What are intermediate Sanctions?
Intermediate Sanctions allow the Internal Revenue Service to impose excise taxes on individuals who improperly benefit from transactions with an exempt organization. Intermediate Sanctions apply to all organizations that are or were described in Section 501(c)(3) or Section 501(c)(4) of the Internal Revenue Code at any time during the last five years, except for private foundations (which are already subject to their own excise tax law), governmental entities and affiliates that are exempt from taxation without regard to section 501(a) or do not have to file annual returns, and foreign organizations that receive substantially all of their support from non-U.S. sources.
Intermediate Sanctions may be imposed on any disqualified person who receives an excess benefit from a covered organization and on each organization manager who approves the excess benefit transaction. A disqualified person is any person who is in a position to exercise substantial influence over the affairs of an exempt organization typically consisting of the following:
- A family member
- An organization
- Members of the board
- Executive officer of the organization
- Treasurer or chief financial officer
An organization manager is defined as any officer, director, trustee or person having similar responsibilities regardless of his or her title. An organization manager also includes anyone serving on the board.
Excess Benefit Transaction:
Generally, an excess benefit transaction occurs anytime a disqualified person receives an economic benefit from an exempt organization that exceeds the value (not the cost) of the benefit provided to the organization by the disqualified person. All benefits from the organization to the disqualified person are taken into account, including every transaction that benefits a disqualified person, whether the benefit is direct or indirect, and whether the benefit is provided directly by the exempt organization or through an organization controlled by the exempt organization. Similarly, all benefits from the disqualified person to the organization are also taken into account.
The excess benefit is defined as the difference between the value of what is received by the organization and the value of what is given by the organization to the disqualified person.
Typically, excess benefit transactions involve compensation arrangements with officers, directors and key suppliers where the compensation is deemed to be unreasonable. Any disqualified person who receives compensation in excess of what is deemed reasonable, as well as organization managers participating in the approval and payment thereof, may be subject to penalties.
Penalties Under Intermediate Sanctions:
In all cases, the excess benefit must be corrected and returned to the organization disgorgement. The correction amount equals the sum of the excess benefit, plus interest. In addition to correction, the penalty to be paid to the IRS by the disqualified person is an amount equal to 25% of the excess benefit. If the monies are not returned “within the taxable period” or the individual fails to return the money to the organization, an additional tax equal to 200% of the excess benefit may be imposed. The taxable period begins on the date the excess benefit transaction occurs and ends on the earlier of the date the notice of deficiency is mailed or the 25% penalty is assessed. If less than the full correction amount is paid, the 200% penalty will be imposed only on the unpaid portion.
A tax equal to 10% (up to $20,000 per transaction) of the excess benefit may also be imposed on each organization manager, board member and involved executive who participates and/or knows of the excess benefit transaction, unless the participation is not willful and is due to reasonable cause. All organization managers participating in the transaction are jointly and severally liable.
Excess Benefit Example:
Disqualified Person (Executive Director of ABC Public Charity)
|Executive director’s total compensation package:||$200,000|
|25% excess benefit tax:||$6,250*|
|Failure to return excess benefit within tax year.
(Add’l 200% of excess):
|Total amount required to pay to the IRS:||$56,250|
*Taxes to be paid by executives to the IRS
**Amount to be disgorged to organization
Organization Manager (ABC Public Charity Board Member)
|Excess benefit of executive director’s compensation:||$25,000|
|10% excess benefit tax:||$2,500|
|Total amount required to pay to the IRS by each organization manager deemed to be involved in determining excess benefit and/or approving:||$2,500|
Safe Harbor Provisions:
Safe Harbor Defined – If an organization manager relies upon the advice of a professional that the transaction is not an excess benefit transaction, the person’s participation will generally not be considered to be knowing and willful. However, to qualify, the advice must be contained in a reasoned written opinion with respect to elements of the transaction within the professional’s expertise. An opinion must apply the specific facts relative to the transaction to the applicable standards and reach a reasoned conclusion. This practice offers the individuals a “safe harbor” against the IRS.
Under the safe harbor provisions, compensation is presumed to be reasonable, and a property transfer is presumed to be at fair market value if:
- The compensation arrangement or terms of transfer are approved, in advance, by an authorized body of the exempt organization, composed entirely of individuals without a conflict of interest
- The board or committee obtained and relied upon appropriate data as to comparability in making its determination
- The board or committee adequately documented the basis for its determination concurrently with making the decision
The disqualified person/organization manager normally has the burden of proving that the compensation was reasonable. However, if the three criteria above are met, the burden of proof shifts to the IRS and the IRS must prove that the compensation was unreasonable.
Role of Compensation Professional – The role of the compensation professional is to provide the exempt organization with an objective analysis of the compensation paid to its disqualified persons and/or organization managers. Typically, the need for the professional occurs either:
- Before individual is hired
- As a preventative measure
- When the IRS comes knocking
To discuss your company’s issues, do not hesitate to contact:
Mary A. Rizzuti, CCP, PHR, SHRM-CP
Sara D. Schmidt, CCP, PHR, SHRM-CP