correction.
(iii) Taxable period.
(iv) Abatement if correction during the correction period.
(d) Tax paid by organization managers.
(1) In general.
(2) Organization manager defined.
(i) In general.
(ii) Special rule for certain committee members.
(3) Participation.
(4) Knowing.
(i) In general.
(ii) Special rule.
(5) Willful.
(6) Due to reasonable cause.
(7) Advice of counsel.
(8) Limits on liability for management.
(9) Joint and several liability.
(e) Date of occurrence.
(f) Statute of limitations.
(g) Effective date for imposition of taxes.
(1) In general.
(2) Existing binding contracts.
Sec. 53.4958-2--Definition of applicable tax-exempt organization.
(a) In general.
(b) Section 501(c)(3) organizations.
(c) Section 501(c)(4) organizations.
Sec. 53.4958-3--Definition of disqualified person.
(a) In general.
(b) Statutory categories of disqualified persons.
(1) Family members.
(2) Thirty-five percent controlled entities.
(i) In general.
(ii) Combined voting power.
(iii) Constructive ownership rules.
(A) Stockholdings.
(B) Profits or beneficial interest.
(c) Persons having substantial influence.
(1) Individuals serving on the governing body who are entitled
to vote.
(2) Presidents, chief executive officers, or chief operating
officers.
(3) Treasurers and chief financial officers.
(4) Persons with a material financial interest in a provider-
sponsored organization.
(d) Persons deemed not to have substantial influence.
(1) Applicable tax-exempt organizations described in section
501(c)(3).
(2) Employees receiving economic benefits of less than specified
amount in a taxable year.
(i) In general.
(ii) Examples.
(e) Facts and circumstances govern in all other cases.
(1) In general.
(2) Facts and circumstances tending to show substantial
influence.
(3) Facts and circumstances tending to show no substantial
influence.
(f) Examples.
(g) Affiliated organizations.
Sec. 53.4958-4 Excess benefit transaction.
(a) Definition of excess benefit transaction.
(1) In general.
(2) Economic benefit provided directly or indirectly.
(3) Certain economic benefits disregarded for purposes of
section 4958.
(i) Reimbursements for reasonable expenses of attending meetings
of governing body.
(ii) Economic benefits provided to a disqualified person solely
as a member of, or volunteer for, the organization.
(iii) Economic benefits provided to a disqualified person solely
as a member of a charitable class.
(4) Insurance or indemnification of excise taxes.
(b) Standards for identifying excess benefits.
(1) In general.
(2) Fair market value for transfer of property.
(3) Reasonable compensation.
(i) In general.
(ii) Items included in determining the value of compensation for
purposes of section 4958.
(iii) Examples.
(c) Establishing intent to treat economic benefit as
consideration for the performance of services.
(1) In general.
(2) Clear and convincing evidence of intent.
(i) In general.
(ii) Reporting of benefit.
(iii) Failure to report due to reasonable cause.
(3) Effect of failing to establish intent.
(4) Examples.
Sec. 53.4958-5 Transaction in which amount of economic benefit
determined in whole or in part by the revenues of one or more
activities of the organization.
(a) In general.
(b) Special rule for allocation or return of net margins or
capital to members of certain cooperatives.
(c) Rules effective prospectively.
(d) Examples.
Sec. 53.4958-6 Rebuttable presumption that transaction is not an
excess benefit transaction.
(a) In general.
(b) Delegation pursuant to procedures.
(c) Rebutting the presumption.
(d) Requirements for invoking rebuttable presumption.
(1) Disinterested governing body or committee.
(i) In general.
(ii) Persons not included on governing body or committee.
(iii) Absence of conflict of interest.
(iv) Rule where ratification of full governing body required.
(2) Appropriate data as to comparability.
(i) In general.
(ii) Special rule for compensation paid by small organizations.
(iii) Additional rules for special rule for small organizations.
(iv) Examples.
(3) Documentation.
(e) No presumption until circumstances exist to determine
reasonableness of compensation.
(f) No inference from absence of presumption.
(g) Period of reliance on rebuttable presumption.
[[Page 41496]]
Sec. 53.4958-7 Special rules.
(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for
church tax inquiries and examinations.
Sec. 53.4958-1 Taxes on excess benefit transactions.
(a) In general. Section 4958 imposes excise taxes on each excess
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4
and Sec. 53.4958-5) between an applicable tax-exempt organization (as
defined in section 4958(e) and Sec. 53.4958-2) and a disqualified
person (as defined in section 4958(f)(1) and Sec. 53.4958-3). A
disqualified person who receives an excess benefit from an excess
benefit transaction is liable for payment of a section 4958(a)(1)
excise tax equal to 25 percent of the excess benefit. If an initial tax
is imposed by section 4958(a)(1) on an excess benefit transaction and
the transaction is not corrected within the taxable period, then any
disqualified person who received an excess benefit from the excess
benefit transaction on which the initial tax was imposed is liable for
an additional tax of 200 percent of the excess benefit. An organization
manager (as defined in section 4958(f)(2) and paragraph (d) of this
section) who participates in an excess benefit transaction, knowing
that it was such a transaction, is liable for payment of a section
4958(a)(2) excise tax equal to 10 percent of the excess benefit, unless
the participation was not willful and was due to reasonable cause. If
an organization manager also receives an excess benefit from an excess
benefit transaction, the manager may be liable for both taxes imposed
by section 4958(a).
(b) Excess benefit defined. Except as provided in Sec. 53.4958-5
with respect to certain revenue-sharing transactions, an excess benefit
is the value of the economic benefit provided by an applicable tax-
exempt organization directly or indirectly to or for the use of any
disqualified person that exceeds the value of the consideration
(including the performance of services) received by the organization
for providing such benefit.
(c) Taxes paid by disqualified person--(1) Initial tax. Section
4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on
each excess benefit transaction. The section 4958(a)(1) tax shall be
paid by any disqualified person who received an excess benefit from
that excess benefit transaction. With respect to any excess benefit
transaction, if more than one disqualified person is liable for the tax
imposed by section 4958(a)(1), all such persons are jointly and
severally liable for that tax.
(2) Additional tax on disqualified person--(i) In general. Section
4958(b) imposes a tax equal to 200 percent of the excess benefit in any
case in which a section 4958(a)(1) tax is imposed on an excess benefit
transaction and the transaction is not corrected (as defined in section
4958(f)(6) and paragraph (c)(2)(ii) of this section) within the taxable
period (as defined in section 4958(f)(5) and paragraph (c)(2)(iii) of
this section). The tax imposed by section 4958(b) is payable by any
disqualified person who received an excess benefit from the excess
benefit transaction on which the initial tax was imposed by section
4958(a)(1). With respect to any excess benefit transaction, if more
than one disqualified person is liable for the tax imposed by section
4958(b), all such persons are jointly and severally liable for that
tax.
(ii) Correction. Correction means, with respect to any excess
benefit transaction, undoing the excess benefit to the extent possible,
and taking any additional measures necessary to place the organization
in a financial position not worse than that in which it would be if the
disqualified person had been dealing under the highest fiduciary
standards. Correction of the excess benefit occurs if the disqualified
person repays the applicable tax-exempt organization an amount of money
equal to the excess benefit, plus any additional amount needed to
compensate the organization for the loss of the use of the money or
other property during the period commencing on the date of the excess
benefit transaction and ending on the date the excess benefit is
corrected. Correction may also be accomplished, in certain
circumstances, by returning property to the organization and taking any
additional steps necessary to make the organization whole. If the
excess benefit transaction consists of the payment of compensation for
services under a contract that has not been completed, termination of
the employment or independent contractor relationship between the
organization and the disqualified person is not required in order to
correct. However, the terms of any ongoing compensation arrangement may
need to be modified to avoid future excess benefit transactions.
(iii) Taxable period. Taxable period means, with respect to any
excess benefit transaction, the period beginning with the date on which
the transaction occurs and ending on the earlier of--
(A) The date of mailing a notice of deficiency under section 6212
with respect to the section 4958(a)(1) tax; or
(B) The date on which the tax imposed by section 4958(a)(1) is
assessed.
(iv) Abatement if correction during the correction period. For
rules relating to abatement of taxes on excess benefit transactions
that are corrected within the correction period, as defined in section
4963(e), see sections 4961(a), 4962(a), and the regulations thereunder.
(d) Tax paid by organization managers--(1) In general. In any case
in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a
tax equal to 10 percent of the excess benefit on the participation of
any organization manager who knowingly participated in the excess
benefit transaction, unless such participation was not willful and was
due to reasonable cause. The tax is to be paid by any organization
manager who so participated.
(2) Organization manager defined--(i) In general. An organization
manager is, with respect to any applicable tax-exempt organization, any
officer, director, or trustee of such organization, or any individual
having powers or responsibilities similar to those of officers,
directors, or trustees of the organization, regardless of title. A
person shall be considered an officer of an organization if--
(A) That person is specifically so designated under the certificate
of incorporation, by-laws, or other constitutive documents of the
organization; or
(B) That person regularly exercises general authority to make
administrative or policy decisions on behalf of the organization.
Independent contractors, acting in a capacity as attorneys,
accountants, and investment managers and advisors, are not officers.
Any person who has authority merely to recommend particular
administrative or policy decisions, but not to implement them without
approval of a superior, is not an officer.
(ii) Special rule for certain committee members. An individual who
is not an officer, director, or trustee, yet serves on a committee of
the governing body of an applicable tax-exempt organization that is
invoking the rebuttable presumption of reasonableness described in
Sec. 53.4958-6 based on the committee's actions, is an organization
manager for purposes of the tax imposed by section 4958(a)(2).
(3) Participation. For purposes of section 4958(a)(2) and this
paragraph (d), participation includes silence or inaction on the part
of an organization manager where the manager is under a
[[Page 41497]]
duty to speak or act, as well as any affirmative action by such
manager. However, an organization manager will not be considered to
have participated in an excess benefit transaction where the manager
has opposed such transaction in a manner consistent with the
fulfillment of the manager's responsibilities to the applicable tax-
exempt organization.
(4) Knowing--(i) In general. For purposes of section 4958(a)(2) and
this paragraph (d), a person participates in a transaction knowing that
it is an excess benefit transaction only if the person--
(A) Has actual knowledge of sufficient facts so that, based solely
upon such facts, such transaction would be an excess benefit
transaction;
(B) Is aware that such an act under these circumstances may violate
the provisions of federal tax law governing excess benefit
transactions; and
(C) Negligently fails to make reasonable attempts to ascertain
whether the transaction is an excess benefit transaction, or the person
is in fact aware that it is such a transaction.
(ii) Special rule. Knowing does not mean having reason to know.
However, evidence tending to show that a person has reason to know of a
particular fact or particular rule is relevant in determining whether
the person had actual knowledge of such a fact or rule. Thus, for
example, evidence tending to show that a person has reason to know of
sufficient facts so that, based solely upon such facts, a transaction
would be an excess benefit transaction is relevant in determining
whether the person has actual knowledge of such facts.
(5) Willful. For purposes of section 4958(a)(2) and this paragraph
(d), participation by an organization manager is willful if it is
voluntary, conscious, and intentional. No motive to avoid the
restrictions of the law or the incurrence of any tax is necessary to
make the participation willful. However, participation by an
organization manager is not willful if the manager does not know that
the transaction in which the manager is participating is an excess
benefit transaction.
(6) Due to reasonable cause. An organization manager's
participation is due to reasonable cause if the manager has exercised
his responsibility on behalf of the organization with ordinary business
care and prudence.
(7) Advice of counsel. If a person, after full disclosure of the
factual situation to legal counsel (including in-house counsel) relies
on the advice of such counsel expressed in a reasoned written legal
opinion that a transaction is not an excess benefit transaction, the
person's participation in such transaction will ordinarily not be
considered knowing or willful and will ordinarily be considered due to
reasonable cause within the meaning of section 4958(a)(2), even if such
transaction is subsequently held to be an excess benefit transaction.
For purposes of satisfying the requirements of section 4958(a)(2), a
written legal opinion is reasoned so long as the opinion addresses
itself to the facts and applicable law. However, a written legal
opinion is not reasoned if it does nothing more than recite the facts
and express a conclusion. The absence of advice of counsel with respect
to an act shall not, by itself, however, give rise to any inference
that a person participated in such act knowingly, willfully, or without
reasonable cause.
(8) Limits on liability for management. The maximum aggregate
amount of tax collectible under section 4958(a)(2) and this paragraph
(d) from organization managers with respect to any one excess benefit
transaction is $10,000.
(9) Joint and several liability. In any case where more than one
person is liable for a tax imposed by section 4958(a)(2), all such
persons shall be jointly and severally liable for the taxes imposed
under section 4958(a)(2) with respect to that excess benefit
transaction.
(e) Date of occurrence. Except as otherwise provided, an excess
benefit transaction occurs on the date on which the disqualified person
receives the economic benefit from the applicable tax-exempt
organization for federal income tax purposes. In the case of a
transaction consisting of payment of deferred compensation, the
transaction occurs on the date the deferred compensation is earned and
vested.
(f) Statute of limitations. See sections 6501(e)(3) and 6501(l) and
the regulations thereunder, as amended, for statute of limitations
rules as they apply to section 4958 excise taxes.
(g) Effective date for imposition of taxes--(1) In general. The
section 4958 taxes imposed on excess benefit transactions or on
participation in excess benefit transactions apply to transactions
occurring on or after September 14, 1995.
(2) Existing binding contracts. The section 4958 taxes do not apply
to any transaction occurring pursuant to a written contract that was
binding on September 13, 1995, and at all times thereafter before the
transaction occurs. A written binding contract that is terminable or
subject to cancellation by the applicable tax-exempt organization
without the disqualified person's consent is treated as a new contract
as of the date that any such termination or cancellation, if made,
would be effective. If a binding written contract is materially
modified (a material modification includes amending the contract to
extend its term or to increase the amount of compensation payable to
the disqualified person), it is treated as a new contract entered into
as of the date of the material modification.
Sec. 53.4958-2 Definition of applicable tax-exempt organization.
(a) In general--(1) An applicable tax-exempt organization is any
organization that, without regard to any excess benefit, would be
described in section 501(c)(3) or (4) and exempt from tax under section
501(a). An applicable tax-exempt organization also includes any
organization that was described in section 501(c)(3) or (4) and was
exempt from tax under section 501(a) at any time during a five-year
period ending on the date of an excess benefit transaction (the
lookback period).
(2) In the case of any transaction occurring before September 14,
2000, the lookback period begins on September 14, 1995, and ends on the
date of the transaction.
(b) Section 501(c)(3) organizations. To be described in section
501(c)(3) for purposes of section 4958, an organization must meet the
requirements of section 508 (subject to any applicable exceptions
provided by that section). A foreign organization that receives
substantially all of its support from sources outside of the United
States is not subject to the requirements of section 508 and is not an
organization described in section 501(c)(3) for purposes of section
4958. A private foundation as defined in section 509(a) is not an
applicable tax-exempt organization for section 4958 purposes.
(c) Section 501(c)(4) organizations. An organization that has
applied for and received recognition of exemption as an organization
described in section 501(c)(4) is an applicable tax-exempt organization
for section 4958 purposes. In addition, an organization that has sought
to take advantage of section 501(c)(4) status by filing an application
for recognition of exemption under section 501(c)(4) with the Internal
Revenue Service, filing an information return as a section 501(c)(4)
organization under the Internal Revenue Code or regulations promulgated
thereunder, or otherwise holding itself out as being described in
section 501(c)(4), is an applicable tax-exempt organization for section
4958 purposes. A foreign organization that receives substantially all
of its support from sources outside of the United States is
[[Page 41498]]
not an applicable tax-exempt organization for section 4958 purposes.
Sec. 53.4958-3 Definition of disqualified person.
(a) In general. Section 4958(f)(1) defines disqualified person,
with respect to any transaction, as any person who was in a position to
exercise substantial influence over the affairs of the organization at
any time during the five-year period ending on the date of the
transaction. If the five-year period ending on the date of the
transaction would have begun on or before September 13, 1995, then the
preceding sentence shall be applied to the period beginning September
14, 1995, and ending on the date of the transaction. Paragraph (b) of
this section further describes other persons who are defined to be
disqualified persons under the statute, including certain family
members of an individual in a position to exercise substantial
influence, and certain 35 percent controlled entities. Paragraph (c) of
this section describes persons in a position to exercise substantial
influence over the affairs of an applicable tax-exempt organization by
virtue of their powers and responsibilities or certain interests they
hold. Paragraph (d) of this section describes persons deemed not to be
in a position to exercise substantial influence. Whether any person not
described in paragraph (b), (c) or (d) of this section is a
disqualified person with respect to the transaction for purposes of
section 4958 is based on all relevant facts and circumstances, as
described in paragraph (e) of this section. Examples in paragraphs
(d)(2)(ii) and (f) of this section illustrate these categories of
persons.
(b) Statutory categories of disqualified persons--(1) Family
members. A person is a disqualified person with respect to any
transaction with an applicable tax-exempt organization if the person is
a member of the family of another disqualified person described in
paragraph (a) of this section with respect to any transaction with the
same organization. A person's family includes--
(i) Spouse;
(ii) Brothers or sisters (by whole or half blood);
(iii) Spouses of brothers or sisters (by whole or half blood);
(iv) Ancestors;
(v) Children;
(vi) Grandchildren;
(vii) Great grandchildren; and
(viii) Spouses of children, grandchildren, and great grandchildren.
(2) Thirty-five percent controlled entities--(i) In general. A
person is a disqualified person with respect to any transaction with an
applicable tax-exempt organization if the person is a 35 percent
controlled entity. A 35 percent controlled entity is--
(A) A corporation in which persons described in this section
(except in this paragraph (b)(2) and paragraph (d) of this section) own
more than 35 percent of the combined voting power;
(B) A partnership in which persons described in this section
(except in this paragraph (b)(2) and paragraph (d) of this section) own
more than 35 percent of the profits interest; or
(C) A trust or estate in which persons described in this section
(except in this paragraph (b)(2) and paragraph (d) of this section) own
more than 35 percent of the beneficial interest.
(ii) Combined voting power. For purposes of this paragraph (b)(2),
combined voting power includes voting power represented by holdings of
voting stock, direct or indirect, but does not include voting rights
held only as a director or trustee.
(iii) Constructive ownership rules--(A) Stockholdings. For purposes
of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings
are taken into account as under section 267(c), except that in applying
section 267(c)(4), the family of an individual shall include the
members of the family specified in section 4958(f)(4) and paragraph
(b)(1) of this section.
(B) Profits or beneficial interest. For purposes of section
4958(f)(3) and this paragraph (b)(2), the ownership of profits or
beneficial interests shall be determined in accordance with the rules
for constructive ownership of stock provided in section 267(c) (other
than section 267(c)(3)), except that in applying section 267(c)(4), the
family of an individual shall include the members of the family
specified in section 4958(f)(4) and paragraph (b)(1) of this section.
(c) Persons having substantial influence. A person is in a position
to exercise substantial influence over the affairs of an applicable
tax-exempt organization if that person has the powers or
responsibilities, or holds the type of interests, described in one of
the following categories:
(1) Individuals serving on the governing body who are entitled to
vote. This category includes any individual serving on the governing
body of the organization who is entitled to vote on matters over which
the governing body has authority.
(2) Presidents, chief executive officers, or chief operating
officers. This category includes any individual who, individually or
with others, serves as the president, chief executive officer, or chief
operating officer of the organization. An individual serves as a
president, chief executive officer, or chief operating officer,
regardless of title, if that individual has or shares ultimate
responsibility for implementing the decisions of the governing body or
supervising the management, administration, or operation of the
applicable organization.
(3) Treasurers and chief financial officers. This category includes
any individual who, independently or with others, serves as treasurer
or chief financial officer of the organization. An individual serves as
a treasurer or chief financial officer, regardless of title, if that
individual has or shares ultimate responsibility for managing the
organization's financial assets and has or shares authority to sign
drafts or direct the signing of drafts, or authorize electronic
transfer of funds, from organization bank accounts.
(4) Persons with a material financial interest in a provider-
sponsored organization. Pursuant to section 501(o), this category
includes any person with a material financial interest in a provider-
sponsored organization (as defined in section 1853(e) of the Social
Security Act (42 U.S.C. 1395w-23)) if a hospital that participates in
the provider-sponsored organization is an applicable tax-exempt
organization.
(d) Persons deemed not to have substantial influence. A person is
deemed not to be in a position to exercise substantial influence over
the affairs of an applicable tax-exempt organization if that person is
described in one of the following categories:
(1) Applicable tax-exempt organizations described in section
501(c)(3). This category includes any other applicable tax-exempt
organization described in section 501(c)(3).
(2) Employees receiving economic benefits of less than specified
amount in a taxable year--(i) In general. This category includes, for
the taxable year in which benefits are provided, any employee of the
applicable tax-exempt organization who--
(A) Receives economic benefits, directly or indirectly from the
organization, of less than the amount of compensation referenced for a
highly compensated employee in section 414(q)(1)(B)(i);
(B) Is not described in Sec. 53.4958-3(b) or (c) with respect to
the organization; and
(C) Is not a substantial contributor to the organization within the
meaning of section 507(d)(2).
[[Page 41499]]
(ii) Examples. The following examples illustrate the category of
persons described in this paragraph (d)(2):
Example 1. N, an artist by profession, works part-time at R, a
local museum. In the first taxable year in which R employs N, R pays
N a modest salary and provides no additional benefits to N except
for free admission to the museum, a benefit R provides to all of its
employees and volunteers. The total economic benefits N receives
from R during the taxable year are less than the amount of
compensation referenced for a highly compensated employee in section
414(q)(1)(B)(i). The part-time job constitutes N's only relationship
with R. N is not related to any other disqualified person with
respect to R. N is deemed not to be in a position to exercise
substantial influence over the affairs of R. Therefore N is not a
disqualified person with respect to any transaction involving N and
R in that year.
Example 2. The facts are the same as in Example 1, except that
in addition to the modest salary that R pays N in exchange for N's
provision of services to R during the taxable year, R also purchases
one of N's paintings for $90,000. The total economic benefits
provided by R to N in that year exceed the amount of compensation
referenced for highly compensated employees in section
414(q)(1)(B)(i). Consequently, whether N is in a position to
exercise substantial influence over the affairs of R for that
taxable year depends upon all relevant facts and circumstances.
(e) Facts and circumstances govern in all other cases--(1) In
general. Whether a person who is not described in paragraph (b), (c) or
(d) of this section is a disqualified person depends upon all relevant
facts and circumstances. A person who has managerial control over a
discrete segment of an organization may nonetheless be in a position to
exercise substantial influence over the affairs of the entire
organization.
(2) Facts and circumstances tending to show substantial influence.
Facts and circumstances tending to show that a person has substantial
influence over the affairs of an organization include, but are not
limited to, the following--
(i) The person founded the organization;
(ii) The person is a substantial contributor (within the meaning of
section 507(d)(2)) to the organization;
(iii) The person's compensation is based on revenues derived from
activities of the organization that the person controls;
(iv) The person has authority to control or determine a significant
portion of the organization's capital expenditures, operating budget,
or compensation for employees;
(v) The person has managerial authority or serves as a key advisor
to a person with managerial authority; or
(vi) The person owns a controlling interest in a corporation,
partnership, or trust that is a disqualified person.
(3) Facts and circumstances tending to show no substantial
influence. Facts and circumstances tending to show that a person does
not have substantial influence over the affairs of an organization
include, but are not limited to--
(i) The person has taken a bona fide vow of poverty as an employee,
agent, or on behalf of a religious organization;
(ii) The person is an independent contractor, such as an attorney,
accountant, or investment manager or advisor, acting in that capacity,
unless the person is acting in that capacity with respect to a
transaction from which the person might economically benefit either
directly or indirectly (aside from fees received for the professional
services rendered); and
(iii) Any preferential treatment a person receives based on the
size of that person's donation is also offered to any other donor
making a comparable contribution as part of a solicitation intended to
attract a substantial number of contributions.
(f) Examples. The following examples illustrate the principles of
this section. Finding a person to be a disqualified person in the
following examples does not indicate that an excess benefit transaction
has occurred, but only that any transaction with the applicable tax-
exempt organization that provides benefits to the disqualified person
directly or indirectly may be scrutinized to determine whether it is an
excess benefit transaction:
Example 1. E is the headmaster of Z, a school that is an
applicable tax-exempt organization for purposes of section 4958. E
reports to Z's board of trustees and is the principal employee
responsible for implementing the board's decisions. E also has
ultimate responsibility for supervising Z's day-to-day operations.
For example, E can hire faculty members and staff, make changes to
the school's curriculum and discipline students without specific
board approval. Because E serves as the chief executive officer of
Z, E is in a position to exercise substantial influence over the
affairs of Z. Therefore E is a disqualified person with respect to
any transaction involving Z that provides economic benefits to E
directly or indirectly.
Example 2. G is a program officer at community organization C,
an applicable tax-exempt organization for purposes of section 4958.
G's total compensation for the taxable year, including benefits, is
less than the amount of compensation referenced for a highly
compensated employee in section 414(q)(1)(B)(i). G is not related to
any other disqualified person with respect to C. G does not serve on
C's governing body and or as an officer of C. G makes a modest
annual contribution to C, but is not a substantial contributor to C
(within the meaning of section 507(d)(2)). G is deemed not to be in
a position to exercise substantial influence over the affairs of C
for this year because G is an employee who receives economic
benefits for the year of less than the amount of compensation
referenced for a highly compensated employee in section
414(q)(1)(B)(i). Therefore, for this year, G is not a disqualified
person with respect to any transaction involving C that provides
economic benefits to G directly or indirectly.
Example 3. Y, an applicable tax-exempt organization for purposes
of section 4958, enters into a contract with B, a company that
manages bingo games. Under the contract, B agrees to provide all of
the staff and equipment necessary to carry out a bingo operation one
night per week, and to pay Y q percent of the revenue from this
activity. B retains the balance of the proceeds. Y provides no goods
or services in connection with the bingo operation other than the
use of its hall for the bingo game. The annual gross revenue earned
from the bingo game represents more than half of Y's total annual
revenue. B's status as a disqualified person is determined by all
relevant facts and circumstances. B's compensation is based on
revenues from an activity B controls. B also has full managerial
authority over Y's principal source of income. Under these facts and
circumstances, B is in a position to exercise substantial influence
over the affairs of Y. Therefore B is a disqualified person with
respect to any transaction involving Y that provides economic
benefits to B directly or indirectly.
Example 4. The facts are the same as in Example 3, with the
additional fact that the stock of B is 100 percent owned by P, an
individual who is actively involved in managing B. Because P owns a
controlling interest (measured by either vote or value) in and
actively manages B, the facts and circumstances establish that P is
also in a position to exercise substantial influence over the
affairs of Y. Therefore P is a disqualified person with respect to
any transaction involving Y that provides economic benefits to P
directly or indirectly.
Example 5. A, an applicable tax-exempt organization for purposes
of section 4958, owns and operates one acute care hospital. B is a
for-profit corporation that owns and operates a number of hospitals.
A and B form C, a limited liability company. In exchange for
proportional ownership interests, A contributes its hospital, and B
contributes other financial assets, to C. All of A's assets then
consist of its membership interest in C. A continues to be operated
for exempt purposes based almost exclusively on the activities it
conducts through C. C enters into a management agreement with a
management company, M, to provide day-to-day management services to
C. M is generally subject to supervision by C's board, but M is
given broad discretion to manage C's day-to-day operation. Under
these facts and circumstances, M is in a position to exercise
substantial influence over the affairs of A because it has day to
day control over the hospital operated by C, A's ownership interest
in C is its primary asset, and C's
[[Page 41500]]
activities form the basis for A's continued exemption as an
organization described in section 501(c)(3). Therefore, M is a
disqualified person with respect to any transaction involving A,
including any transaction that A conducts through C, that provides
economic benefits to M directly or indirectly.
Example 6. T is a large university and an applicable tax-exempt
organization for purposes of section 4958. L is the dean of the
College of Law of T, a major source of revenue for T. The College of
Law is important to T's reputation for excellent teaching and high
quality faculty scholarship. T relies on this reputation to attract
students and contributions from alumni and foundations. L plays a
key role in faculty hiring and has authority to control or determine
a significant portion of T's capital expenditures and operating
budget because of L's position in the College of Law. L's
compensation is greater than the amount of compensation referenced
for a highly compensated employee in section 414(q)(1)(B)(i) in the
year benefits are provided. Because of the importance of the College
of Law to T and L's managerial control over that segment of T, L is
in a position to exercise substantial influence over the affairs of
T. Therefore L is a disqualified person with respect to any
transaction involving T that provides economic benefits to L
directly or indirectly.
Example 7. X is a radiologist employed by U, a large acute-care
hospital that is an applicable tax-exempt organization for purposes
of section 4958. X has no managerial authority over any part of U or
its operations. X gives instructions to staff with respect to the
radiology work X conducts, but X does not serve as supervisor to
other U employees. X's total compensation package includes
nontaxable retirement and welfare benefits and a specified amount of
salary. X's compensation is greater than the amount of compensation
referenced for a highly compensated employee in section
414(q)(1)(B)(i) in the year benefits are provided. X is not related
to any other disqualified person of U. X does not serve on U's
governing body or as an officer of U. Although U participates in a
provider-sponsored organization (as defined in section 1853(e) of
the Social Security Act), X does not have a material financial
interest in that organization. Whether X is a disqualified person is
determined by all relevant facts and circumstances. X did not found
U, and although X makes a modest annual financial contribution to U,
the amount of the contribution does not make X a substantial
contributor within the meaning of section 507(d)(2). X does not
receive compensation based on revenues derived from activities of U
that X controls, and has no authority to control or determine a
significant portion of U's capital expenditures, operating budget,
or compensation for employees. Under these facts and circumstances,
X does not have substantial influence over the affairs of U, and
therefore X is not a disqualified person with respect to any
transaction involving U that provides economic benefits to X
directly or indirectly.
Example 8. W is a cardiologist and head of the cardiology
department of the same hospital U described in Example 7. W does not
serve on U's board and does not serve as an officer of U. W does not
have a material financial interest in the provider-sponsored
organization (as defined in section 1853(e) of the Social Security
Act) in which U participates. W is compensated personally with a
salary and retirement and welfare benefits fixed by a three-year
renewable employment contract with U. W's annual amount of
compensation exceeds the amount referenced for a highly compensated
employee in section 414(q)(1)(B)(i). Whether W is a disqualified
person is determined by all relevant facts and circumstances. W has
managerial authority for the cardiology department. The cardiology
department is a principal source of patients admitted to U and
consequently a major source of revenue for U. W also has authority
to allocate the budget for that department, which includes authority
to distribute incentive bonuses among cardiologists according to
criteria that he has authority to set. The pool for the bonuses is
funded by a portion of U's revenues attributable to the cardiology
department. Because of the importance of the cardiology department
to U and W's managerial control over that segment of U, W is in a
position to exercise substantial influence over the affairs of U.
Therefore W is a disqualified person with respect to any transaction
involving U that provides economic benefits to W directly or
indirectly.
Example 9. D is an accountant who periodically provides
accounting and tax advisory services as an independent contractor in
return for a fee to M, a museum that is an applicable tax-exempt
organization for purposes of section 4958. For several years, D has
advised M's officers and members of M's governing body with respect
to accounting and tax matters. D's firm also prepares tax returns on
behalf of M. D has no relationship with M other than as a
professional accounting and tax advisor. D is not related to any
other disqualified person of M. D's firm has a policy prohibiting
employees from providing professional advice with respect to a
transaction from which they might economically benefit either
directly or indirectly (aside from fees received for the
professional services rendered). D abides by the firm's policy in
all activities, including the work for M. Whether D is a
disqualified person is determined by all relevant facts and
circumstances. Because D acts only in D's capacity as an independent
contractor providing occasional professional services to M and
abides by the firm's conflict of interest policy, under these facts
and circumstances, D is not a disqualified person with respect to
any transaction with M.
Example 10. F, a repertory theater company that is an applicable
tax-exempt organization for purposes of section 4958, holds a fund-
raising campaign to pay for the construction of a new theater. J is
a regular subscriber to F's productions who has made modest gifts to
F in the past. J has no relationship to F other than as a subscriber
and contributor. F solicits contributions as part of a broad public
campaign intended to attract a large number of donors, including a
substantial number of donors making large gifts. In its
solicitations for contributions, F promises to invite all
contributors giving $z or more to a special opening production and
party held at the new theater. These contributors are also given a
special number to call in F's office to reserve tickets for
performances, make ticket exchanges, and make other special
arrangements for their convenience. J makes a contribution of $z to
F, which makes J a substantial contributor within the meaning of
section 507(d)(2). F provides J with the preferential treatment
described in its solicitation. Whether J is a disqualified person is
determined by all relevant facts and circumstances. Under these
facts and circumstances, any influence that may arise from the size
of J's donation is limited by F's commitment to provide similar
treatment to any other member of the public making a similar
contribution and by the nature of the benefits being offered.
Accordingly, the preferential treatment that J receives does not
indicate that J is in a position to exercise substantial influence
over the affairs of the organization. Therefore, barring a change in
J's relationship with F, J is not a disqualified person with respect
to any transaction involving F that provides economical benefits to
J directly or indirectly.
(g) Affiliated organizations. In the case of multiple organizations
affiliated by common control or governing documents, the determination
of whether a person does or does not have substantial influence shall
be made separately for each applicable tax-exempt organization.
Sec. 53.4958-4 Excess benefit transaction.
(a) Definition of excess benefit transaction--(1) In general. An
excess benefit transaction means any transaction in which an economic
benefit is provided by an applicable tax-exempt organization directly
or indirectly, to or for the use of, any disqualified person, and the
value of the economic benefit provided exceeds the value of the
consideration (including the performance of services) received by the
organization for providing such benefit. An excess benefit transaction
also includes certain revenue-sharing transactions described in
Sec. 53.4958-5. An economic benefit shall not be treated as
consideration for the performance of services unless the organization
providing the benefit clearly indicates its intent to treat the benefit
as compensation when the benefit is paid.
(2) Economic benefit provided directly or indirectly. An excess
benefit transaction occurs when an applicable tax-exempt organization
provides an excess benefit directly or indirectly to a disqualified
person. A benefit may be provided indirectly through the use of one or
more entities controlled by or affiliated with the applicable tax-
exempt organization. For example, if an
[[Page 41501]]
applicable tax-exempt organization causes its taxable subsidiary to pay
excessive compensation to, or engage in a transaction at other than
fair market value with, a disqualified person of the parent
organization, the payment of the compensation or the transfer of
property is an excess benefit transaction.
(3) Certain economic benefits disregarded for purposes of section
4958. The following economic benefits are disregarded for purposes of
section 4958:
(i) Reimbursements for reasonable expenses of attending meetings of
governing body. Paying reasonable expenses for members of the governing
body of an applicable tax-exempt organization to attend meetings of the
governing body of the organization will be disregarded for purposes of
section 4958. For purposes of the preceding sentence, reasonable
expenses do not include luxury travel or spousal travel.
(ii) Economic benefits provided to a disqualified person solely as
a member of, or volunteer for, the organization. An economic benefit
provided to a disqualified person that the disqualified person receives
solely as a member of, or volunteer for, the organization is
disregarded for purposes of section 4958 if the benefit is provided to
members of the public in exchange for a membership fee of $75 or less
per year. Thus, for example, if a disqualified person is also a member
of the organization and receives membership benefits such as advance
ticket purchases and a discount at the organization's gift shop that
would normally be provided in exchange for a membership fee of $75 or
less per year, then the membership benefit is disregarded for purposes
of section 4958.
(iii) Economic benefits provided to a disqualified person solely as
a member of a charitable class. An economic benefit provided to a
disqualified person that the disqualified person receives solely as a
member of a charitable class that the applicable tax-exempt
organization intends to benefit as part of the accomplishment of the
organization's exempt purpose is generally disregarded for purposes of
section 4958.
(4) Insurance or indemnification of excise taxes. The payment of a
premium for an insurance policy providing liability insurance to a
disqualified person for the taxes imposed under this section or
indemnification of a disqualified person for such taxes by an
applicable tax-exempt organization will not constitute an excess
benefit transaction for purposes of section 4958 if the premium or the
indemnification is treated as compensation to the disqualified person
when paid, and the total compensation paid to the disqualified person
is reasonable.
(b) Standards for identifying excess benefits--(1) In general. If
an economic benefit provided by the applicable tax-exempt organization
to or for the use of any disqualified person exceeds the fair market
value of the consideration, the excess is the excess benefit on which
tax is imposed by section 4958. See Sec. 53.4958-5(c) for rules
concerning the excess benefit in certain revenue-sharing transactions.
(2) Fair market value for transfer of property. The fair market
value of property, including the right to use property, is the price at
which property or the right to use property would change hands between
a willing buyer and a willing seller, neither being under any
compulsion to buy, sell or transfer property or the right to use
property, and both having reasonable knowledge of relevant facts.
(3) Reasonable compensation--(i) In general. Compensation paid may
not exceed what is reasonable under all the circumstances. Compensation
for the performance of services is reasonable if it is only such amount
as would ordinarily be paid for like services by like enterprises under
like circumstances. Generally, the circumstances to be taken into
consideration are those existing at the date when the contract for
services was made. However, where reasonableness of compensation cannot
be determined based on circumstances existing at the date when the
contract for services was made, then that determination is made based
on all facts and circumstances, up to and including circumstances as of
the date of payment. In no event shall circumstances existing at the
date when the contract is questioned be considered in making a
determination of the reasonableness of compensation. A written binding
contract that is terminable or subject to cancellation by the
applicable tax-exempt organization without the disqualified person's
consent is treated as a new contract as of the date that any such
termination or cancellation, if made, would be effective. If a binding
written contract is materially modified, it is treated as a new
contract entered into as of the date of the material modification. A
material modification includes, but is not limited to, amending the
contract to extend its term or to increase the amount of compensation
payable to the disqualified person. The fact that a State or local
legislative or agency body or court has authorized or approved a
particular compensation package paid to a disqualified person is not
determinative of the reasonableness of compensation paid for purposes
of section 4958 excise taxes.
(ii) Items included in determining the value of compensation for
purposes of section 4958. Compensation for purposes of section 4958
includes all items of compensation provided by an applicable tax-exempt
organization in exchange for the performance of services. These items
of compensation include, but are not limited to--
(A) All forms of cash and noncash compensation, including salary,
fees, bonuses, and severance payments paid;
(B) All forms of deferred compensation that is earned and vested,
whether or not funded, and whether or not paid under a deferred
compensation plan that is a qualified plan under section 401(a), but if
deferred compensation for services performed in multiple prior years
vests in a later year, then that compensation is attributed to the
years in which the services were performed;
(C) The amount of premiums paid for liability or any other
insurance coverage, as well as any payment or reimbursement by the
organization of charges, expenses, fees, or taxes not covered
ultimately by the insurance coverage;
(D) All other benefits, whether or not included in income for tax
purposes, including payments to welfare benefit plans on behalf of the
persons being compensated, such as plans providing medical, dental,
life insurance, severance pay, and disability benefits, and both
taxable and nontaxable fringe benefits (other than working condition
fringe benefits described in section 132(d) and de minimis fringe
benefits described in section 132(e)), including expense allowances or
reimbursements or foregone interest on loans that the recipient must
report as income on his separate income tax return; and
(E) Any economic benefit provided by an applicable tax-exempt
organization, whether provided directly or through another entity
owned, controlled by or affiliated with the applicable tax-exempt
organization, whether such other entity is taxable or tax-exempt.
(iii) Examples. The following examples illustrate whether the
reasonableness of compensation can be determined based on circumstances
existing at the time a contract for the performance of services was
made under the rules of this paragraph (b)(3):
Example 1. G is an applicable tax-exempt organization for
purposes of section 4958. H is an employee of G and a disqualified
person with respect to any transaction involving G that provides
economic benefits to H directly
[[Page 41502]]
or indirectly. H's multi-year employment contract provides for
payment of a salary and provision of specific amounts of health and
retirement benefits. The contract provides for an annual increase in
H's salary equal to the percentage increase, if any, over the
preceding year in the Consumer Price Index (CPI). The CPI for a year
is determined using an average of the monthly CPI as determined for
each month in that calendar year. The health benefits consist of
insurance coverage under a plan that is available to all of G's
employees. The retirement benefits are equal to the maximum amount G
is permitted to contribute under the rules applicable to qualified
retirement plans. Under these facts, the reasonableness of H's
compensation can be determined based on the circumstances existing
at the time G and H enter into the employment contract.
Example 2. N is an applicable tax-exempt organization for
purposes of section 4958. N uses the cash method of accounting and a
calendar year as its taxable year. On January 2, N's governing body
enters into a one-year employment contract for K, its new executive
director, who is a disqualified person with respect to any
transaction involving N and K. In addition to providing that K will
receive a specified amount of salary, deferred compensation, and
other health and retirement benefits from N in return for K's
services, the terms of the contract permit N's governing body to
declare a bonus to be paid to K at any time during the year covered
by the contract. Declaration and payment of any bonus is within the
governing body's discretion, with no specified limitations or
guidelines. The reasonableness of K's compensation cannot be
determined based on the circumstances existing as of the date the
contract was made because there were no guidelines in the contract
for the bonus that N may potentially pay. Therefore, the
determination of whether N's compensation is reasonable must be made
based on all circumstances, up to and including circumstances as of
the date of payment of any bonus actually paid under the contract.
If N pays K a bonus on December 31, the reasonableness of K's
compensation must be based on all circumstances from January 2
through December 31.
(c) Establishing intent to treat economic benefit as consideration
for the performance of services--(1) In general. An applicable tax-
exempt organization will be treated as having intended to provide an
economic benefit as compensation for services only if the organization
provides clear and convincing evidence that it intended to so treat the
economic benefit when the benefit was paid.
(2) Clear and convincing evidence of intent--(i) In general. If an
applicable tax-exempt organization or a disqualified person reports an
economic benefit as described in paragraph (c)(2)(ii) of this section
then the organization will have provided clear and convincing evidence
that it intended to provide an economic benefit as compensation for
services when the benefit was paid. If an applicable tax-exempt
organization's failure to report an economic benefit as required under
the Internal Revenue Code is due to reasonable cause (within the
meaning Sec. 301.6724-1 of this chapter and paragraph (c)(2)(iii) of
this section), then the organization will be treated as having provided
clear and convincing evidence of the requisite intent. An organization
may use methods other than those described in paragraphs (c)(2)(ii) and
(iii) of this section to provide clear and convincing evidence of its
intent.
(ii) Reporting of benefit. The organization reports the economic
benefit as compensation on original or amended federal tax information
returns with respect to the payment (e.g., Form W-2 or 1099) or with
respect to the organization (e.g., Form 990), filed before the
commencement of an Internal Revenue Service examination in which the
reporting of the benefit is questioned. For purposes of section 4958
and this section, an Internal Revenue Service examination of an
applicable tax-exempt organization has commenced if the organization
has received written notification from the Exempt Organizations
Division of an impending Exempt Organizations examination, or written
notification of an impending referral for an Exempt Organizations
examination, and also includes having been under an Exempt
Organizations examination that is now in Appeals or in litigation for
issues raised in an Exempt Organizations examination of the period in
which the excess benefit transaction occurred. Reporting of an economic
benefit to provide clear and convincing evidence of intent is also
accomplished if the recipient disqualified person reports the benefit
as income on the person's Form 1040 for the year in which the benefit
is received.
(iii) Failure to report due to reasonable cause. To show that its
failure to report an economic benefit that should have been reported on
an information return was due to reasonable cause, an applicable tax-
exempt organization must establish that there were significant
mitigating factors with respect to its failure to report (as described
in Sec. 301.6724-1(b) of this chapter), or the failure arose from
events beyond the organization's control (as described in
Sec. 301.6724-1(c) of this chapter), and that the organization acted in
a responsible manner both before and after the failure occurred (as
described in Sec. 301.6724-1(d) of this chapter).
(3) Effect of failing to establish intent. If an organization fails
to provide clear and convincing evidence that it intended to provide an
economic benefit as compensation for services when paid, any services
provided by the disqualified person will not be treated as provided in
consideration for the economic benefit.
(4) Examples. The following examples illustrate the rules for an
organization to establish its intent to treat an economic benefit as
consideration for the performance of services as defined in this
paragraph (c):
Example 1. G is an applicable tax-exempt organization for
purposes of section 4958. G hires an individual contractor, P, to
design a computer program for it, executes a contract for that
purpose, and pays P $1,000 in a timely manner pursuant to the
contract. Before January 31 of the next year, G reports the full
amount paid to P under the contract on a Form 1099 filed with the
Internal Revenue Service. G has provided clear and convincing
evidence of its intent to provide the $1,000 paid to P as
compensation for the services P performed under the contract.
Example 2. The facts are the same as in Example 1, except that
the services are provided by Corporation V. The contract executed by
Corporation V and G and placed in G's files indicates that the
payment made to Corporation V is in return for computer programming
services provided by employees of Corporation V. G does not issue an
information return to Corporation V because Corporation V is not an
individual taxpayer. The contract constitutes clear and convincing
evidence of G's intent to provide the payment as compensation for
Corporation V's services.
Example 3. G is an applicable tax-exempt organization for
purposes of section 4958. D is the chief operating officer of G, and
a disqualified person with respect to any transaction involving G
that provides economic benefits to D directly or indirectly. D
receives a bonus at the end of the year. A copy of the letter from G
to D describing the amount and the basis for D's bonus is placed in
D's personnel file. Information provided to all employees in the
personnel handbook clearly states that bonuses are treated as
taxable income, and included in the total wages figure reported on
each employee's Form W-2. G's accounting department determines that
the bonus is to be reported on D's Form W-2. Due to a computer
malfunction after data was entered incorrectly by personnel of G's
accounting department, the bonus is not reflected on D's Form W-2.
As a result, D fails to report the bonus on his individual income
tax return. G acts to amend Forms W-2 affected as soon as G becomes
aware of the data entry error and consequent computer malfunction.
G's failure to report the bonus on an information return issued to D
arose from events beyond G's control, and G acted in a responsible
manner both before and after the failure occurred. Thus, because G
had reasonable cause for failing to report D's bonus, G will be
treated as having clear and convincing evidence of its intent to
provide the bonus as compensation for services when paid.
[[Page 41503]]
Sec. 53.4958-5 Transaction in which amount of economic benefit
determined in whole or in part by the revenues of one or more
activities of the organization.
(a) In general. Whether a transaction in which the amount of an
economic benefit provided by an applicable tax-exempt organization to
or for the use of a disqualified person is determined in whole or in
part by the revenues of one or more activities of the applicable tax-
exempt organization (revenue-sharing transaction) results in inurement
and therefore constitutes an excess benefit transaction, depends upon
all relevant facts and circumstances. A revenue-sharing transaction may
constitute an excess benefit transaction regardless of whether the
economic benefit provided to the disqualified person exceeds the fair
market value of the consideration provided in return if, at any point,
it permits a disqualified person to receive additional compensation
without providing proportional benefits that contribute to the
organization's accomplishment of its exempt purpose. If the economic
benefit is provided as compensation for services, relevant facts and
circumstances include, but are not limited to, the relationship between
the size of the benefit provided and the quality and quantity of the
services provided, as well as the ability of the party receiving the
compensation to control the activities generating the revenues on which
the compensation is based.
(b) Special rule for allocation or return of net margins or capital
to members of certain cooperatives. The allocation or return of net
margins or capital to the members of certain cooperatives in accordance
with their incorporating statute and bylaws does not result in
inurement of the net earnings to the benefit of any private shareholder
or individual, and therefore does not constitute an excess benefit
transaction for section 4958 purposes. The preceding sentence applies
to cooperatives that were determined by the Secretary of the Treasury
or his delegate to be described in section 501(c)(4) and exempt from
tax under section 501(a) before July 30, 1996, and have substantially
the same incorporating statute and bylaws as existed on July 30, 1996.
(c) Rules effective prospectively. The rules in this section apply
to any revenue-sharing transaction described in this section that
occurs on or after the date of publication of final regulations. The
excess benefit shall consist of the entire economic benefit provided in
any transaction described in this section. Any revenue-sharing
transaction occurring after September 13, 1995, may still constitute an
excess benefit transaction if the economic benefit provided to the
disqualified person exceeds the fair market value of the consideration
provided in return. Before the date of publication of final
regulations, however, the excess benefit shall consist only of that
portion of the economic benefit that exceeds the fair market value of
the consideration provided in return.
(d) Examples. The following examples illustrate the principles used
in determining whether a revenue-sharing transaction constitutes an
excess benefit transaction under the rules of this section:
Example 1. A is the manager of the investment portfolio of M, an
applicable tax-exempt organization for purposes of section 4958. A
and several other professional investment managers work exclusively
for M in an office in M's building. A's compensation consists of a
flat base annual salary, health insurance, eligibility to
participate in a retirement plan, and a bonus that is equal to a
percentage of any increase in the value of M's portfolio over the
year (net of expenses for investment management other than the in-
house managers' compensation). The revenue-based portion of A's
compensation gives A an incentive to provide the highest quality
service in order to maximize benefits and minimize expenses to M. A
has a measure of control over the activities generating the revenues
on which his bonus is based, but A can increase his own compensation
only if M also receives a proportional benefit. Under these facts
and circumstances, the payment to A of the bonus described above
does not constitute an excess benefit transaction under the rules of
this section.
Example 2. L, an applicable tax-exempt organization for purposes
of section 4958, enters into a contract with H, a company who
manages charitable gaming activities for public charities. As a
result of the contractual relationship, H becomes a disqualified
person with respect to any transaction involving L that provides
economic benefits to H directly or indirectly. Under the contract, H
agrees to provide all of the staff and equipment necessary to carry
out charitable gaming operations on behalf of L, and to pay L z
percent of the net profits, which are calculated as the gross
revenue less rental for the equipment, wages for the staff, prizes
for the winners, and other specified operating expenses. H retains
the balance of the proceeds after expenses and after paying L its z
percent of the net profits. As manager, H controls the activities
generating the revenue on which its compensation is based. In
addition, because H owns the equipment and employs the staff needed
to operate the charitable gaming activities, H controls what L is
charged, including the profit H makes above the cost of these items.
Therefore, H can also control the net revenues relative to the gross
revenues from the gaming activity. The structure of the compensation
H receives for its services does not provide H with an appropriate
incentive to maximize benefits and minimize costs to L. H benefits
whether expenses are high and net revenues are low or expenses are
low and net revenues are high. By contrast, L suffers if expenses
for the charitable gaming operation are high and net revenues are
low. All of the gross revenues generated by the charitable gaming
operation belong to L. The arrangement between H and L allows a
portion of those revenues to inure to H. Therefore, this arrangement
results in the inurement of L's net earnings to the benefit of H,
and the entire amount paid to H under this arrangement constitutes
an excess benefit under the rules of this section.
Example 3. R, a professor and faculty member at S, a university
that is an applicable tax-exempt organization for purposes of
section 4958, is the principal investigator in charge of certain
scientific research at S. The research produces an invention. In
accordance with S's agreement with its faculty, S owns the
invention. R assists S in preparing a patent application. S receives
a patent for R's invention, which S owns. Also in accordance with
S's agreement with its faculty, S grants R the right to receive v
percent of S's royalties on the patent, payable semi-annually. R
also receives an annual compensation package of salary and benefits.
The availability of revenue-based compensation under these
circumstances does not give R any incentive or opportunity to act
contrary to S's interests in accomplishing its exempt purpose. R
receives the revenue-based compensation, i.e., the percentage of
royalties, as an incentive and a reward for producing work of
especially high quality. In addition, any time R benefits by
receiving royalties, S benefits as well and to a proportionate
degree. Finally, because the patent belongs to S, R has no control
over how the patent is used nor the stream of revenue it generates.
Under these facts and circumstances, S's payment of revenue-based
compensation to R does not constitute an excess benefit transaction
under the rules of this section.
Sec. 53.4958-6 Rebuttable presumption that transaction is not an
excess benefit transaction.
(a) In general. Payments under a compensation arrangement between
an applicable tax-exempt organization and a disqualified person shall
be presumed to be reasonable, and a transfer of property, right to use
property, or any other benefit or privilege between an applicable tax-
exempt organization and a disqualified person shall be presumed to be
at fair market value, if the following conditions are satisfied--
(1) The compensation arrangement or terms of transfer are approved
by the organization's governing body or a committee of the governing
body composed entirely of individuals who do not have a conflict of
interest with respect to the arrangement or transaction;
(2) The governing body, or committee thereof, obtained and relied
upon
[[Page 41504]]
appropriate data as to comparability prior to making its determination;
and
(3) The governing body or committee adequately documented the basis
for its determination concurrently with making that determination.
(b) Delegation pursuant to procedures. To the extent permitted
under local law, the governing body of an applicable tax-exempt
organization may authorize other parties to act on its behalf by
following specified procedures that satisfy the three requirements for
invoking the rebuttable presumption of reasonableness. An arrangement
or transaction that is subsequently approved by the board's designee or
designees in accordance with those procedures shall be subject to the
rebuttable presumption even though the governing body does not vote
separately on the specific arrangement or transaction.
(c) Rebutting the presumption. The presumption established by
satisfying the three requirements of paragraph (a) of this section may
be rebutted by additional information showing that the compensation was
not reasonable or that the transfer was not at fair market value.
(d) Requirements for invoking rebuttable presumption--(1)
Disinterested governing body or committee--(i) In general. The
governing body is the board of directors, board of trustees, or
equivalent controlling body of the applicable tax-exempt organization.
A committee of the governing body may be composed of any individuals
permitted under state law to serve on such a committee, and may act on
behalf of the governing body to the extent permitted by state law.
However, if the rebuttable presumption arises as the result of actions
taken by a committee, any members of such a committee who are not
members of the governing body are deemed to be organization managers
for purposes of the tax imposed by section 4958(a)(2), subject to the
rules of Sec. 53.4958-1(d).
(ii) Persons not included on governing body or committee. For
purposes of determining whether the requirements of paragraph (a) of
this section have been met with respect to a specific transaction or
compensation arrangement, a person is not included on the governing
body or committee when it is reviewing a transaction if that person
meets with other members only to answer questions, and otherwise
recuses himself from the meeting and is not present during debate and
voting on the transaction or compensation arrangement.
(iii) Absence of conflict of interest. A member of the governing
body, or committee thereof, does not have a conflict of interest with
respect to a compensation arrangement or transaction if the member--
(A) Is not the disqualified person and is not related to any
disqualified person participating in or economically benefiting from
the compensation arrangement or transaction by a relationship described
in section 4958(f)(4) or Sec. 53.4958-3(b)(1);
(B) Is not in an employment relationship subject to the direction
or control of any disqualified person participating in or economically
benefiting from the compensation arrangement or transaction;
(C) Is not receiving compensation or other payments subject to
approval by any disqualified person participating in or economically
benefiting from the compensation arrangement or transaction;
(D) Has no material financial interest affected by the compensation
arrangement or transaction; and
(E) Does not approve a transaction providing economic benefits to
any disqualified person participating in the compensation arrangement
or transaction, who in turn has approved or will approve a transaction
providing economic benefits to the member.
(iv) Rule where ratification by full governing body required. An
arrangement or transaction has not been approved by a committee of a
governing body if, under the governing documents of the organization or
state law, the committee's decision must be ratified by the full
governing body in order to become effective.
(2) Appropriate data as to comparability--(i) In general. A
governing body or committee has appropriate data as to comparability
if, given the knowledge and expertise of its members, it has
information sufficient to determine whether, under the standards set
forth in Sec. 53.4958-4(b), a compensation arrangement will result in
the payment of reasonable compensation or a transaction will be for
fair market value. Relevant information would include, but not be
limited to, compensation levels paid by similarly situated
organizations, both taxable and tax-exempt, for functionally comparable
positions; the availability of similar services in the geographic area
of the applicable tax-exempt organization; independent compensation
surveys compiled by independent firms; actual written offers from
similar institutions competing for the services of the disqualified
person; and independent appraisals of the value of property that the
applicable organization intends to purchase from, or sell or provide
to, the disqualified person.
(ii) Special rule for compensation paid by small organizations. For
organizations with annual gross receipts of less than $1 million
reviewing compensation arrangements, the governing body or committee
will be considered to have appropriate data as to comparability if it
has data on compensation paid by five comparable organizations in the
same or similar communities for similar services. No inference is
intended with respect to whether circumstances falling outside this
safe harbor will meet the requirement with respect to the collection of
appropriate data.
(iii) Additional rules for special rule for small organizations.
For purposes of determining applicability of the special rule for small
organizations described in paragraph (d)(2)(ii) of this section, a
rolling average based on the three prior taxable years may be used to
calculate annual gross receipts of an organization. If any applicable
tax-exempt organization is affiliated with another entity by common
control or governing documents, the annual gross receipts of all such
related organizations must be aggregated to determine applicability of
the special rule stated in paragraph (d)(2)(ii) of this section.
(iv) Examples. The following examples illustrate the rules for
appropriate data as to comparability for purposes of invoking the
rebuttable presumption of reasonableness described in this section:
Example 1. Z is a large university that is an applicable tax-
exempt organization for purposes of section 4958. Z has had gross
receipts of $200 million for the preceding three taxable years. Z is
negotiating a new contract with its president because the old
contract will expire at the end of the year. In determining the
compensation for its president, the executive committee of the Board
of Trustees relies on a national survey of compensation for
university presidents; this survey does not divide its data by any
measure of university size or any other criteria. None of the
members of the executive committee has any particular expertise in
higher education compensation matters, although many members have
significant business experience. Given the lack of specificity in
the data collected and the lack of relevant expertise and experience
of the executive committee members, the data relied on by the
executive committee does not constitute appropriate data as to
comparability.
Example 2. X, a tax-exempt hospital that is an applicable tax-
exempt organization for purposes of section 4958, has average annual
gross receipts of $250 million. Before renewing the contracts of X's
chief executive officer and chief financial officer, X's governing
board commissioned a customized
[[Page 41505]]
compensation survey from an independent firm that specializes in
consulting on issues related to executive placement and
compensation. The survey covered executives with comparable
responsibilities at a significant number of hospitals. The survey
data are sorted by a number of different variables, including the
size of the hospitals and the nature of the services they provide,
the level of experience and specific responsibilities of the
executives, and the composition of the compensation packages. The
board members were provided with the survey results, a detailed
written analysis comparing the hospital's executives to those
covered by the survey and an opportunity to ask questions of a
member of the firm that prepared the survey. The survey, as prepared
and presented to X's board, constitutes appropriate data as to
comparability.
Example 3. W is a local repertory theater and an applicable tax-
exempt organization for purposes of section 4958. W has had annual
gross receipts ranging from $400,000 to $800,000 over its past three
taxable years. In determining the next year's compensation for W's
artistic director, the board relies on data compiled from a
telephone survey of six other unrelated repertory theaters of
similar size in various communities throughout the same geographic
region. A member of the board drafts a brief written summary of the
salary information obtained from this informal survey. This
information is later included in a written report that also includes
information about the membership of the board of directors, and an
evaluation of the artistic director's prior salary and performance
that is discussed and voted on by the board. The salary information
obtained in the telephone survey is appropriate data as to
comparability.
(3) Documentation--(i) For a decision to be documented adequately,
the written or electronic records of the governing body or committee
must note--
(A) The terms of the transaction that was approved and the date it
was approved;
(B) The members of the governing body or committee who were present
during debate on the transaction or arrangement that was approved and
those who voted on it;
(C) The comparability data obtained and relied upon by the
committee and how the data was obtained; and
(D) The actions taken with respect to consideration of the
transaction by anyone who is otherwise a member of the governing body
or committee but who had a conflict of interest with respect to the
transaction or arrangement.
(ii) If the governing body or committee determines that reasonable
compensation for a specific arrangement or fair market value in a
specific transaction is higher or lower than the range of comparable
data obtained, the governing body or committee must record the basis
for its determination. For a decision to be documented concurrently,
records must be prepared by the next meeting of the governing body or
committee occurring after the final action or actions of the governing
body or committee are taken. Records must be reviewed and approved by
the governing body or committee as reasonable, accurate and complete
within a reasonable time period thereafter.
(e) No presumption until circumstances exist to determine
reasonableness of compensation. If reasonableness of the compensation
cannot be determined based on circumstances existing at the date when a
contract for services was made, then the rebuttable presumption of this
section cannot arise until circumstances exist so that reasonableness
of compensation can be determined, and the three requirements for the
presumption under paragraph (d) of this section subsequently are
satisfied. See Sec. 53.4958-4(b)(3)(i).
(f) No inference from absence of presumption. The fact that a
transaction between an applicable tax-exempt organization and a
disqualified person is not subject to the presumption described in this
section shall not create any inference that the transaction is an
excess benefit transaction. Neither shall the fact that a transaction
qualifies for the presumption exempt or relieve any person from
compliance with any federal or state law imposing any obligation, duty,
responsibility, or other standard of conduct with respect to the
operation or administration of any applicable tax-exempt organization.
(g) Period of reliance on rebuttable presumption. The rebuttable
presumption applies to all payments made or transactions completed in
accordance with a contract provided that the three requirements of the
rebuttable presumption were met at the time the contract was agreed
upon.
Sec. 53.4958-7 Special rules.
(a) Substantive requirements for exemption still apply. The excise
taxes imposed by section 4958 do not affect the substantive statutory
standards for tax exemption under sections 501(c)(3) or (4).
Organizations are described in those sections only if no part of their
net earnings inure to the benefit of any private shareholder or
individual.
(b) Interaction between section 4958 and section 7611 rules for
church tax inquiries and examinations. The procedures of section 7611
will be used in initiating and conducting any inquiry or examination
into whether an excess benefit transaction has occurred between a
church and a disqualified person. For purposes of this rule, the
reasonable belief required to initiate a church tax inquiry is
satisfied if there is a reasonable belief that a section 4958 tax is
due from a disqualified person with respect to a transaction involving
a church. See Sec. 301.7611-1 Q&A 19 of this chapter.
Sec. 53.4963-1 [Amended]
Par. 3. In Sec. 53.4963-1, paragraphs (a), (b), and (c) are amended
by adding the reference ``4958,'' immediately after the reference
``4955,'' in each place it appears.
PART 301--PROCEDURE AND ADMINISTRATION
Par. 4. The authority citation for part 301 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Sec. 301.6213-1 [Amended]
Par. 5. Section 301.6213-1, paragraph (e) is amended by adding the
reference ``4958,'' immediately after the reference ``4955,'' in the
first sentence.
Sec. 301.6501(e)-1 [Amended]
Par. 6. Section 301.6501(e)-1 is amended as follows:
1. Paragraph (c)(3)(ii), first and second sentences are amended by
removing the language ``or trust'' and adding ``trust, or other
organization'' in its place.
2. Paragraph (c)(3)(ii), the first sentence is amended by removing
the language ``and 4953'' and adding ``4953, and 4958'' in its place.
Sec. 301.6501(n)-1 [Amended]
Par. 7. Section 301.6501(n)-1 is amended as follows:
1. The paragraph heading for paragraph (a) is amended by removing
the language ``or trust'' and adding ``trust, or other organization''
in its place.
2. Paragraph (a)(1), the first sentence is amended by removing the
language ``or trust'' and adding ``trust, or other organization'' in
its place.
3. Paragraph (b), the heading and the first sentence are amended by
removing the language ``or trust'' and adding ``trust, or other
organization'' in its place.
Sec. 301.7422-1 [Amended]
Par. 8. In section 301.7422-1, paragraphs (a) introductory text,
(c) introductory text and (d) are amended by adding the reference
``4958,'' immediately after the reference ``4955,''.
Sec. 301.7611-1 [Amended]
Par. 9. In Sec. 301.7611-1, the Table of Contents is amended by
adding
[[Page 41506]]
``Application to Section 4958......19'' immediately after ``Effective
Date......18''.
Par. 10. In Sec. 301.7611-1, an undesignated centerheading and Q-19
and A-19 are added to read as follows:
Sec. 301.7611-1 Questions and answers relating to church tax inquiries
and examinations.
* * * * *
Application to Section 4958
Q-19: When do the church tax inquiry and examination procedures
described in section 7611 apply to a determination of whether there was
an excess benefit transaction described in section 4958?
A-19: See Sec. 53.4958-7(b) of this chapter for rules governing the
interaction between section 4958 excise taxes on excess benefit
transactions and section 7611 church tax inquiry and examination
procedures.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-20419 Filed 7-30-98; 8:45 am]
BILLING CODE 4830-01-U
