[Federal Register Volume 66, Number 7 (Wednesday, January 10, 2001)]
[Rules and Regulations]
[Pages 2144-2172]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-256]
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Part IV
Department of the Treasury
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Internal Revenue Service
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26 CFR Parts 53, 301 and 602
Excise Taxes on Excess Benefit Transactions; Final Rule and Proposed
Rule
Federal Register / Vol. 66, No. 7 / Wednesday, January 10, 2001 /
Rules and Regulations
[[Page 2144]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 53, 301, and 602
[TD 8920]
RIN 1545-AY64
Excise Taxes on Excess Benefit Transactions
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Temporary regulations.
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SUMMARY: This document contains temporary regulations relating to the
excise taxes on excess benefit transactions under section 4958 of the
Internal Revenue 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 imposes excise taxes on transactions that provide excess economic
benefits to disqualified persons of public charities and social welfare
organizations (referred to as applicable tax-exempt organizations).
Disqualified persons who benefit from an excess benefit transaction
with an applicable tax-exempt organization are liable for a tax of 25
percent of the excess benefit. Such persons are also liable for a tax
of 200 percent of the excess benefit if the excess benefit is not
corrected by a certain date. Additionally, organization managers who
participate in an excess benefit transaction knowingly, willfully, and
without reasonable cause, are liable for a tax of 10 percent of the
excess benefit. The tax for which participating organization managers
are liable cannot exceed $10,000 for any one excess benefit
transaction.
DATES: Effective Date: These regulations are effective January 10,
2001.
Applicability Date: These regulations apply as of January 10, 2001
and will cease to apply January 9, 2004.
FOR FURTHER INFORMATION CONTACT: Phyllis D. Haney, (202) 622-4290 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these temporary
regulations have been reviewed and approved by the Office of Management
and Budget in accordance with the Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545-1623, in conjunction with the notice of
proposed rulemaking published August 4, 1998, 63 FR 41486, REG-246256-
96, Failure by Certain Charitable Organizations to Meet Certain
Qualification Requirements; Taxes on Excess Benefit Transactions.
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 and records relating to the 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
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. The IRS notified
the general public of the new section 4958 excise taxes in Notice 96-46
(1996-2 C.B. 112), which also solicited comments on the new law.
On August 4, 1998, a notice of proposed rulemaking (REG-246256-96)
clarifying certain definitions and rules contained in section 4958 was
published in the Federal Register (63 FR 41486). The IRS received
numerous written comments responding to this notice, including a
comment from the public on the collections of information estimates
contained therein.
That commentator expressed concern that the purchase of independent
compensation surveys is required to certify the reasonableness of
certain outside and personnel contracts; and that the proposed
regulations place a burden on governing bodies of applicable tax-exempt
organizations, increasing the personal risk of members of those
governing bodies. The collections of information in the proposed
regulations are voluntary on the part of the governing bodies of
applicable tax-exempt organizations. Although the collections of
information allow the organization to rely on a presumption that a
transaction is reasonable or at fair market value, the failure to
obtain the collections of information in no way implies that a
transaction is unreasonable.
Further, as discussed under Explanation of Provisions of this
preamble (under the heading Rebuttable presumption that a transaction
is not an excess benefit transaction), the IRS and the Treasury
Department believe that any applicable tax-exempt organization may
compile its own comparability data rather than obtain an independent
survey to satisfy the requirement to obtain appropriate data as to
comparability. Therefore, although the comment on Paperwork Reduction
Act requirements was considered in the new estimates of the annual
burden per recordkeeper and per respondent, these temporary regulations
continue to conclude that 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.
A public hearing was held on March 16 and 17, 1999. After
consideration of all the comments, the proposed regulations under
section 4958 were revised as follows. The major areas of the comments
and revisions are discussed below.
Explanation of Provisions
Additional Taxes on Disqualified Person
A disqualified person benefitting from an excess benefit
transaction must correct the excess benefit within the taxable period
to avoid liability for the 200-percent tax under section 4958(b). The
taxable period is defined by section 4958 as the period beginning on
the date the transaction occurred and ending on the earlier of the date
of mailing a notice of deficiency, or the date on which the 25-percent
tax is assessed.
A commentator questioned whether the disqualified person would
receive any notice that the IRS was examining a possible excess benefit
transaction before either of the events ending the taxable period
occur. In fact, a disqualified person would be notified if an
examination of that person were opened pursuant to an examination of an
applicable tax-exempt organization. The IRS has an obligation under
Internal Revenue Code (Code) section 7602(c) to notify taxpayers at the
beginning of the examination and collection process that the IRS might
contact third parties (such as the organization) about the taxpayer's
tax liabilities. Additionally, the IRS follows the procedure of issuing
a ``first letter of proposed deficiency'' allowing the taxpayer an
opportunity for administrative review in the IRS Office of Appeals.
This first letter is issued 30 days before the notice of deficiency is
issued. Consequently, a disqualified person would be aware of any
examination of a potential excess benefit transaction before the end of
the taxable period.
Although it is also IRS practice to issue a single notice of
deficiency for both the 25-percent and 200-percent
[[Page 2145]]
section 4958 taxes for which the disqualified person is liable, the
abatement rules under section 4961 provide that the 200-percent tax
under section 4958(b) is not to be assessed (and if assessed, is to be
abated) if the excess benefit is corrected within 90 days after the
mailing of the notice of deficiency for that tax.
Correction
Section 4958(f)(6) defines correction 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 were dealing
under the highest fiduciary standards.'' The proposed regulations
provide a short, general description of correction, referring to the
statutory language. The proposed regulations define correction as
repaying 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'' from the date of the excess
benefit transaction to the date the excess benefit is corrected. The
proposed regulations further allow correction ``in certain
circumstances'' by permitting the disqualified person to return
property to the organization and ``taking any additional steps
necessary to make the organization whole.'' Where there is an ongoing
contract for services, the proposed regulations provide that the
parties need not terminate the contract in order to correct, but the
contract ``may need to be modified'' to avoid future excess benefit
transactions.
The IRS received numerous comments and requests for additional
guidance relating to correction as defined in the proposed regulations.
A number of commentators requested that final regulations state
explicitly that correction requires a disqualified person to pay
interest on the excess benefit amount, and to specify the rate of
interest.
The temporary regulations state that the disqualified person must
pay the applicable tax-exempt organization a correction amount in order
to correct an excess benefit transaction and prevent imposition of the
200-percent tax. The correction amount equals the sum of the excess
benefit and interest on the excess benefit. The amount of the interest
charge is determined by multiplying the excess benefit by an interest
rate, compounded annually, for the period from the date the excess
benefit transaction occurred to the date of correction. The interest
rate used for this purpose must be a rate that equals or exceeds the
applicable Federal rate (AFR), compounded annually, for the month in
which the transaction occurred. The period from the date the excess
benefit transaction occurred to the date of correction is used to
determine whether the appropriate AFR is the Federal short-term rate,
the Federal mid-term rate, or the Federal long-term rate.
Commentators requested that an applicable tax-exempt organization
have discretion to determine the appropriate form of correction; for
example, payment of money, return of property, or some combination.
Alternatively, one commentator requested an explicit rule that monetary
payment is always sufficient and that a buy-back or return of property
is not required. Another requested clarification that rescission could
constitute an appropriate form of correction.
The temporary regulations provide, in general, that a disqualified
person corrects an excess benefit only by making a payment in cash or
cash equivalents to the applicable tax-exempt organization equal to the
correction amount. The disqualified person may, however, with the
agreement of the applicable tax-exempt organization, make a payment by
returning specific property previously transferred in the excess
benefit transaction. In the latter case, the amount of the payment
equals the lesser of the fair market value of the property determined
on the date the property is returned to the organization, or the fair
market value of the property on the date the excess benefit transaction
occurred.
Under the temporary regulations, if the payment made by returning
the property is less than the correction amount, the disqualified
person must make an additional cash payment to the organization of the
difference. Conversely, if the payment made by returning the property
exceeds the correction amount, the organization may make a cash payment
to the disqualified person of the difference. The disqualified person
who engaged in the excess benefit transaction with the applicable tax-
exempt organization may not participate in the applicable tax-exempt
organization's decision whether to accept as a correction payment the
return of specific property previously transferred in the excess
benefit transaction. An organization may always refuse the return of
that property as payment, and require instead that the disqualified
person make a payment in cash (or cash equivalents) of the full
correction amount.
The temporary regulations provide a special rule relating to the
correction of an excess benefit transaction resulting from the vesting
of benefits provided under a nonqualified deferred compensation plan.
To the extent that such benefits have not been distributed to the
disqualified person, the disqualified person may correct the portion of
the excess benefit attributable to such undistributed deferred
compensation by relinquishing any right to receive such benefits
(including any earnings thereon).
The temporary regulations provide five new examples that illustrate
acceptable forms of correction. The temporary regulations also clarify
that, if the disqualified person makes a payment of less than the full
correction amount, the 200-percent tax is imposed only on the unpaid
portion of the correction amount.
Another commentator suggested that where an organization failed to
establish its intent to treat an economic benefit as consideration for
the performance of services, amending an information return, rather
than requiring the disqualified person to repay the benefit, should be
sufficient to correct the excess benefit transaction, assuming that the
total amount of compensation was reasonable. In this regard, the
proposed regulations specifically allow the reporting of an economic
benefit by an organization on an original or amended Federal tax
information return to establish that a benefit was intended as
compensation. The proposed regulations and these temporary regulations
permit an organization to establish its intent by amending an
information return at any time prior to when the IRS commences an
examination. Additionally, the temporary regulations explicitly allow
the disqualified person to amend the person's Federal tax return to
report a benefit as income at any time prior to when the IRS commences
an examination of the disqualified person or the applicable tax-exempt
organization for the taxable year in which the transaction occurs.
In addition, under the proposed regulations and these temporary
regulations, if an organization can show reasonable cause (using
existing standards under section 6724) for failing to report an
economic benefit as compensation as required under the Code or
regulations, then the organization will be treated as clearly
indicating its intent to provide an economic benefit as compensation
for services. The section 6724 standards include acting in a
responsible manner before and after the failure to report occurred,
along with either significant
[[Page 2146]]
mitigating factors or events beyond the organization's control.
Where the applicable tax-exempt organization provides taxable
benefits to a disqualified person, section 4958(c)(1) requires a clear
indication that the organization intended to provide the benefits as
consideration for the performance of services. Where there is no such
clear indication, the value of those benefits generally is an excess
benefit, regardless of any claim of reasonableness of the total
compensation package. In this case, the regular correction rules apply.
The temporary regulations provide that failure of the organization
or the disqualified person to report nontaxable economic benefits (or
otherwise document a clear intent) does not result automatically in an
excess benefit transaction. This rule is consistent with the
legislative history. (H. REP. NO. 506, 104th Congress, 2d SESS. (1996),
53, 57, note 8). These nontaxable benefits must still be taken into
account (unless specifically excluded elsewhere in the regulations)
when determining whether the total amount of compensation paid to a
disqualified person is reasonable. Therefore, only to the extent that
total compensation exceeds what is reasonable could a section 4958
excise tax be imposed and correction be required with respect to
nontaxable economic benefits.
The temporary regulations provide additional guidance regarding
correction where an applicable tax-exempt organization has ceased to
exist or is no longer tax-exempt under section 501(a) as an
organization described in section 501(c)(3) or (4). The temporary
regulations make clear that a disqualified person must correct the
excess benefit transaction in either event. In the case of section
501(c)(3) organizations, the disqualified person must pay the
correction amount to another organization described in section
501(c)(3) in accordance with the dissolution clause of the applicable
tax-exempt organization involved in the excess benefit transaction,
provided the other organization is not related to the disqualified
person. In the case of section 501(c)(4) organizations, the
disqualified person must pay the correction amount to the successor
section 501(c)(4) organization or, if there is no tax-exempt successor,
to any section 501(c)(3) or section 501(c)(4) organization not related
to the disqualified person.
Several commentators requested clarification that a disqualified
person is allowed to deduct the payment of a correction amount as a
business expense. The issue is beyond the scope of these regulations.
The provisions of Subtitle A of the Code govern the deductibility of
any part of a correction payment.
Tax Paid by Organization Managers: Reliance on Advice of Counsel
The proposed regulations provide a safe harbor under which a
manager's participation in a transaction will ordinarily not be subject
to tax under section 4958(a)(2), even though the transaction is
subsequently held to be an excess benefit transaction, if the manager
fully discloses the factual situation to legal counsel, then relies on
the advice of such counsel expressed in a reasoned written legal
opinion that a transaction is not an excess benefit transaction. This
safe harbor parallels the rules for foundation manager taxes contained
in the regulations under section 4941 (taxes on self-dealing) and
section 4945 (taxes on taxable expenditures).
A number of commentators suggested that the final regulations
expand the advice-of-counsel safe harbor to allow reliance on the
advice of other professionals. Specifically mentioned were section 7525
practitioners (Federally authorized tax practitioners), professional
tax advisors, and compensation consultants and appraisers with respect
to valuation issues. Commentators likewise suggested that parallel
revisions should be made to the section 4941 and 4945 regulations.
The temporary regulations expand the safe harbor contained in the
proposed regulations. The temporary regulations provide that an
organization manager's participation in an excess benefit transaction
will ordinarily not be considered knowing to the extent that, after
full disclosure of the factual situation to an appropriate
professional, the organization manager relies on a reasoned written
opinion of that professional with respect to elements of the
transaction within the professional's expertise. For this purpose,
appropriate professionals are legal counsel (including in-house
counsel), certified public accountants or accounting firms with
expertise regarding the relevant tax law matters, and independent
valuation experts who meet specified requirements. The requirements for
appropriate valuation experts are modeled after the section 170
regulations that define qualified appraisers for charitable deduction
purposes. Under the section 4958 temporary regulations, the valuation
experts must hold themselves out to the public as appraisers or
compensation consultants; perform the relevant valuations on a regular
basis; be qualified to make valuations of the type of property or
services being valued; and include in the written opinion a
certification that they meet the preceding requirements. This section
4958 regulations project did not undertake any revisions to the advice-
of-counsel safe harbor or the definition of knowing in the section 4941
and 4945 regulations.
The temporary regulations contain an additional safe harbor,
providing that an organization manager's participation in a transaction
will ordinarily not be considered knowing if the manager relies on the
fact that the requirements giving rise to the rebuttable presumption of
reasonableness are satisfied with respect to the transaction (for the
requirements, see discussion under the heading Rebuttable presumption
that a transaction is not an excess benefit transaction of this
preamble).
Date of Occurrence
Section 4958 does not specify when an excess benefit transaction
occurs. The proposed regulations provide that 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. The proposed regulations
also provide that a transaction consisting of the payment of deferred
compensation occurs on the date the deferred compensation is earned and
vested. Several comments were received requesting additional guidance
about the timing of an excess benefit transaction. Specifically, one
commentator requested clarification in the case of multiple payments.
The temporary regulations continue to provide as a general rule
that an excess benefit transaction occurs on the date the disqualified
person receives the economic benefit for Federal income tax purposes.
The temporary regulations contain additional rules for a series of
compensation payments or other payments arising pursuant to a single
contractual arrangement provided to a disqualified person over the
course of the disqualified person's taxable year (or part of a taxable
year). In such a case, any excess benefit transaction with respect to
these aggregate payments is deemed to occur on the last day of the
taxable year (or, if the payments continue for part of the year, the
date of the last payment in the series).
The temporary regulations also contain special rules for deferred,
contingent, and certain noncash compensation. The temporary
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regulations state that in the case of benefits provided pursuant to a
qualified pension, profit-sharing, or stock bonus plan, the transaction
occurs on the date the benefit is vested. In the case of a transfer of
property that is subject to a substantial risk of forfeiture, or in the
case of rights to future compensation or property (including benefits
under a nonqualified deferred compensation plan), the transaction
occurs on the date the property, or the rights to future compensation
or property, is not subject to a substantial risk of forfeiture.
However, where the disqualified person elects to include an amount in
gross income in the taxable year of transfer pursuant to section 83(b),
the general rule applies, such that the transaction occurs on the date
the disqualified person receives the economic benefit from the
applicable tax-exempt organization for Federal income tax purposes. Any
excess benefit transaction with respect to benefits under a deferred
compensation plan which vest during any taxable year of the
disqualified person is deemed to occur on the last day of the
disqualified person's taxable year.
The temporary regulations continue to reference the relevant Code
sections for statute of limitations rules as they apply to section 4958
excise taxes. Generally, the statute of limitations for section 4958
taxes begins with the filing of the applicable tax-exempt
organization's return for the year in which the excess benefit
transaction occurred. If the organization discloses an item on its
return or on an attached schedule or statement in a manner sufficient
to apprise the IRS of the existence and nature of an excess benefit
transaction, the three-year limitation on assessment and collection
applies. If the transaction is not so disclosed, a six-year limitation
on assessment and collection applies, unless an exception listed in
section 6501(c) applies.
Definition of Applicable Tax-Exempt Organization
Section 4958(e) defines an applicable tax-exempt organization as
``any organization which (without regard to any excess benefit) would
be described in paragraph (3) or (4) of section 501(c) and exempt from
tax under section 501(a) * * *'' (except private foundations). An
applicable tax-exempt organization also includes any organization that
was described in section 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).
The temporary regulations revise the section defining applicable
tax-exempt organizations to clarify that an organization is not
described in section 501(c)(3) or (4) for purposes of section 4958
during any period covered by a final determination or adjudication that
the organization is not exempt from tax under section 501(a) as an
organization described in section 501(c)(3) or (4), so long as that
determination or adjudication is not based upon participation in
inurement or one or more excess benefit transactions.
A number of commentators requested that the final regulations
clarify the status of section 115 governmental entities that
voluntarily applied for a determination of their section 501(c)(3)
status. Others requested that those governmental entities that applied
for section 501(c)(3) exemption before the enactment of section 4958 be
exempt from section 4958. In response to these comments, the temporary
regulations provide that any governmental entity that is exempt from
(or not subject to) taxation without regard to section 501(a) is not an
applicable tax-exempt organization for purposes of section 4958.
Definition of Disqualified Person
Section 4958(f)(1) defines a disqualified person with respect to
any transaction as ``any person who was, at any time during the 5-year
period ending on the date of such transaction, in a position to
exercise substantial influence over the affairs of the organization * *
*'' (and several other categories of related persons). The proposed
regulations list the statutory categories of related persons (i.e.,
certain family members and 35-percent controlled entities) that are
treated as disqualified persons for section 4958 purposes. The proposed
regulations also list several categories of persons who are treated as
disqualified persons by virtue of the functions they perform for, or
the interests they hold in, the organization. The proposed regulations
further provide that other persons may be treated as disqualified
persons depending on all relevant facts and circumstances and list some
of the factors to be considered.
Some commentators questioned certain categories of persons who are
deemed to have substantial influence under the proposed regulations
(e.g., presidents, chief executive officers, treasurers), arguing that
these per se categories conflict with a statement in the legislative
history that ``[a] person having the title of `officer, director, or
trustee' does not automatically have the status of a disqualified
person.'' These commentators requested that final regulations adopt an
alternative approach of listing these categories as facts and
circumstances tending to show that a person has substantial influence
over the affairs of an organization. In response to these comments, the
temporary regulations clarify that the per se categories of persons who
are in a position to exercise substantial influence for section 4958
purposes are defined by reference to the actual powers and
responsibilities held by the person and not merely by the person's
title or formal position. Thus, for example, it is possible that a
person with the mere title of ``president'' could be treated as not
having substantial influence if it is demonstrated that the person, in
fact, does not have ultimate responsibility for implementing the
decisions of the governing body or for supervising the management,
administration, or operation of the organization.
A number of commentators objected to a provision in the proposed
regulations under which a person who has or shares authority to sign
drafts or to authorize electronic transfer of the organization's funds
is treated as a treasurer or chief financial officer who is in a
position to exercise substantial influence over the affairs of the
organization. Other commentators requested that the final regulations
recognize that a person who may authorize transfer of only minimal
amounts of the organization's funds should not be treated as a
disqualified person solely by reason of that authority.
The temporary regulations clarify that a person who has the powers
and responsibilities of a treasurer or chief financial officer is in a
position to exercise substantial influence, provided that the person
has ultimate responsibility for managing the finances of the
organization. As requested by commentators, the temporary regulations
delete the provision from the proposed regulations that refers to
having, or sharing, authority to sign drafts or to authorize electronic
transfer of funds.
The IRS and the Treasury Department considered, but declined to
adopt at present, a special rule with respect to so-called ``donor
advised funds'' maintained by an applicable tax-exempt organization.
Unlike other segments of an applicable tax-exempt organization, such as
an operating department (or division) of the organization, a donor
advised fund consists of a segregated fund maintained for the specific
purpose of allowing certain persons to provide ongoing advice regarding
the
[[Page 2148]]
organization's use of amounts contributed by a particular donor (or
donors). Although these persons cannot properly have legal control over
the segregated fund, they nonetheless are in a position to exercise
substantial influence over the amount, timing, or recipients of
distributions from the fund. Accordingly, the IRS and the Treasury
Department request comments regarding potential issues raised by
applying the fair market value standard of section 4958 to
distributions from a donor advised fund to (or for the use of) the
donor or advisor.
The proposed regulations deem certain persons not to have
substantial influence, including any applicable tax-exempt organization
described in section 501(c)(3) (i.e., public charities subject to
section 4958). Various commentators requested that section 501(c)(4)
applicable tax-exempt organizations, section 115 governmental entities,
corporations or associations organized as non-profits under the laws of
any State, or entities 100-percent controlled by and for the benefit of
section 501(c)(3) applicable tax-exempt organizations, be deemed not to
exercise substantial influence over the affairs of applicable tax-
exempt organizations.
The temporary regulations provide that any organization described
in section 501(c)(3) and exempt from tax under section 501(a)
(including a private foundation), is not a disqualified person. The
temporary regulations do not specifically exclude from disqualified
person status section 115 and section 501(c)(4) organizations
generally, as requested in comments. However, the temporary regulations
state that an organization described in section 501(c)(4) is deemed not
to have substantial influence with respect to another applicable tax-
exempt organization described in section 501(c)(4). Additionally, the
temporary regulations provide that the transfer of economic benefits to
a government entity for exclusively public purposes is disregarded for
purposes of section 4958.
A number of comments were received on the section of the proposed
regulations providing that facts and circumstances govern in all cases
where disqualified person status is not explicitly described.
Commentators variously requested revision or deletion of the statement
that a person with managerial control over a discrete segment of an
organization could be in a position to exercise substantial influence
over the affairs of the entire organization. Instead of considering
this factor in an overall evaluation of the facts and circumstances,
the temporary regulations provide that the fact that a ``person manages
a discrete segment or activity of the organization that represents a
substantial portion of the activities, assets, income, or expenses of
the organization'' is a separate factor tending to show substantial
influence. The IRS and the Treasury Department believe that, in some
circumstances, a person managing a discrete segment or activity of an
organization is, in fact, in a position to exercise substantial
influence over the organization as a whole.
With respect to the factor that a person is a substantial
contributor within the meaning of section 507(d)(2), requests were made
to define a substantial contributor as a person contributing more than
two percent of the organization's total support; to use a higher
threshold, such as the greater of $50,000 or 10 percent of total
contributions received; to limit the treatment of substantial
contributor status as a factor to a reasonable time (e.g., four years);
and to tie substantial contributor status to persons required to be
disclosed as such on Form 990 or Schedule A of that form. Additionally,
a request was made to specify how the five-year lookback period applies
to substantial contributors.
The temporary regulations continue to include as a factor tending
to show substantial influence the fact that a person is a substantial
contributor, generally as defined in section 507(d)(2)(A). However, the
temporary regulations clarify that, to determine whether a person is a
substantial contributor for section 4958 purposes, only contributions
received by the organization during its current taxable year and the
four preceding taxable years are taken into account.
With respect to the factor that a person's compensation is based on
revenues derived from activities of the organization that the person
controls, a number of commentators requested that a determination of
disqualified person status not be based solely on this factor. Several
commentators specifically requested clarification of this factor with
respect to physicians in particular, and others requested that the
factor be deleted altogether. Other commentators requested that the
factor be narrowed to situations where the person's compensation is
based on revenues from activities that provide over half of the
organization's annual revenue, or that the factor be modified to apply
only if a person's compensation is based to a significant extent on
revenues derived from activities of the organization that the person
controls. In response to these comments, the temporary regulations
modify the factor to require that the person's compensation is
primarily based on revenues derived from activities of the organization
that the person controls.
A number of commentators argued that it is inappropriate to include
all persons with managerial authority, or persons serving as key
advisors to a person with managerial authority, as potential
disqualified persons. Additional comments on this issue requested that
the final regulations clarify the meaning of managerial authority or
delete that factor from the regulations. Others suggested that the term
key advisor be limited to those with real, substantial authority, or
deleted altogether and replaced by a standard that a person can have
managerial authority by virtue of his or her actual impact on the
organization's affairs without regard to title or position. In response
to these comments, the temporary regulations delete as a factor tending
to show substantial influence the fact that a person serves as a key
advisor to a manager. Moreover, with respect to managerial authority,
the temporary regulations list revised factors tending to show
substantial influence, including whether: (1) The person has or shares
authority to control or determine a substantial portion of the
organization's capital expenditures, operating budget, or compensation
for employees; and (2) the person manages a discrete segment or
activity of the organization that represents a substantial portion of
the activities, assets, income, or expenses of the organization, as
compared to the organization as a whole.
With respect to factors tending to show that a person does not have
substantial influence, one commentator requested that the fact that the
person has had no prior involvement or relationship with the
organization be added as a factor. Another commentator requested that
the independent contractor factor be modified so that all ``outside,
independent professionals performing services on a strictly fee-for-
service arrangement'' are presumed not to be disqualified persons.
Other commentators requested that additional factors tending to show no
substantial influence be added for employees. In this regard, suggested
factors included that the person reports to a disqualified person, does
not participate in major policy or financial decisions affecting the
organization as a whole, or holds a position three or more levels below
the governing body. In response to these comments, the temporary
regulations provide as a factor tending to show no substantial
influence the fact that a
[[Page 2149]]
person is an independent contractor (such as an attorney, accountant,
or investment manager or advisor) whose sole relationship to the
organization is providing professional advice, but who does not have
decision-making authority, with respect to transactions from which the
independent contractor will not economically benefit either directly or
indirectly (aside from customary fees received for the professional
advice rendered). In addition, the temporary regulations add as factors
tending to show no substantial influence the fact that the direct
supervisor of the individual is not a disqualified person, and that the
person does not participate in any management decisions affecting the
organization as a whole or a substantial, discrete segment or activity
of the organization. The temporary regulations also address the issue
of persons with no prior involvement with the organization by providing
a special exception for initial contracts (see the discussion under the
heading Initial Contract Exception in this preamble).
Definition of Excess Benefit Transaction
Section 4958(c)(1) defines the phrase excess benefit transaction as
``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.'' The
excess benefit is the amount by which the value of the economic
benefits provided to (or for the use of) the disqualified person
exceeds the value of the consideration received. The proposed
regulations further define certain terms in the statutory definition of
excess benefit transaction and delineate specific items that either are
disregarded or must be taken into account in determining the value of a
compensation package. The proposed regulations also prescribe standards
for determining fair market value for section 4958 purposes. In
response to comments received on these topics, the temporary
regulations make numerous changes to the provisions of the proposed
regulations that define the phrase excess benefit transaction (as
summarized under the next six topic headings).
The IRS and the Treasury Department considered whether embezzled
amounts should be viewed as provided by the organization for section
4958 purposes. In this regard, the IRS and the Treasury Department
believe that any economic benefit received by a disqualified person
(who by definition has substantial influence) from the assets of the
organization is provided by the organization even if the transfer of
the benefit was not authorized under the regular procedures of the
organization.
Economic Benefit Provided Directly or Indirectly
Section 4958(c)(1)(A) provides that an excess benefit transaction
may arise when economic benefits are provided by an applicable tax-
exempt organization directly or indirectly to or for the use of any
disqualified person. In this regard, the proposed regulations provide
that ``[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 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.'' This example is based on similar language
contained in the legislative history to section 4958 (See H. REP. NO.
506, 104th Congress, 2d SESS. (1996), 53, 56, note 3).
A number of commentators requested further clarification of the
definition of indirect excess benefit transactions. Some commentators
requested that the final regulations clarify that any compensation
disqualified persons receive from unrelated third parties through the
acquiescence of the employing applicable tax-exempt organization not be
considered in determining reasonable compensation. Another commentator
suggested that, as a general rule, an excess benefit may be found to be
provided indirectly through an entity controlled by an applicable tax-
exempt organization only when the funds or other benefits at issue can
clearly be traced to the parent organization. Additionally, a request
was received to specify that payment by a subsidiary of excessive
compensation does not, by itself, justify the conclusion that the
parent organization caused the subsidiary to engage in an excess
benefit transaction. Other requests were made to clarify that services
received by the applicable tax-exempt organization may include services
provided by the disqualified person to one or more other entities
controlled by or affiliated with the organization.
Commentators also suggested several clarifications to the phrase
``controlled by or affiliated with'' for purposes of determining
whether an indirect excess benefit transaction has occurred. One
commentator suggested that control or affiliation must exist at the
time the benefit is authorized or approved, rather than when the
benefit is received by the disqualified person. Others suggested that
the definition of ``controlled by or affiliated with'' follow more
closely the definition of control under the section 4941 self-dealing
regulations or under section 512(b)(13) (including constructive
ownership rules contained in section 318). Another commentator
suggested defining the term affiliated to mean that organizations share
a majority of governing body members or principal officers. Other
commentators requested that the final regulations state that approval
of a benefit by a board independent of the applicable tax-exempt
organization would prevent finding that the organization indirectly
provided an excess benefit to a disqualified person. Commentators also
requested that the final regulations include examples demonstrating
that the mere existence of a relationship between two entities,
including a control relationship, is insufficient to justify a
conclusion that a benefit has been indirectly provided to a
disqualified person unless a purposeful avoidance of section 4958 by
conducting a transaction indirectly is shown.
In response to these comments, the temporary regulations clarify
that an applicable tax-exempt organization may provide an economic
benefit indirectly to a disqualified person either through a controlled
entity or through an intermediary. In this regard, the temporary
regulations parallel the section 4941 self-dealing regulations, except
that the temporary regulations generally adopt the section 512(b)(13)
standard for control. (The section 512(b)(13) standard for control
considers only the tax-exempt organization's interest in the controlled
entity, or the tax-exempt organization's control of a nonstock
corporation's directors or trustees. In contrast, the section 4941
regulations' definition of control also considers interests held
individually by the directors or trustees of the foundation). The
temporary regulations provide that all consideration and benefits
exchanged between a disqualified person and an applicable tax-exempt
organization, and all entities the organization controls, are taken
into account to determine whether there has been an excess benefit
transaction.
The temporary regulations provide that an applicable tax-exempt
organization provides an economic
[[Page 2150]]
benefit indirectly through an intermediary when: (1) An applicable tax-
exempt organization provides an economic benefit to a third party (the
intermediary); (2) the intermediary provides economic benefits to a
disqualified person of the applicable tax-exempt organization; and (3)
either (a) there is evidence of an oral or written agreement or
understanding that the intermediary will transfer property to a
disqualified person; or (b) the intermediary lacks a significant
business purpose or exempt purpose of its own for engaging in such a
transfer. The temporary regulations also include four new examples
illustrating different fact patterns under which economic benefits are
provided indirectly to a disqualified person through a controlled
entity or through an intermediary.
Initial Contract Exception
The proposed regulations do not provide any special rules for
transactions conducted pursuant to the first contract that a previously
unrelated person enters into with the applicable tax-exempt
organization. Several comments received during the regular comment
period requested that a person having no prior relationship with an
organization not be considered a disqualified person with respect to
the first contractual arrangement with the organization.
After the close of the written comment period for the proposed
regulations (November 2, 1998), but before the public hearing (March 16
and 17, 1999), the United States Court of Appeals for the Seventh
Circuit issued its decision in United Cancer Council, Inc. v.
Commissioner of Internal Revenue, 165 F.3d 1173 (7th Cir. 1999),
rev'ing and remanding 109 T.C. 326 (1997). In this case, the Seventh
Circuit reversed the Tax Court's finding that a contract between a
charity and a previously unrelated fundraising company resulted in
private inurement in violation of the charity's tax-exempt status. The
Seventh Circuit remanded the case back to the Tax Court to address the
question whether the fundraising contract resulted in private benefit
in violation of section 501(c)(3).
In United Cancer Council, the Seventh Circuit concluded that
prohibited inurement under section 501(c)(3) cannot result from a
contractual relationship negotiated at arm's length with a party having
no prior relationship with the organization, regardless of the relative
bargaining strength of the parties or resultant control over the tax-
exempt organization created by the terms of the contract. The
transactions at issue in United Cancer Council were conducted prior to
the effective date of section 4958. Consequently, United Cancer Council
involved interpretations of the general requirements for tax-exempt
status under section 501(c)(3), and not questions of disqualified
person status or the existence of an excess benefit transaction under
section 4958. Nevertheless, at the public hearing and in supplemental
comments received after the hearing, commentators referenced the
Seventh Circuit decision and requested that the proposed regulations be
modified so that section 4958 excise taxes will not be imposed on the
first transaction or contract between an applicable tax-exempt
organization and a previously unrelated person.
The temporary regulations address the issue raised by United Cancer
Council by providing that section 4958 does not apply to any fixed
payment made to a person pursuant to an initial contract, regardless of
whether the payment would otherwise constitute an excess benefit
transaction. For this purpose, an initial contract is defined as a
binding written contract between an applicable tax-exempt organization
and a person who was not a disqualified person immediately prior to
entering into the contract. A fixed payment means an amount of cash or
other property specified in the contract, or determined by a fixed
formula specified in the contract, which is paid or transferred in
exchange for the provision of specified services or property. A fixed
formula may incorporate an amount that depends upon future specified
events or contingencies (e.g., revenues generated by activities of the
organization), provided that no person exercises discretion when
calculating the amount of a payment or deciding whether to make a
payment. As suggested by some commentators, however, the initial
contract rule does not apply if the contract is materially modified or
if a person fails to substantially perform his or her obligations under
the contract.
Thus, under the temporary regulations, to the extent that an
applicable tax-exempt organization and a person who is not yet a
disqualified person conduct negotiations and specify the amounts to be
paid to the person (or specify an objective formula for paying that
person), then these fixed payments are not subject to scrutiny under
section 4958, even if paid after the person becomes a disqualified
person. An initial contract may provide for both fixed and non-fixed
(i.e., discretionary) payments. In this case, the fixed payments are
not subject to section 4958, while the non-fixed payments will be
subject to scrutiny under section 4958 (taking into account all
consideration exchanged between the parties). In effect, the initial
contract rule contained in the temporary regulations protects from
section 4958 liability those payments made pursuant to fixed, objective
terms specified in a contract entered into before the person was in a
position to exercise substantial influence, yet allows for scrutiny
under section 4958 to the extent the contract allows for subsequent
discretion to be exercised (which may be subject to influence by the
disqualified person) when calculating the amount of a payment or
deciding whether to make a payment. The temporary regulations include
eleven examples to illustrate the application of the initial contract
rule.
Certain Economic Benefits Disregarded for Purposes of Section 4958
For ease of administration, the proposed regulations list several
economic benefits that are disregarded for purposes of section 4958.
These disregarded items include reimbursements for reasonable expenses
of attending meetings of the governing body (but not luxury or spousal
travel); certain economic benefits provided to a disqualified person
solely as a member of, or volunteer for, the organization; and economic
benefits provided to a disqualified person solely as a member of a
charitable class. A number of comments recommended modifying these
provisions.
With respect to reimbursements for expenses of attending meetings
of the governing body (but not luxury travel or spousal travel),
suggestions were made to clarify or delete these terms; to provide as
an alternative that all travel expenses that are not lavish or
extravagant within the meaning of section 162 may be disregarded; to
disregard spousal travel expenses in circumstances where the spousal
attendance furthers the exempt purposes of the organization or meets
the section 274 bona fide business purpose test; and to address the
issue of travel expenses by generally disregarding working condition
fringe benefits and de minimis fringe benefits described in sections
132(d) and (e). Other commentators requested that any benefits received
by a disqualified person should be disregarded if incidental to the
organization's achievement of its exempt purposes, such as when
disqualified persons attend fundraising dinners or conferences on
behalf of the organization.
In response to these comments, the temporary regulations delete the
[[Page 2151]]
separate provision that provides that reasonable expenses of attending
meetings of the governing body may be disregarded. In place of this
provision, the temporary regulations substitute a more general rule
providing that all fringe benefits excluded from income under section
132 (except for certain liability insurance premiums, payments or
reimbursements, discussed below) are disregarded for section 4958
purposes. This change addresses comments received on the limitation in
the proposed regulations with respect to luxury and spousal travel. By
referring to fringe benefits excluded from income under section 132,
the temporary regulations adopt existing standards under section 162
and section 274 (which are incorporated into section 132) to determine
whether payments or reimbursements of travel expenses of an employee
or-- any other expenses--should be disregarded for section 4958
purposes or, instead, treated as part of the disqualified person's
compensation.
With respect to economic benefits provided to a disqualified person
solely as a member of, or volunteer for, the organization, the proposed
regulations disregard such benefits for section 4958 purposes only if
the organization provides the same benefits to members of the general
public in exchange for a membership fee of $75 or less per year.
Commentators suggested that this provision be expanded in the final
regulations to apply to any benefit (without a dollar limitation)
provided to a disqualified person solely by virtue of that person being
a donor, volunteer, or member, provided that any member of the general
public making a comparable contribution receives a similar benefit.
Another commentator requested a similar modification, with the
additional requirement that a significant number of non-disqualified
persons (e.g., 10 or more) actually make a comparable payment to the
organization and are given the option of receiving substantially the
same benefit.
The temporary regulations continue to disregard for section 4958
purposes economic benefits provided to a volunteer (who is also a
disqualified person) if that benefit is provided by the organization to
the general public in exchange for a membership fee or contribution of
$75 or less per year. In contrast, economic benefits provided to a
disqualified person as a member of, or a donor to, an applicable tax-
exempt organization are no longer limited by a specific dollar cap. The
temporary regulations disregard economic benefits provided to a member
of an organization solely on account of the payment of a membership
fee, or to a donor solely on account of a contribution deductible under
section 170 if: (1) Any non-disqualified person paying a membership fee
or making a contribution above a specified amount to the organization
is given the option of receiving substantially the same economic
benefit; and (2) the disqualified person and a significant number of
non-disqualified persons in fact make a payment or contribution of at
least the specified amount.
The temporary regulations clarify that section 162 standards apply
in determining reasonableness of compensation for section 4958
purposes, taking into account all benefits provided to a person (other
than benefits that are specifically disregarded for section 4958
purposes) and the rate at which any deferred compensation accrues. The
temporary regulations also provide that the fact that a bonus or
revenue-sharing arrangement is subject to a cap is a relevant factor in
determining the reasonableness of compensation.
Insurance or Indemnification of Excise Taxes
The legislative history to section 4958 indicates that
reimbursements of excise tax liability, or payment of premiums for
liability insurance for excess benefit taxes, by an applicable tax-
exempt organization constitute an excess benefit unless they are
included in the disqualified person's compensation during the year paid
and the total compensation package for that person is reasonable. See
H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 58. Following
this legislative history, the proposed regulations specifically provide
that payment of a premium for insurance for section 4958 taxes or
indemnification of a disqualified person for these taxes 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 person is reasonable. However, some
commentators read the special rule in conjunction with another section
of the proposed regulations--which listed ``[t]he 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'' as an
item included in compensation for purposes of section 4958--as
potentially mandating that such insurance premium or indemnification
payments be treated as taxable income to the disqualified person in
order to avoid being characterized as an excess benefit transaction.
Several commentators requested that premiums for liability
insurance be disregarded entirely for section 4958 purposes, along with
non-compensatory indemnification of members of the governing body and
officers against liability in civil proceedings (as described in the
private foundation self-dealing regulations under section 4941), or
that de minimis costs (e.g., $200) associated with such insurance
coverage be disregarded.
Other commentators suggested that a portion of the premium payment
be allocated to section 4958 tax coverage, and that only that portion
be included in compensation of the disqualified person. Others
requested that the portion of a premium allocable to liability
insurance coverage for an organization manager who is also a
disqualified person to cover the person's potential liability for the
manager-level tax under section 4958(a)(2) be considered a working
condition fringe under section 132(d). Others requested that benefits
under indemnification plans be taken into account for section 4958
purposes only if and when paid.
To clarify the treatment of insurance premiums and reimbursements
of excise tax liability, the temporary regulations include a special
rule, which includes in a disqualified person's compensation for
section 4958 purposes the payment of liability insurance premiums for,
or the payment or reimbursement by the organization of: (1) Any
penalty, tax, or expense of correction owed under section 4958; (2) any
expense not reasonably incurred by the person in connection with a
civil judicial or civil administrative proceeding arising out of the
person's performance of services on behalf of the applicable tax-exempt
organization; and (3) any expense resulting from an act or failure to
act with respect to which the person has acted willfully and without
reasonable cause. This rule parallels the section 4941 regulations
governing the treatment of directors and officers liability insurance
and indemnification. As under the section 4941 regulations, however,
the temporary regulations provide that insurance premiums and
reimbursements may be disregarded if they qualify as de minimis fringe
benefits excludable from income under section 132(a)(4).
In addition, the temporary regulations clarify that the inclusion
of an item in compensation for section 4958 purposes does not govern
its income tax treatment. Thus, the mere fact that a premium or
reimbursement payment, or any other benefit, provided to a
[[Page 2152]]
disqualified person must be taken into account in determining the
reasonableness of that person's total compensation package for section
4958 purposes is not determinative of whether or not that benefit is
included in the disqualified person's gross income for income tax
purposes.
Timing Rules for Determining Reasonableness
Section 4958(c)(1) defines an excess benefit transaction as a
transaction in which the value of an economic benefit provided to a
disqualified person exceeds the value of the consideration received
(including the performance of services), but the statutory provisions
do not directly address the issue of when to value the benefits and
consideration exchanged. In this regard, the proposed regulations
provide that whether compensation is reasonable is generally determined
when the parties enter into the contract for services. The proposed
regulations further provide, however, that ``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.'' Many commentators
objected to the uncertainty created by this additional sentence.
To clarify the issue of the timing of the reasonableness
determination, the temporary regulations provide that reasonableness is
determined with respect to any fixed payment (as defined for purposes
of the initial contract rule discussed above) at the time the parties
enter into the contract. However, the temporary regulations provide
that the reasonableness of any amounts not fixed in the contract itself
or paid pursuant to an objective formula is determined based on all
facts and circumstances, up to and including circumstances as of the
date of the payment at issue, because determining the amount of such a
payment (or whether a payment is made) requires the exercise of
discretion after the contract is entered into.
Establishing Intent To Treat Economic Benefit as Consideration for the
Performance of Services
The second sentence of section 4958(c)(1)(A) defining excess
benefit transaction states that an economic benefit will not be treated
as consideration for the performance of services unless the applicable
tax-exempt organization clearly indicated its intent to so treat the
benefit. The proposed regulations generally require the organization to
provide clear and convincing evidence of its intent to treat the
benefit as compensation for services when the benefit is paid. Under
the proposed regulations, this requirement is satisfied if the
organization reports the economic benefit on a federal tax information
return filed before the commencement of an IRS examination in which the
reporting of the benefit is questioned, or 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. In addition, an
organization is deemed to satisfy the clear and convincing evidence
requirement if the organization's failure to report a payment is due to
reasonable cause as defined in the section 6724 regulations. The
proposed regulations also provide that an organization may use other
methods to provide clear and convincing evidence of its intent. The
preamble of the proposed regulations explicitly solicited comments on
appropriate ways of applying this rule that would not create an
unnecessary burden on affected organizations.
A number of comments were received with regard to establishing an
organization's intent to treat a benefit as compensation for services.
Several commentators suggested that the clear and convincing standard
is higher than appropriate. Others requested that organizations not be
required to demonstrate intent with respect to specific benefits, such
as: reimbursement arrangements that are clearly part of the employment
arrangement; de minimis amounts (for example, taxable benefits of up to
$500 per year provided to a disqualified person); and certain
nontaxable benefits. Other commentators requested that final
regulations clarify the appropriate method for substantiating an
organization's intent in the case of certain nontaxable benefits and
transfers of property subject to section 83. Others requested guidance
on how to report compensation paid to a disqualified person on Form 990
if that person is not an officer or director or one of the five highest
paid employees. Some commentators suggested that the final regulations
allow other methods to establish an intention to treat benefits as
compensation, such as a written contract of employment. Commentators
also suggested that an organization's reasonable belief that a benefit
is nontaxable should constitute reasonable cause for failure to report,
or that the reasonable cause standard be expanded to ordinary business
care and prudence.
In response to these comments, the temporary regulations modify the
requirement that an organization provide clear and convincing evidence
of its intent to treat benefits provided to a disqualified person as
compensation for services. Consistent with the legislative history, the
temporary regulations provide instead that an organization must provide
``written substantiation that is contemporaneous with the transfer of
benefits at issue.'' H. REP. NO. 506, 104th Congress, 2d SESS. (1996),
53, 57, note 8.
The temporary regulations also provide a safe harbor for nontaxable
benefits. Under this safe harbor, an applicable tax-exempt organization
is not required to indicate its intent to provide an economic benefit
as compensation for services if the economic benefit is excluded from
the disqualified person's gross income for income tax purposes under
chapter 1 of the Internal Revenue Code. Examples of such benefits
include: employer-provided health benefits, contributions to a
qualified pension, profit-sharing, or stock bonus plan under Internal
Revenue Code section 401(a), and benefits described in sections 127
(educational assistance programs) and 137 (adoption assistance
programs). The safe harbor is consistent with the legislative history,
which indicates that Congress intended to except nontaxable benefits
from this contemporaneous substantiation requirement. H. REP. NO. 506,
104th Congress, 2d SESS. (1996), 53, 57, note 8. However, the benefits
must still be taken into account (unless specifically disregarded under
the regulations) in determining the reasonableness of the disqualified
person's compensation for purposes of section 4958.
Consistent with the legislative history, the temporary regulations
also clarify that, if a benefit is not reported on a return filed with
the IRS, other written contemporaneous evidence (such as an approved
written employment contract executed on or before the date of the
transfer) may be used to demonstrate that the appropriate decision-
making body or an authorized officer approved a transfer as
compensation for services in accordance with established procedures.
Transaction in Which the Amount of the Economic Benefit Is Determined
in Whole or in Part by the Revenues of One or More Activities of the
Organization
Section 4958(c)(2) describes a second type of excess benefit
transaction: ``any transaction in which the amount of any economic
benefit provided to or for the use of a disqualified person is
determined in whole or in part by the revenues of 1 or more activities
of the organization * * *'', if the transaction
[[Page 2153]]
results in inurement under section 501(c)(3) or (4). However, a
revenue-sharing transaction is treated as an excess benefit transaction
under this special statutory rule only ``[t]o the extent provided in
regulations prescribed by the Secretary * * *. ''
The proposed regulations provide that whether a revenue-sharing
transaction results in inurement, and therefore constitutes an excess
benefit transaction, depends upon all relevant facts and circumstances.
The proposed regulations provide that, in general, 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 services (or other consideration)
rendered, if a disqualified person is permitted to receive additional
compensation without providing proportional benefits that contribute to
the organization's accomplishment of its exempt purpose.
The proposed regulations consider an improper revenue-sharing
transaction, in its entirety, to be an excess benefit subject to
section 4958. Special rules governing revenue-sharing transactions,
however, will be effective only for transactions occurring on or after
the date of publication of final regulations containing such rules.
Until special rules for revenue-sharing transactions are adopted in
final regulations, these transactions are potentially subject to
section 4958 liability under the general rules governing excess benefit
transactions, but only to the extent that the value of the economic
benefits provided to the disqualified person is shown to exceed the
value of the services (or other consideration) received in return.
Numerous comments were received with respect to revenue-sharing
transactions. Some commentators did not believe a different standard
from that applied to all other transactions (fair market value) should
apply, and that the value of consideration provided by a disqualified
person in a revenue-sharing transaction should be taken into account in
determining the excess benefit in these transactions.
Others objected to the revenue-sharing transaction standard of the
proposed regulations, and requested that it be replaced by a standard
based on approaches the IRS has taken in prior unpublished rulings.
Some commentators requested guidance as to the meaning of proportional
benefits or other concepts incorporated in the proposed regulations
standard. Others requested that existing contractual arrangements not
be subject to this section of the final regulations, or that the effect
of the final rules for existing arrangements be phased in. In addition,
several commentators requested that the final regulations clarify
whether the rebuttable presumption of reasonableness is available for
revenue-sharing transactions. In sum, commentators offered multiple,
often conflicting, suggestions and recommendations to address the many
issues raised with respect to revenue-sharing transactions.
The temporary regulations reserve the separate section governing
revenue-sharing transactions. Accordingly, the IRS and the Treasury
Department will continue to consider the many comments received on this
issue. Any revised regulations that may, in the future, be issued
governing revenue-sharing transactions in particular will be issued in
proposed form. This will provide an additional opportunity for public
comment, and any special rules governing revenue-sharing transactions
will become effective only after being published in final form. In the
meantime, revenue sharing transactions will be evaluated under the
general rules (contained in Sec. 53.4958-4T of the temporary
regulations) defining excess benefit transactions, which apply to all
transactions with disqualified persons regardless of whether the
person's compensation is computed by reference to revenues of the
organization.
Rebuttable Presumption That a Transaction is not an Excess Benefit
Transaction
Although the statute is silent on this point, the legislative
history accompanying section 4958 indicated Congress' intent that the
parties to a transaction are entitled to rely on a rebuttable
presumption of reasonableness with respect to any transaction with a
disqualified person that is approved by a board of directors or
trustees (or committee thereof) that: (1) Is composed entirely of
individuals unrelated to and not subject to the control of the
disqualified person(s) involved in the transaction; (2) obtained and
relied upon appropriate data as to comparability; and (3) adequately
documented the basis for its determination. If these three requirements
are satisfied, the IRS can impose section 4958 taxes only if it
develops sufficient contrary evidence to rebut the probative value of
the evidence put forth by the parties to the transaction. H. REP. NO.
506, 104th Congress, 2d SESS. (1996), 53, 56-7.
The proposed regulations incorporate this rebuttable presumption
and provide guidance regarding the three requirements for invoking the
rebuttable presumption. The proposed regulations provide that the
presumption established by satisfying the 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.
Additionally, the proposed regulations provide that, if the
reasonableness of compensation cannot be determined based on
circumstances existing at the date when a contract for services was
made, then the presumption cannot arise until reasonableness of
compensation can be determined and the three requirements subsequently
are satisfied.
Comments were received on various aspects of the rebuttable
presumption of reasonableness. With regard to the requirement that the
compensation arrangement or property transfer must be approved by a
governing body (or committee) composed entirely of individuals who do
not have a conflict of interest with respect to the transaction, one
commentator suggested that the final regulations adopt standards
consistent with the model conflicts of interest policy published by the
IRS. The IRS and the Treasury Department believe that the standards
contained in the proposed regulations for determining the absence of a
conflict of interest are consistent with the legislative history of
section 4958, which requires that the governing body (or committee) be
composed entirely of individuals who are free of any conflict of
interest, and not merely that its members disclose the existence of any
conflict of interest. Accordingly, the temporary regulations retain
these standards.
With regard to the requirement that the governing body (or a
committee thereof) obtain appropriate data as to comparability,
numerous commentators requested that the final regulations expand the
acceptable types of comparability data and authorize additional methods
for determining fair market value or reasonable compensation. For
example, some commentators requested clarification that an organization
need not obtain an independent, customized survey, but may rely on an
independent salary survey prepared for general publication if that
survey contains information specific enough to provide meaningful data
for comparison purposes. Other commentators requested that the
governing body (or committee) be permitted to rely on compensation
surveys compiled by staff members (other than disqualified persons)
under the supervision of an independent
[[Page 2154]]
director or committee member, rather than incurring the additional cost
of obtaining compensation surveys compiled by independent firms. Some
commentators requested that the final regulations provide that
comparability data is viable for some period of time (e.g., three
years).
The temporary regulations continue to require only that the
authorized body have sufficient information to determine whether,
consistent with the valuation standards in other sections of the
regulations, the compensation arrangement is reasonable, or the
property transfer is at fair market value. The temporary regulations
clarify that a compensation arrangement in its entirety must be
evaluated and also provide examples of relevant comparability data. In
the case of a compensation arrangement, the temporary regulations
provide that relevant information may include a current compensation
survey compiled by an independent firm. As in the proposed regulations,
this list of relevant comparability data is not exclusive, and the
authorized body may rely on other appropriate data. For clarity, the
temporary regulations list separately examples of the types of relevant
information for compensation arrangements and property transfers. The
temporary regulations add competitive bids received from unrelated
third parties as another example of relevant information in the case of
a property transfer. In response to comments, the temporary regulations
revise examples from the proposed regulations and add several examples
illustrating appropriate comparability data.
Comments were also received regarding the special rule for
compensation paid by small organizations. The proposed regulations
allow small organizations (those with annual gross receipts of less
than $1 million) to satisfy the requirement of appropriate data as to
comparability by obtaining data on compensation paid by five comparable
organizations in the same or similar communities for similar services.
Some commentators indicated that the $1 million threshold is too low,
because organizations having gross receipts above that amount may lack
the resources to hire an independent compensation firm. These
commentators requested that the ceiling for small organizations be
increased from $1 million to $5 million in gross receipts. Others
suggested allowing small organizations to obtain data from fewer than
five comparable organizations.
The IRS and the Treasury Department believe the general rule
regarding appropriate comparability data is flexible enough to permit
any organization (not just small organizations) to compile its own
comparability data. Therefore, the IRS and the Treasury Department did
not believe it was necessary to extend the special safe-harbor rule to
organizations with annual gross receipts over $1 million. As requested
by commentators, however, the temporary regulations reduce the number
of comparables small organizations must obtain for that safe harbor
from five to three.
Certain commentators requested that the final regulations provide a
mechanism for an applicable tax-exempt organization to satisfy the
requirements of the rebuttable presumption of reasonableness with
respect to large groups of employees, such as mid-level managers,
rather than requiring the governing body to approve the compensation
paid to each individual. The IRS and the Treasury Department believe
that changes to the definition of disqualified person in the temporary
regulations, including eliminating as a factor tending to show
substantial influence the fact that a person has any managerial
authority, or serves as a key advisor to a manager, reduce the
potential burden on the governing body. Moreover, the temporary
regulations continue to allow the governing body to delegate
responsibility for approving compensation arrangements and property
transfers, to the extent permitted under State law. Consistent with the
legislative history, the temporary regulations continue to require that
the rebuttable presumption requirements be satisfied on an individual
basis.
With respect to the requirement that the governing body (or
committee) adequately document the basis for its determination,
comments were received requesting that the final regulations allow
additional time for records to be prepared. In response to these
comments, the temporary regulations provide that the records must be
prepared by the later of the next meeting of the authorized body or 60
days after final approval of the particular arrangement or transfer.
Although one commentator objected to the requirement in the proposed
regulations that the governing body (or committee) review and approve
the records within a reasonable period of time thereafter, the
temporary regulations retain this requirement in order to ensure that
the records are accurate and complete.
Several commentators requested that the final regulations permit
organizations to establish a rebuttable presumption of reasonableness
with respect to deferred or contingent compensation arrangements when
the contract for services is entered into if the terms of the
arrangement are sufficiently certain (even if the exact dollar amounts
are not known) and the governing body (or committee) obtains
appropriate data as to comparability. Other commentators simply
requested that the final regulations indicate when the board should
take the necessary steps to put the presumption in place in the event
that reasonableness cannot be determined as of the date the contract is
entered into. Consistent with the general rule contained in the
temporary regulations regarding the timing of the reasonableness
determination, the temporary regulations provide that, with respect to
fixed payments (including payments made pursuant to a fixed formula,
although the exact dollar amount is not known at the time the contract
is entered into), the rebuttable presumption can arise at the time the
parties enter into the contract giving rise to the payments. Under a
special rule in the temporary regulations, payments pursuant to a
qualified pension, profit-sharing, or stock bonus plan under section
401(a) are treated as fixed payments for purposes of section 4958, even
if the employer exercises discretion with respect to the plan or
program. Therefore, a rebuttable presumption can arise with respect to
such payments at the time the parties enter into the contract for
services.
In contrast, the temporary regulations provide that the rebuttable
presumption generally can arise with respect to a payment that is not a
fixed payment (as defined for purposes of the initial contract
exception) only after discretion is exercised, the exact amount of the
payment is determined (or a fixed formula for calculating the payment
is specified), and the three requirements for the presumption
subsequently are satisfied. The temporary regulations contain a limited
exception to this general rule for certain non-fixed payments which are
subject to a cap. Under this exception, an applicable tax-exempt
organization may establish the rebuttable presumption, even with
respect to non-fixed payments, at the time the contract is entered into
if: (1) Prior to approving the contract, the governing body (or
committee) obtains appropriate comparability data indicating that a
fixed payment of up to a certain amount to a particular disqualified
person would represent reasonable compensation; (2) the maximum amount
payable under the
[[Page 2155]]
contract (including both fixed and non-fixed payment amounts) does not
exceed the reasonable compensation figure; and (3) the other
requirements for establishing the rebuttable presumption are satisfied.
However, the general rules for the timing of the reasonableness
determination apply, such that the IRS may rebut the presumption of
reasonableness with respect to a non-fixed payment subject to a cap
based on all facts and circumstances, up to and including circumstances
as of the date of payment.
Some commentators suggested that the final regulations provide
specific standards the IRS must meet in order to rebut any presumption
established by satisfying the three requirements described above. For
example, one commentator suggested that the IRS should be allowed to
overcome the presumption only if it is able to produce clear and
convincing evidence that the transaction was, in fact, an excess
benefit transaction. Another commentator suggested that the IRS should
be required to establish that one of the requirements for invoking the
presumption has not been met in order to rebut the presumption.
Consistent with the legislative history, the temporary regulations
provide that, if the rebuttable presumption of reasonableness is
established, the IRS may rebut the presumption only if it develops
sufficient contrary evidence to rebut the probative value of the
comparability data relied upon by the authorized body.
Finally, some commentators requested clarification whether entities
controlled by or affiliated with an applicable tax-exempt organization
that provide economic benefits to a disqualified person can establish
the presumption, even if those entities are not themselves applicable
tax-exempt organizations. Consistent with the rules relating to
indirect excess benefit transactions, the temporary regulations clarify
that an authorized body of an entity controlled by an applicable tax-
exempt organization (as defined for purposes of describing indirect
transfers of economic benefits) may establish the rebuttable
presumption.
Special Rules
The proposed regulations provided several special rules, one of
which stated 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. Several comments were received on this rule,
including one stating that there is no statutory authority to extend
section 7611 protection to churches for section 4958 tax inquiries.
Other comments requested that final regulations specify when
information from an informant alone is sufficient to form the basis for
a reasonable belief on the part of the IRS for purposes of applying
this rule, and clarify how section 4958 interacts with the section 7611
exception for records related to the income tax of an individual
employed by the church. The temporary regulations do not modify the
special rules for churches.
Additional Issues
Section 4958 does not contain provisions governing the relationship
of the taxes imposed under that section to revocation of the
organization's tax-exempt status under sections 501(c)(3) and (4). With
respect to this issue, the legislative history to section 4958
indicates as follows: ``In general, the intermediate sanctions are 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 practice, revocation of tax-exempt status, with or
without the imposition of excise taxes, would occur only when the
organization no longer operates as a charitable organization.'' H. REP.
NO. 506, 104th Congress, 2d SESS. (1996), 53, 59, note 15. However, the
same legislative history also indicates that ``[t]he intermediate
sanctions for `excess benefit transactions' may be imposed by the IRS
in lieu of (or in addition to) revocation of the organization's tax-
exempt status.'' Id. at 59 (emphasis added)
In the Comments and Requests for a Public Hearing section of the
preamble of the proposed regulations, the IRS and the Treasury
Department specifically requested comments concerning the relationship
between revocation of tax-exempt status and imposition of section 4958
taxes. Additionally, the preamble of the proposed regulations lists
four factors that the IRS will consider in determining whether to
revoke an applicable tax-exempt organization's status: (1) Whether the
organization has been involved in repeated excess benefit transactions;
(2) the size and scope of the excess benefit transaction; (3) whether,
after concluding that it has been party to an excess benefit
transaction, the organization has implemented safeguards to prevent
future recurrences; and (4) whether there was compliance with other
applicable laws. The preamble also states that 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.
A number of commentators requested that the final regulations
expressly provide that section 4958 taxes are the principal sanction
with respect to excess benefit transactions, in lieu of revocation of
the organization's tax-exempt status. Other commentators suggested that
the final regulations incorporate factors to be considered by the IRS
in deciding whether to impose section 4958 excise taxes or revoke tax-
exempt status, or both.
The temporary regulations do not foreclose revocation of tax-exempt
status in appropriate cases. The IRS and the Treasury Department
believe that to do so would effectively change the substantive standard
for tax-exempt status under sections 501(c)(3) and (4). Accordingly,
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 IRS
will publish guidance concerning the factors that it will consider in
exercising its discretion as it gains more experience administering the
section 4958 regime.
The temporary regulations reiterate that section 4958 does not
affect the substantive standards for tax exemption under section
501(c)(3) or (4), including the requirements that the organization be
organized and operated exclusively for exempt purposes, and that no
part of its earnings inure to the benefit of any private shareholder or
individual. Thus, regardless of whether a particular transaction is
subject to excise taxes under section 4958, existing principles and
rules may be implicated, such as the limitation on private benefit. For
example, transactions that are not subject to section 4958 because of
the initial contract exception may, under certain circumstances,
jeopardize an organizations's tax-exempt status.
Some comments regarding revenue-sharing transactions included
requests to address gainsharing arrangements in the final regulations;
or to provide that certain transactions are not revenue-sharing
arrangements because they do not involve a payment that is contingent
on the revenues of (but rather the cost savings to) the organization.
As noted earlier, these temporary regulations reserve the separate
section governing revenue-sharing transactions. However, because the
Office of Inspector General, Department of Health and Human Services,
believes the methodology involved in calculating payments under
gainsharing arrangements may violate
[[Page 2156]]
sections 1128A(b)(1) and (2) of the Social Security Act in situations
where patient care may be affected by the cost savings, the IRS will
not issue private letter rulings under section 4958 on these
arrangements. The Office of Inspector General issued a Special Advisory
Bulletin on July 8, 1999, addressing the application of sections
1128A(b)(1) and (2) of the Social Security Act to gainsharing
arrangements, entitled ``Gainsharing Arrangements and CMPs [Civil Money
Penalties] for Hospital Payments to Physicians to Reduce or Limit
Services to Beneficiaries''.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. Because no
preceding notice of proposed rulemaking is required for this temporary
regulation, the provisions of the Regulatory Flexibility Act do not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
temporary regulation will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact
on business.
Drafting Information
The principal author of these regulations is Phyllis D. Haney,
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and The
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.
26 CFR Part 602
Reporting and recordkeeping requirements
Amendments to the Regulations
Accordingly, 26 CFR parts 53, 301, and 602 are 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 53.4958-0T through 53.4958-8T are added to read as
follows:
Sec. 53.4958-0T Table of contents (temporary).
This section lists the major captions contained in Secs. 53.4958-1T
through 53.4958-8T.
Sec. 53.4958-1T Taxes on excess benefit transactions (temporary).
(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) Taxable period.
(iii) 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) Amplification of general rule.
(iii) Reliance on professional advice.
(iv) Reliance on rebuttable presumption of reasonableness.
(5) Willful.
(6) Due to reasonable cause.
(7) Limits on liability for management.
(8) Joint and several liability.
(9) Burden of proof.
(e) Date of occurrence.
(1) In general.
(2) Special rules.
(3) Statute of limitations rules.
(f) Effective date for imposition of taxes.
(1) In general.
(2) Existing binding contracts.
Sec. 53.4958-2T Definition of applicable tax-exempt organization
(temporary).
(a) Organizations described in section 501(c)(3) or (4) and exempt
from tax under section 501(a).
(1) In general.
(2) Organizations described in section 501(c)(3).
(3) Organizations described in section 501(c)(4).
(4) Effect of non-recognition or revocation of exempt status.
(b) Special rules.
(1) Transition rule for lookback period.
(2) Certain foreign organizations.
Sec. 53.4958-3T Definition of disqualified person (temporary).
(a) In general.
(1) Scope of definition.
(2) Transition rule for lookback period.
(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) Voting members of the governing body.
(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) Tax-exempt organizations described in section 501(c)(3).
(2) Certain section 501(c)(4) organizations.
(3) Employees receiving economic benefits of less than a specified
amount in a taxable year.
(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) Affiliated organizations.
(g) Examples.
Sec. 53.4958-4T Excess benefit transaction (temporary).
(a) Definition of excess benefit transaction.
(1) In general.
(2) Economic benefit provided indirectly.
(i) In general.
(ii) Through a controlled entity.
(A) In general.
(B) Definition of control.
(1) In general.
(2) Constructive ownership.
(iii) Through an intermediary.
(iv) Examples.
(3) Exception for fixed payments made pursuant to an initial
contract.
(i) In general.
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(ii) Fixed payment.
(A) In general.
(B) Special rules.
(iii) Initial contract.
(iv) Substantial performance required.
(v) Treatment as a new contract.
(vi) Evaluation of non-fixed payments.
(vii) Examples.
(4) Certain economic benefits disregarded for purposes of section
4958.
(i) Nontaxable fringe benefits.
(ii) Certain economic benefits provided to a volunteer for the
organization.
(iii) Certain economic benefits provided to a member of, or donor
to, the organization.
(iv) Economic benefits provided to a charitable beneficiary.
(v) Certain economic benefits provided to a governmental unit.
(b) Valuation standards.
(1) In general.
(i) Fair market value of property.
(ii) Reasonable compensation.
(A) In general.
(B) Items included in determining the value of compensation for
purposes of determining reasonableness under section 4958.
(C) Inclusion in compensation for reasonableness determination does
not govern income tax treatment.
(2) Timing of reasonableness determination.
(i) In general.
(ii) Treatment as a new contract.
(iii) Examples.
(c) Establishing intent to treat economic benefit as consideration
for the performance of services.
(1) In general.
(2) Nontaxable benefits.
(3) Contemporaneous substantiation.
(i) Reporting of benefit.
(ii) Other evidence of contemporaneous substantiation.
(iii) Failure to report due to reasonable cause.
(4) Examples.
Sec. 53.4958-5T Transaction in which the amount of the economic
benefit is determined in whole or in part by the revenues of one or
more activities of the organization (temporary). [Reserved]
Sec. 53.4958-6T Rebuttable presumption that a transaction is not an
excess benefit transaction (temporary).
(a) In general.
(b) Rebutting the presumption.
(c) Requirements for invoking rebuttable presumption.
(1) Approval by an authorized body.
(i) In general.
(ii) Individuals not included on authorized body.
(iii) Absence of conflict of interest.
(2) Appropriate data as to comparability.
(i) In general.
(ii) Special rule for compensation paid by small organizations.
(iii) Application of special rule for small organizations.
(iv) Examples.
(3) Documentation.
(d) No presumption with respect to non-fixed payments until amounts
are determined.
(1) In general.
(2) Special rule for certain non-fixed payments subject to a cap.
(e) No inference from absence of presumption.
(f) Period of reliance on rebuttable presumption.
Sec. 53.4958-7T Correction (temporary).
(a) In general.
(b) Form of correction.
(1) Cash or cash equivalents.
(2) Anti-abuse rule.
(3) Special rule relating to nonqualified deferred compensation.
(4) Return of specific property.
(i) In general.
(ii) Payment not equal to correction amount.
(iii) Disqualified person may not participate in decision.
(c) Correction amount.
(d) Correction where contract has been partially performed.
(e) Correction in the case of an applicable tax-exempt organization
that has ceased to exist, or is no longer tax-exempt.
(1) In general.
(2) Section 501(c)(3) organizations.
(3) Section 501(c)(4) organizations.
(f) Examples.
Sec. 53.4958-8T Special rules (temporary).
(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for
church tax inquiries and examinations.
(c) Three year duration of these temporary regulations.
Sec. 53.4958-1T Taxes on excess benefit transactions (temporary).
(a) In general. Section 4958 imposes excise taxes on each excess
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4T)
between an applicable tax-exempt organization (as defined in section
4958(e) and Sec. 53.4958-2T) and a disqualified person (as defined in
section 4958(f)(1) and Sec. 53.4958-3T). 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
(as defined in section 4958(f)(6) and Sec. 53.4958-7T) within the
taxable period (as defined in section 4958(f)(5) and paragraph
(c)(2)(ii) of this section), 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. An excess benefit is the amount by
which 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 exceeds the value of the consideration (including
the performance of services) received 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 section 4958(a)(1) imposes a 25-percent tax on an excess
benefit transaction and the transaction is not corrected (as defined in
section 4958(f)(6) and Sec. 53.4958-7T) within the taxable period (as
defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this
section). If a disqualified person makes a payment of less than the
full correction amount under the rules of Sec. 53.4958-7T, the 200-
percent tax is imposed only on the unpaid portion of the correction
amount (as described in Sec. 53.4958-7T(c)). The tax imposed by section
4958(b) is payable by any disqualified person who
[[Page 2158]]
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) 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.
(iii) 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.
The abatement rules of section 4961 specifically provide for a 90-day
correction period after the date of mailing a notice of deficiency
under section 6212 with respect to the section 4958(b) 200-percent tax.
If the excess benefit is corrected during that correction period, the
200-percent tax imposed shall not be assessed, and if assessed the
assessment shall be abated, and if collected shall be credited or
refunded as an overpayment. For special rules relating to abatement of
the 25-percent tax, see section 4962.
(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. Any organization manager who so participated
in the excess benefit transaction must pay the tax.
(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 is an officer of an organization if that person--
(A) Is specifically so designated under the certificate of
incorporation, by-laws, or other constitutive documents of the
organization; or
(B) Regularly exercises general authority to make administrative or
policy decisions on behalf of the organization. An independent
contractor who acts solely in a capacity as an attorney, accountant, or
investment manager or advisor, is not an officer. For purposes of this
paragraph (d)(2)(i)(B), 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 (or as a
designee of the governing body described in Sec. 53.4958-6T(c)(1)) that
is attempting to invoke the rebuttable presumption of reasonableness
described in Sec. 53.4958-6T based on the committee's (or designee'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 paragraph
(d) of this section, participation includes silence or inaction on the
part of an organization manager where the manager is under a duty to
speak or act, as well as any affirmative action by such manager. An
organization manager is not considered to have participated in an
excess benefit transaction, however, where the manager has opposed the
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
paragraph (d) of this section, a manager participates in a transaction
knowingly only if the person--
(A) Has actual knowledge of sufficient facts so that, based solely
upon those facts, such transaction would be an excess benefit
transaction;
(B) Is aware that such a transaction 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
manager is in fact aware that it is such a transaction.
(ii) Amplification of general rule. Knowing does not mean having
reason to know. However, evidence tending to show that a manager has
reason to know of a particular fact or particular rule is relevant in
determining whether the manager had actual knowledge of such a fact or
rule. Thus, for example, evidence tending to show that a manager 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 manager has actual knowledge of such facts.
(iii) Reliance on professional advice. An organization manager's
participation in a transaction is ordinarily not considered knowing
within the meaning of section 4958(a)(2), even though the transaction
is subsequently held to be an excess benefit transaction to the extent
that, after full disclosure of the factual situation to an appropriate
professional, the organization manager relies on a reasoned written
opinion of that professional with respect to elements of the
transaction within the professional's expertise. For purposes of
section 4958(a)(2) and this paragraph (d), a written opinion is
reasoned even though it reaches a conclusion that is subsequently
determined to be incorrect so long as the opinion addresses itself to
the facts and the applicable standards. However, a written opinion is
not reasoned if it does nothing more than recite the facts and express
a conclusion. The absence of a written opinion of an appropriate
professional with respect to a transaction shall not, by itself,
however, give rise to any inference that an organization manager
participated in the transaction knowingly. For purposes of this
paragraph, appropriate professionals on whose written opinion an
organization manager may rely, are limited to--
(A) Legal counsel, including in-house counsel;
(B) Certified public accountants or accounting firms with expertise
regarding the relevant tax law matters; and
(C) Independent valuation experts who--
(1) Hold themselves out to the public as appraisers or compensation
consultants;
(2) Perform the relevant valuations on a regular basis;
(3) Are qualified to make valuations of the type of property or
services involved; and
(4) Include in the written opinion a certification that the
requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this
section are met.
(iv) Reliance on rebuttable presumption of reasonableness. An
organization manager's participation in a transaction is ordinarily not
considered knowing within the meaning of section 4958(a)(2), even
though the transaction is subsequently held to be an excess benefit
transaction, if the organization manager relies on the fact
[[Page 2159]]
that the requirements of Sec. 53.4958-6T(a) are satisfied with respect
to the transaction.
(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
responsibility on behalf of the organization with ordinary business
care and prudence.
(7) 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.
(8) 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.
(9) Burden of proof. For provisions relating to the burden of proof
in cases involving the issue of whether an organization manager has
knowingly participated in an excess benefit transaction, see section
7454(b) and Sec. 301.7454-2. In these cases, the Commissioner bears the
burden of proof.
(e) Date of occurrence--(1) In general. Except as otherwise
provided, an excess benefit transaction occurs on the date on which the
disqualified person receives the economic benefit for Federal income
tax purposes. When a single contractual arrangement provides for a
series of compensation or other payments to (or for the use of) a
disqualified person over the course of the disqualified person's
taxable year (or part of a taxable year), any excess benefit
transaction with respect to these aggregate payments is deemed to occur
on the last day of the taxable year (or if the payments continue for
part of the year, the date of the last payment in the series).
(2) Special rules. In the case of benefits provided pursuant to a
qualified pension, profit-sharing, or stock bonus plan, the transaction
occurs on the date the benefit is vested. In the case of a transfer of
property that is subject to a substantial risk of forfeiture or in the
case of rights to future compensation or property (including benefits
under a nonqualified deferred compensation plan), the transaction
occurs on the date the property, or the rights to future compensation
or property, is not subject to a substantial risk of forfeiture.
However, where the disqualified person elects to include an amount in
gross income in the taxable year of transfer pursuant to section 83(b),
the general rule of paragraph (e)(1) of this section applies to the
property with respect to which the section 83(b) election is made. Any
excess benefit transaction with respect to benefits under a deferred
compensation plan which vest during any taxable year of the
disqualified person is deemed to occur on the last day of such taxable
year. For the rules governing the timing of the reasonableness
determination for deferred, contingent, and certain other noncash
compensation, see Sec. 53.4958-4T(b)(2).
(3) Statute of limitations rules. See sections 6501(e)(3) and
6501(l) and the regulations thereunder for statute of limitations rules
as they apply to section 4958 excise taxes.
(f) 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 (including as the result of a
breach of contract by the disqualified person) and without substantial
penalty to the organization, is no longer treated as a binding contract
as of the earliest date that any such termination or cancellation, if
made, would be effective. If a binding written contract is materially
changed, it is treated as a new contract entered into as of the date
the material change is effective. A material change includes an
extension or renewal of the contract (other than an extension or
renewal that results from the person contracting with the applicable
tax-exempt organization unilaterally exercising an option expressly
granted by the contract), or a more than incidental change to any
payment under the contract.
Sec. 53.4958-2T Definition of applicable tax-exempt organization
(temporary).
(a) Organizations described in section 501(c)(3) or (4) and exempt
from tax under section 501(a)--(1) In general. 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). A private foundation as defined in section
509(a) is not an applicable tax-exempt organization for section 4958
purposes. A governmental entity that is exempt from (or not subject to)
taxation without regard to section 501(a) is not an applicable tax-
exempt organization for section 4958 purposes.
(2) Organizations described in section 501(c)(3). An organization
is described in section 501(c)(3) for purposes of section 4958 only if
the organization provides the notice described in section 508, unless
the organization otherwise is described in section 501(c)(3) and
specifically is excluded from the requirements of section 508 by that
section.
(3) Organizations described in section 501(c)(4). An organization
is described in section 501(c)(4) for purposes of section 4958 if the
organization--
(i) Has applied for and received recognition from the Internal
Revenue Service as an organization described in section 501(c)(4); or
(ii) Has filed an application for recognition under section
501(c)(4) with the Internal Revenue Service, has filed an annual
information return as a section 501(c)(4) organization under the
Internal Revenue Code or regulations promulgated thereunder, or has
otherwise held itself out as being described in section 501(c)(4) and
exempt from tax under section 501(a).
(4) Effect of non-recognition or revocation of exempt status. An
organization is not described in paragraph (a)(2) or (a)(3) of this
section during any period covered by a final determination or
adjudication that the organization is not exempt from tax under section
501(a) as an organization described in section 501(c)(3) or (4), so
long as that determination or adjudication is not based upon
participation in inurement or one or more excess benefit transactions.
However, the organization may be an applicable tax-exempt organization
for that period as a result of the five-year
[[Page 2160]]
lookback rule described in paragraph (a)(1) of this section.
(b) Special rules--(1) Transition rule for lookback period. In the
case of any excess benefit transaction occurring before September 14,
2000, the lookback period described in paragraph (a)(1) of this section
begins on September 14, 1995, and ends on the date of the transaction.
(2) Certain foreign organizations. A foreign organization,
recognized by the Internal Revenue Service or by treaty, that receives
substantially all of its support (other than gross investment income)
from sources outside of the United States is not an organization
described in section 501(c)(3) or (4) for purposes of section 4958.
Sec. 53.4958-3T Definition of disqualified person (temporary).
(a) In general--(1) Scope of definition. 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
an applicable tax-exempt organization at any time during the five-year
period ending on the date of the transaction (the lookback period).
Paragraph (b) of this section describes 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 who
is not described in paragraph (b), (c) or (d) of this section is a
disqualified person with respect to a transaction for purposes of
section 4958 is based on all relevant facts and circumstances, as
described in paragraph (e) of this section. Paragraph (f) of this
section describes special rules for affiliated organizations. Examples
in paragraph (g) of this section illustrate these categories of
persons.
(2) Transition rule for lookback period. In the case of any excess
benefit transaction occurring before September 14, 2000, the lookback
period described in paragraph (a)(1) of this section begins on
September 14, 1995, and ends on the date of the transaction.
(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 a person who is a disqualified person
described in paragraph (a) of this section (other than as a result of
this paragraph) with respect to any transaction with the same
organization. For purposes of the following sentence, a legally adopted
child of an individual is treated as a child of such individual by
blood. A person's family is limited to--
(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 paragraphs (b)(2) and (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 paragraphs (b)(2) and (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 paragraphs (b)(2) and (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, trustee, or other fiduciary.
(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 who holds any of
the following powers, responsibilities, or interests is in a position
to exercise substantial influence over the affairs of an applicable
tax-exempt organization:
(1) Voting members of the governing body. This category includes
any individual serving on the governing body of the organization who is
entitled to vote on any matter over which the governing body has
authority.
(2) Presidents, chief executive officers, or chief operating
officers. This category includes any person who, regardless of title,
has ultimate responsibility for implementing the decisions of the
governing body or for supervising the management, administration, or
operation of the organization. A person who serves as president, chief
executive officer, or chief operating officer has this ultimate
responsibility unless the person demonstrates otherwise. If this
ultimate responsibility resides with two or more individuals (e.g., co-
presidents), who may exercise such responsibility in concert or
individually, then each individual is in a position to exercise
substantial influence over the affairs of the organization.
(3) Treasurers and chief financial officers. This category includes
any person who, regardless of title, has ultimate responsibility for
managing the finances of the organization. A person who serves as
treasurer or chief financial officer has this ultimate responsibility
unless the person demonstrates otherwise. If this ultimate
responsibility resides with two or more individuals who may exercise
the responsibility in concert or individually, then each individual is
in a position to exercise substantial influence over the affairs of the
organization.
(4) Persons with a material financial interest in a provider-
sponsored organization. For purposes of section 4958, if a hospital
that participates in a provider-sponsored organization (as defined in
section 1855(e) of the Social Security Act, 42 U.S.C. 1395w-25) is an
applicable tax-exempt organization, then any person with a material
financial interest (within the meaning of section 501(o)) in the
provider-sponsored organization has substantial influence with respect
to the hospital.
(d) Persons deemed not to have substantial influence. A person is
deemed not to be in a position to exercise substantial influence over
the
[[Page 2161]]
affairs of an applicable tax-exempt organization if that person is
described in one of the following categories:
(1) Tax-exempt organizations described in section 501(c)(3). This
category includes any organization described in section 501(c)(3) and
exempt from tax under section 501(a).
(2) Certain section 501(c)(4) organizations. Only with respect to
an applicable tax-exempt organization described in section 501(c)(4)
and Sec. 53.4958-2T(a)(3), this category includes any other
organization so described.
(3) Employees receiving economic benefits of less than a specified
amount in a taxable year. This category includes, for the taxable year
in which benefits are provided, any full-or part-time employee of the
applicable tax-exempt organization who--
(i) Receives economic benefits, directly or indirectly from the
organization, of less than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i);
(ii) Is not described in Sec. 53.4958-3T(b) or (c) with respect to
the organization; and
(iii) Is not a substantial contributor to the organization within
the meaning of section 507(d)(2)(A), taking into account only
contributions received by the organization during its current taxable
year and the four preceding taxable years.
(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.
(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 to the organization
(within the meaning of section 507(d)(2)(A)), taking into account only
contributions received by the organization during its current taxable
year and the four preceding taxable years;
(iii) The person's compensation is primarily based on revenues
derived from activities of the organization that the person controls;
(iv) The person has or shares authority to control or determine a
substantial portion of the organization's capital expenditures,
operating budget, or compensation for employees;
(v) The person manages a discrete segment or activity of the
organization that represents a substantial portion of the activities,
assets, income, or expenses of the organization, as compared to the
organization as a whole;
(vi) The person owns a controlling interest (measured by either
vote or value) in a corporation, partnership, or trust that is a
disqualified person; or
(vii) The person is a non-stock organization controlled, directly
or indirectly, by one or more disqualified persons.
(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, the following--
(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) whose sole relationship
to the organization is providing professional advice (without having
decision-making authority) with respect to transactions from which the
independent contractor will not economically benefit either directly or
indirectly (aside from customary fees received for the professional
advice rendered);
(iii) The direct supervisor of the individual is not a disqualified
person;
(iv) The person does not participate in any management decisions
affecting the organization as a whole or a discrete segment or activity
of the organization that represents a substantial portion of the
activities, assets, income, or expenses of the organization, as
compared to the organization as a whole; or
(v) Any preferential treatment a person receives based on the size
of that person's donation is also offered to all other donors making a
comparable contribution as part of a solicitation intended to attract a
substantial number of contributions.
(f) 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. A
person may be a disqualified person with respect to transactions with
more than one applicable tax-exempt organization.
(g) 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. If a person is a disqualified person, the rules of
section 4958(c) and Sec. 53.4958-4T apply to determine whether an
excess benefit transaction has occurred. The examples are as follows:
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 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 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 R in that year.
Example 2. The facts are the same as in Example 1, except that
in addition to the salary that R pays N for N's services during the
taxable year, R also purchases one of N's paintings for $x. The
total of N's salary plus $x exceeds the amount 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 of the
relevant facts and circumstances.
Example 3: Q is a member of K, a section 501(c)(3) organization
with a broad-based public membership. Members of K are entitled to
vote only with respect to the annual election of directors and the
approval of major organizational transactions such as a merger or
dissolution. Q is not related to any other disqualified person of K.
Q has no other relationship to K besides being a member of K and
occasionally making modest donations to K. Whether Q is a
disqualified person is determined by all relevant facts and
circumstances. Q's voting rights, which are the same as granted to
all members of K, do not place Q in a position to exercise
substantial influence over K. Under these facts and circumstances, Q
is not a disqualified person with respect K.
Example 4. 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 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
has ultimate responsibility for supervising the operation 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 Z.
Example 5. Y is an applicable tax-exempt organization for
purposes of section 4958 that decides to use bingo games as a method
of generating revenue. Y enters into a contract with B, a company
that operates bingo games. Under the contract, B manages the
promotion and operation of the bingo activity, provides
[[Page 2162]]
all necessary staff, equipment, and services, and pays 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 games.
The annual gross revenue earned from the bingo games represents more
than half of Y's total annual revenue. B's compensation is primarily
based on revenues from an activity B controls. B also manages a
discrete activity of Y that represents a substantial portion of Y's
income compared to the organization as a whole. 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 Y.
Example 6. The facts are the same as in Example 5, with the
additional fact that P owns a majority of the stock of B and is
actively involved in managing B. Because P owns a controlling
interest (measured by either vote or value) in and actively manages
B, P is also in a position to exercise substantial influence over
the affairs of Y. Therefore, under these facts and circumstances, P
is a disqualified person with respect to Y.
Example 7. A, an applicable tax-exempt organization for purposes
of section 4958, owns and operates one acute care hospital. B, a
for-profit corporation, 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 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 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 A.
Example 8. 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 substantial source of revenue for T,
including contributions from alumni and foundations. L is not
related to any other disqualified person of T. L does not serve on
T's governing body or have ultimate responsibility for managing the
university as whole. However, as dean of the College of Law, L plays
a key role in faculty hiring and determines a substantial portion of
the capital expenditures and operating budget of the College of Law.
L's compensation is greater than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i) in the year benefits
are provided. L's management of a discrete segment of T that
represents a substantial portion of the income of T (as compared to
T as a whole) places L in a position to exercise substantial
influence over the affairs of T. Under these facts and circumstances
L is a disqualified person with respect to T.
Example 9. S chairs a small academic department in the College
of Arts and Sciences of the same university T described in Example
8. S is not related to any other disqualified person of T. S does
not serve on T's governing body or as an officer of T. As department
chair, S supervises faculty in the department, approves the course
curriculum, and oversees the operating budget for the department.
S's compensation is greater than the amount referenced for a highly
compensated employee in section 414(q)(1)(B)(i) in the year benefits
are provided. Even though S manages the department, that department
does not represent a substantial portion of T's activities, assets,
income, expenses, or operating budget. Therefore, S does not
participate in any management decisions affecting either T as a
whole, or a discrete segment or activity of T that represents a
substantial portion of its activities, assets, income, or expenses.
Under these facts and circumstances, S does not have substantial
influence over the affairs of T, and therefore S is not a
disqualified person with respect to T.
Example 10. U is a large acute-care hospital that is an
applicable tax-exempt organization for purposes of section 4958. U
employs X as a radiologist. X gives instructions to staff with
respect to the radiology work X conducts, but X does not supervise
other U employees or manage any substantial part of U's operations.
X's compensation is primarily in the form of a fixed salary. In
addition, X is eligible to receive an incentive award based on
revenues of the radiology department. X's compensation is greater
than the amount 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 1855(e) of
the Social Security Act), X does not have a material financial
interest in that organization. X does not receive compensation
primarily based on revenues derived from activities of U that X
controls. X does not participate in any management decisions
affecting either U as a whole or a discrete segment of U that
represents a substantial portion of its activities, assets, income,
or expenses. 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 U.
Example 11. W is a cardiologist and head of the cardiology
department of the same hospital U described in Example 10. The
cardiology department is a major source of patients admitted to U
and consequently represents a substantial portion of U's income, as
compared to U as a whole. W does not serve on U's governing board or
as an officer of U. W does not have a material financial interest in
the provider-sponsored organization (as defined in section 1855(e)
of the Social Security Act) in which U participates. W receives a
salary and retirement and welfare benefits fixed by a three-year
renewable employment contract with U. W's compensation is greater
than the amount referenced for a highly compensated employee in
section 414(q)(1)(B)(i) in the year benefits are provided. As
department head, W manages the cardiology department and has
authority to allocate the budget for that department, which includes
authority to distribute incentive bonuses among cardiologists
according to criteria that W has authority to set. W's management of
a discrete segment of U that represents a substantial portion of its
income and activities (as compared to U as a whole) places W in a
position to exercise substantial influence over the affairs of U.
Under these facts and circumstances, W is a disqualified person with
respect to U.
Example 12. M is a museum that is an applicable tax-exempt
organization for purposes of section 4958. D provides accounting
services and tax advice to M as an independent contractor in return
for a fee. D has no other relationship with M and is not related to
any disqualified person of M. D does not provide professional advice
with respect to any transaction from which D might economically
benefit either directly or indirectly (aside from fees received for
the professional advice rendered). Because D's sole relationship to
M is providing professional advice (without having decision-making
authority) with respect to transactions from which D will not
economically benefit either directly or indirectly (aside from
customary fees received for the professional advice rendered), under
these facts and circumstances, D is not a disqualified person with
respect to M.
Example 13. F is a repertory theater company that is an
applicable tax-exempt organization for purposes of section 4958. F
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)(A), taking into account only contributions
received by F during its current and the four preceding taxable
years. J receives the benefits described in F's solicitation.
Because F offers the same benefit to all donors of $z or more, 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,
[[Page 2163]]
under these facts and circumstances, J is not a disqualified person
with respect to F.
Sec. 53.4958-4T Excess benefit transaction (temporary).
(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 for
providing the benefit. Subject to the limitations of paragraph (c) of
this section (relating to the treatment of economic benefits as
compensation for the performance of services), to determine whether an
excess benefit transaction has occurred, all consideration and benefits
(except disregarded benefits described in paragraph (a)(4) of this
section) exchanged between a disqualified person and the applicable
tax-exempt organization and all entities the organization controls
(within the meaning of paragraph (a)(2)(ii)(B) of this section) are
taken into account. For example, in determining the reasonableness of
compensation that is paid (or vests, or is no longer subject to a
substantial risk of forfeiture) in one year, services performed in
prior years may be taken into account. For rules regarding valuation
standards, see paragraph (b) of this section. For the requirement that
an applicable tax-exempt organization clearly indicate its intent to
treat a benefit as compensation for services when paid, see paragraph
(c) of this section.
(2) Economic benefit provided indirectly--(i) In general. A
transaction that would be an excess benefit transaction if the
applicable tax-exempt organization engaged in it directly with a
disqualified person is likewise an excess benefit transaction when it
is accomplished indirectly. An applicable tax-exempt organization may
provide an excess benefit indirectly to a disqualified person through a
controlled entity or through an intermediary, as described in
paragraphs (a)(2)(ii) and (iii) of this section, respectively.
(ii) Through a controlled entity--(A) In general. An applicable
tax-exempt organization may provide an excess benefit indirectly
through the use of one or more entities it controls. For purposes of
section 4958, economic benefits provided by a controlled entity will be
treated as provided by the applicable tax-exempt organization.
(B) Definition of control--(1) In general. For purposes of this
paragraph, control by an applicable tax-exempt organization means--
(i) In the case of a stock corporation, ownership (by vote or
value) of more than 50 percent of the stock in such corporation;
(ii) In the case of a partnership, ownership of more than 50
percent of the profits interests or capital interests in the
partnership;
(iii) In the case of a nonstock organization (i.e., an entity in
which no person holds a proprietary interest), that at least 50 percent
of the directors or trustees of the organization are either
representatives (including trustees, directors, agents, or employees)
of, or directly or indirectly controlled by, an applicable tax-exempt
organization; or
(iv) In the case of any other entity, ownership of more than 50
percent of the beneficial interest in the entity.
(2) Constructive ownership. Section 318 (relating to constructive
ownership of stock) shall apply for purposes of determining ownership
of stock in a corporation. Similar principles shall apply for purposes
of determining ownership of interests in any other entity.
(iii) Through an intermediary. An applicable tax-exempt
organization may provide an excess benefit indirectly through an
intermediary. An intermediary is any person (including an individual or
a taxable or tax-exempt entity) who participates in a transaction with
one or more disqualified persons of an applicable tax-exempt
organization. For purposes of section 4958, economic benefits provided
by an intermediary will be treated as provided by the applicable tax-
exempt organization when--
(A) An applicable tax-exempt organization provides an economic
benefit to an intermediary; and
(B) In connection with the receipt of the benefit by the
intermediary--
(1) There is evidence of an oral or written agreement or
understanding that the intermediary will provide economic benefits to
or for the use of a disqualified person; or
(2) The intermediary provides economic benefits to or for the use
of a disqualified person without a significant business purpose or
exempt purpose of its own.
(iv) Examples. The following examples illustrate when economic
benefits are provided indirectly under the rules of paragraph (a)(2) of
this section:
Example 1. K is an applicable tax-exempt organization for
purposes of section 4958. L is an entity controlled by K within the
meaning of paragraph (a)(2)(ii)(B) of this section. J is employed by
K, and is a disqualified person with respect to K. K pays J an
annual salary of $12m, and reports that amount as compensation
during calendar year 2001. Although J only performed services for K
for nine months of 2001, J performed equivalent services for L
during the remaining three months of 2001. Taking into account all
of the economic benefits K provided to J, and all of the services J
performed for K and L, $12m does not exceed the fair market value of
the services J performed for K and L during 2001. Therefore, under
these facts, K does not provide an excess benefit to J directly or
indirectly.
Example 2. F is an applicable tax-exempt organization for
purposes of section 4958. D is an entity controlled by F within the
meaning of paragraph (a)(2)(ii)(B) of this section. T is the chief
executive officer (CEO) of F. As CEO, T is responsible for
overseeing the activities of F. T's duties as CEO make him a
disqualified person with respect to F. T's compensation package with
F represents the maximum reasonable compensation for T's services as
CEO. Thus, any additional economic benefits that F provides to T
without T providing additional consideration constitute an excess
benefit. D contracts with T to provide enumerated ``consulting
services'' to D. However, the contract does not require T to perform
any additional services for D that T is not already obligated to
perform as F's chief executive officer. Therefore, any payment to T
pursuant to the consulting contract with D represents an indirect
excess benefit that F provides through a controlled entity, even if
F, D, or T treats the additional payment to T as compensation.
Example 3. P is an applicable tax-exempt organization for
purposes of section 4958. S is a taxable entity controlled by P
within the meaning of paragraph (a)(2)(ii)(B) of this section. V is
the chief executive officer of S, for which S pays V $w in salary
and benefits. V also serves as a voting member of P's governing
body. Consequently, V is a disqualified person with respect to P. P
provides V with $x representing compensation for the services V
provides P as a member of its governing body. Although $x represents
reasonable compensation for the services V provides directly to P as
a member of its governing body, the total compensation of $w + $x
exceeds reasonable compensation for the services V provides to P and
S collectively. Therefore, the portion of total compensation that
exceeds reasonable compensation is an excess benefit provided to V.
Example 4. G is an applicable tax-exempt organization for
section 4958 purposes. F is a disqualified person who was last
employed by G in a position of substantial influence three years
ago. H is an entity engaged in scientific research and is unrelated
to either F or G. G makes a grant to H to fund a research position.
H subsequently advertises for qualified candidates for the research
position. F is among several highly qualified candidates who apply
for the research position. H hires F. There was no evidence
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of an oral or written agreement or understanding with G that H will
use G's grant to provide economic benefits to or for the use of F.
Although G provided economic benefits to H, and in connection with
the receipt of such benefits, H will provide economic benefits to or
for the use of F, H acted with a significant business purpose or
exempt purpose of its own. Under these facts, G did not provide an
economic benefit to F indirectly through the use of an intermediary.
(3) Exception for fixed payments made pursuant to an initial
contract--(i) In general. Except as provided in paragraph (iv), section
4958 does not apply to any fixed payment made to a person pursuant to
an initial contract.
(ii) Fixed payment--(A) In general. For purposes of paragraph
(a)(3)(i) of this section, fixed payment means an amount of cash or
other property specified in the contract, or determined by a fixed
formula specified in the contract, which is to be paid or transferred
in exchange for the provision of specified services or property. A
fixed formula may incorporate an amount that depends upon future
specified events or contingencies, provided that no person exercises
discretion when calculating the amount of a payment or deciding whether
to make a payment (such as a bonus). A specified event or contingency
may include the amount of revenues generated by (or other objective
measure of) one or more activities of the applicable tax-exempt
organization. A fixed payment does not include any amount paid to a
person under a reimbursement (or similar) arrangement where discretion
is exercised by any person with respect to the amount of expenses
incurred or reimbursed.
(B) Special rules. Amounts payable pursuant to a qualified pension,
profit-sharing, or stock bonus plan under Internal Revenue Code section
401(a), or pursuant to an employee benefit program that is subject to
and satisfies coverage and nondiscrimination rules under the Code
(e.g., sections 127 and 137), other than nondiscrimination rules under
section 9802, are treated as fixed payments for purposes of this
section, regardless of the applicable tax-exempt organization's
discretion with respect to the plan or program. The fact that a person
contracting with an applicable tax-exempt organization is expressly
granted the choice whether to accept or reject any economic benefit is
disregarded in determining whether the benefit constitutes a fixed
payment for purposes of this paragraph.
(iii) Initial contract. For purposes of paragraph (a)(3)(i) of this
section, initial contract means a binding written contract between an
applicable tax-exempt organization and a person who was not a
disqualified person within the meaning of section 4958(f)(1) and
Sec. 53.4958-3T immediately prior to entering into the contract.
(iv) Substantial performance required. Paragraph (a)(3)(i) of this
section does not apply to any fixed payment made pursuant to the
initial contract during any taxable year of the person contracting with
the applicable tax-exempt organization if the person fails to perform
substantially the person's obligations under the initial contract
during that year.
(v) Treatment as a new contract. A written binding contract that
provides that the contract is terminable or subject to cancellation by
the applicable tax-exempt organization (other than as a result of a
lack of substantial performance by the disqualified person, as
described in paragraph (a)(3)(iv) of this section) without the other
party's consent and without substantial penalty to the organization is
treated as a new contract as of the earliest date that any such
termination or cancellation, if made, would be effective. Additionally,
if the parties make a material change to a contract, it is treated as a
new contract as of the date the material change is effective. A
material change includes an extension or renewal of the contract (other
than an extension or renewal that results from the person contracting
with the applicable tax-exempt organization unilaterally exercising an
option expressly granted by the contract), or a more than incidental
change to any amount payable under the contract. The new contract is
tested under paragraph (a)(3)(iii) of this section to determine whether
it is an initial contract for purposes of this section.
(vi) Evaluation of non-fixed payments. Any payment that is not a
fixed payment (within the meaning of paragraph (a)(3)(ii) of this
section) is evaluated to determine whether it constitutes an excess
benefit transaction under section 4958. In making this determination,
all payments and consideration exchanged between the parties are taken
into account, including any fixed payments made pursuant to an initial
contract with respect to which section 4958 does not apply.
(vii) Examples. The following examples illustrate the rules
governing fixed payments made pursuant to an initial contract. Unless
otherwise stated, assume that the person contracting with the
applicable tax-exempt organization has performed substantially the
person's obligations under the contract with respect to the payment.
The examples are as follows:
Example 1. T is an applicable tax-exempt organization for
purposes of section 4958. On January 1, 2000, T hires S as its chief
financial officer by entering into a five-year written employment
contract with S. S was not a disqualified person within the meaning
of section 4958(f)(1) and Sec. 53.4958-3T immediately prior to
entering into the January 1, 2000, contract (initial contract). S's
duties and responsibilities under the contract make S a disqualified
person with respect to T (see Sec. 53.4958-3T(a)). Under the initial
contract, T agrees to pay S an annual salary of $200,000, payable in
monthly installments. The contract provides that, beginning in 2001,
S's annual salary will be adjusted by the increase in the Consumer
Price Index (CPI) for the prior year. Section 4958 does not apply
because S's compensation under the contract is a fixed payment
pursuant to an initial contract within the meaning of paragraph
(a)(3) of this section. Thus, for section 4958 purposes, it is
unnecessary to evaluate whether any portion of the compensation paid
to S pursuant to the initial contract is an excess benefit
transaction.
Example 2. The facts are the same as in Example 1, except that
the initial contract provides that, in addition to a base salary of
$200,000, T may pay S an annual performance-based bonus. The
contract provides that T's governing body will determine the amount
of the annual bonus as of the end of each year during the term of
the contract, based on the board's evaluation of S's performance,
but the bonus cannot exceed $100,000 per year. Unlike the base
salary portion of S's compensation, the bonus portion of S's
compensation is not a fixed payment pursuant to an initial contract,
because the governing body has discretion over the amount, if any,
of the bonus payment. Section 4958 does not apply to payment of the
$200,000 base salary (as adjusted for inflation), because it is a
fixed payment pursuant to an initial contract within the meaning of
paragraph (a)(3) of this section. By contrast, the annual bonuses
that may be paid to S under the initial contract are not protected
by the initial contract exception. Therefore, each bonus payment
will be evaluated under section 4958, taking into account all
payments and consideration exchanged between the parties.
Example 3. The facts are the same as in Example 1, except that
in 2001, T changes its payroll system, such that T makes biweekly,
rather than monthly, salary payments to its employees. Beginning in
2001, T also grants its employees an additional two days of paid
vacation each year. Neither change is a material change to S's
initial contract within the meaning of paragraph (a)(3)(v) of this
section. Therefore, section 4958 does not apply to the base salary
payments to S due to the initial contract exception.
Example 4. The facts are the same as in Example 1, except that
on January 1, 2001, S becomes the chief executive officer of T and a
new chief financial officer is hired. At the same time, T's board of
directors approves an increase in S's annual base salary from
$200,000 to $240,000, effective on that day. These changes in S's
employment relationship constitute material
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changes of the initial contract within the meaning of paragraph
(a)(3)(v) of this section. As a result, S is treated as entering
into a new contract with T on January 1, 2001, at which time S is a
disqualified person within the meaning of section 4958(f)(1) and
Sec. 53.4958-3T. T's payments to S made pursuant to the new contract
will be evaluated under section 4958, taking into account all
payments and consideration exchanged between the parties.
Example 5. J is a performing arts organization and an applicable
tax-exempt organization for purposes of section 4958. J hires W to
become the chief executive officer of J. W was not a disqualified
person within the meaning of section 4958(f)(1) and Sec. 53.4958-3T
immediately prior to entering into the employment contract with J.
As a result of this employment contract, W's duties and
responsibilities make W a disqualified person with respect to J (see
Sec. 53.4958-3T(c)(2)). Under the contract, J will pay W $x (a
specified amount) plus a bonus equal to 2 percent of the total
season subscription sales that exceed $100z. The $x base salary is a
fixed payment pursuant to an initial contract within the meaning of
paragraph (a)(3) of this section. The bonus payment is also a fixed
payment pursuant to an initial contract within the meaning of
paragraph (a)(3) of this section, because no person exercises
discretion when calculating the amount of the bonus payment or
deciding whether the bonus will be paid. Therefore, section 4958
does not apply to any of J's payments to W pursuant to the
employment contract due to the initial contract exception.
Example 6. Hospital B is an applicable tax-exempt organization
for purposes of section 4958. Hospital B hires E as its chief
operating officer. E was not a disqualified person within the
meaning of section 4958(f)(1) and Sec. 53.4958-3T immediately prior
to entering into the employment contract with Hospital B. As a
result of this employment contract, E's duties and responsibilities
make E a disqualified person with respect to Hospital B (see
Sec. 53.4958-3T(c)(2)). E's initial employment contract provides
that E will have authority to enter into hospital management
arrangements on behalf of Hospital B. In E's personal capacity, E
owns more than 35 percent of the combined voting power of Company X.
Consequently, at the time E becomes a disqualified person with
respect to B, Company X also becomes a disqualified person with
respect to B (see Sec. 53.4958-3T(b)(2)(A)). E, acting on behalf of
Hospital B as chief operating officer, enters into a contract with
Company X under which Company X will provide billing and collection
services to Hospital B. The initial contract exception of paragraph
(a)(3)(i) of this section does not apply to the billing and
collection services contract, because at the time that this
contractual arrangement was entered into, Company X was a
disqualified person with respect to Hospital B. Although E's
employment contract (which is an initial contract) authorizes E to
enter into hospital management arrangements on behalf of Hospital B,
the payments made to Company X are not made pursuant to E's
employment contract, but rather are made by Hospital B pursuant to a
separate contractual arrangement with Company X. Therefore, even if
payments made to Company X under the billing and collection services
contract are fixed payments (within the meaning of paragraph
(a)(3)(ii) of this section), section 4958 nonetheless applies to
payments made by Hospital B to Company X because the billing and
collection services contract itself does not constitute an initial
contract under paragraph (a)(3)(iii) of this section. Accordingly,
all payments made to Company X under the billing and collection
services contract will be evaluated under section 4958.
Example 7. Hospital C, an applicable tax-exempt organization,
enters into a contract with Company Y, under which Company Y will
provide a wide range of hospital management services to Hospital C.
Upon entering into this contractual arrangement, Company Y becomes a
disqualified person with respect to Hospital C. The contract
provides that Hospital C will pay Company Y a management fee of x
percent of adjusted gross revenue (i.e., gross revenue increased by
the cost of charity care provided to indigents) annually for a five-
year period. The management services contract specifies the cost
accounting system and the standards for indigents to be used in
calculating the cost of charity care. The cost accounting system
objectively defines the direct and indirect costs of all health care
goods and services provided as charity care. Because Company Y was
not a disqualified person with respect to Hospital C immediately
before entering into the management services contract, that contract
is an initial contract within the meaning of paragraph (a)(3)(iii)
of this section. The annual management fee paid to Company Y is
determined by a fixed formula specified in the contract, and is
therefore a fixed payment within the meaning of paragraph (a)(3)(ii)
of this section. Accordingly, section 4958 does not apply to the
annual management fee due to the initial contract exception.
Example 8. The facts are the same as in Example 7, except that
the management services contract also provides that Hospital C will
reimburse Company Y on a monthly basis for certain expenses incurred
by Company Y that are attributable to management services provided
to Hospital C (e.g., legal fees and travel expenses). These
reimbursement payments that Hospital C makes to Company Y for the
various expenses covered by the contract are not fixed payments
within the meaning of paragraph (a)(3)(ii) of this section, because
Company Y exercises discretion with respect to the amount of
expenses incurred. Therefore, any reimbursement payments that
Hospital C pays pursuant to the contract will be evaluated under
section 4958.
Example 9. X, an applicable tax-exempt organization for purposes
of section 4958, hires C to conduct scientific research. On January
1, 2000, C enters into a three-year written employment contract with
X (``initial contract''). Under the terms of the contract, C is
required to work full-time at X's laboratory for a fixed annual
salary of $90,000. Immediately prior to entering into the employment
contract, C was not a disqualified person within the meaning of
section 4958(f)(1) and Sec. 53.4958-3T, nor did C become a
disqualified person pursuant to the initial contract. However, two
years after joining X, C marries D, who is the child of X's
president. As D's spouse, C is a disqualified person within the
meaning of section 4958(f)(1) and Sec. 53.4958-3T with respect to X.
Nonetheless, section 4958 does not apply to X's salary payments to C
due to the initial contract exception.
Example 10. The facts are the same as in Example 9, except that
the initial contract included a below-market loan provision under
which C has the unilateral right to borrow up to a specified dollar
amount from X at a specified interest rate for a specified term.
After C's marriage to D, C borrows money from X to purchase a home
under the terms of the initial contract. Section 4958 does not apply
to X's loan to C due to the initial contract exception.
Example 11. The facts are the same as in Example 9, except that
after C's marriage to D, C works only sporadically at the
laboratory, and performs no other services for X. Notwithstanding
that C fails to perform substantially C's obligations under the
initial contract, X does not exercise its right to terminate the
initial contract for nonperformance and continues to pay full salary
to C. Pursuant to paragraph (a)(3)(iv) of this section, the initial
contract exception does not apply to any payments made pursuant to
the initial contract during any taxable year of C in which C fails
to perform substantially C's obligations under the initial contract.
(4) Certain economic benefits disregarded for purposes of section
4958. The following economic benefits are disregarded for purposes of
section 4958:
(i) Nontaxable fringe benefits. An economic benefit that is
excluded from income under section 132, except any liability insurance
premium, payment, or reimbursement that must be taken into account
under Sec. 53.4958-4T(b)(1)(ii)(B)(2);
(ii) Certain economic benefits provided to a volunteer for the
organization. An economic benefit provided to a volunteer for the
organization if the benefit is provided to the general public in
exchange for a membership fee or contribution of $75 or less per year;
(iii) Certain economic benefits provided to a member of, or donor
to, the organization. An economic benefit provided to a member of an
organization solely on account of the payment of a membership fee, or
to a donor solely on account of a contribution deductible under section
170, if--
(A) Any non-disqualified person paying a membership fee or making a
contribution above a specified amount to the organization is given the
option of receiving substantially the same economic benefit; and
(B) The disqualified person and a significant number of non-
disqualified
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persons make a payment or contribution of at least the specified
amount;
(iv) Economic benefits provided to a charitable beneficiary. An
economic benefit provided to a person 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; and
(v) Certain economic benefits provided to a governmental unit. Any
transfer of an economic benefit to or for the use of a governmental
unit defined in section 170(c)(1), if the transfer is for exclusively
public purposes.
(b) Valuation standards--(1) In general. This section provides
rules for determining the value of economic benefits for purposes of
section 4958.
(i) Fair market value of property. The value of property, including
the right to use property, for purposes of section 4958 is the fair
market value (i.e., 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).
(ii) Reasonable compensation--(A) In general. The value of services
is the amount that would ordinarily be paid for like services by like
enterprises under like circumstances (i.e., reasonable compensation).
Section 162 standards apply in determining reasonableness of
compensation, taking into account the aggregate benefits (other than
any benefits specifically disregarded under paragraph (a)(4) of this
section) provided to a person and the rate at which any deferred
compensation accrues. The fact that a bonus or revenue-sharing
arrangement is subject to a cap is a relevant factor in determining the
reasonableness of compensation. 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 for purposes of
section 4958.
(B) Items included in determining the value of compensation for
purposes of determining reasonableness under section 4958. Except for
economic benefits that are disregarded for purposes of section 4958
under paragraph (a)(4) of this section, compensation for purposes of
determining reasonableness under section 4958 includes all economic
benefits provided by an applicable tax-exempt organization in exchange
for the performance of services. These benefits include, but are not
limited to--
(1) All forms of cash and noncash compensation, including salary,
fees, bonuses, severance payments, and deferred and noncash
compensation described in Sec. 53.4958-1T(e)(2);
(2) Unless excludable from income as a de minimis fringe benefit
pursuant to section 132(a)(4), the payment of liability insurance
premiums for, or the payment or reimbursement by the organization of--
(i) Any penalty, tax, or expense of correction owed under section
4958;
(ii) Any expense not reasonably incurred by the person in
connection with a civil judicial or civil administrative proceeding
arising out of the person's performance of services on behalf of the
applicable tax-exempt organization; or
(iii) Any expense resulting from an act or failure to act with
respect to which the person has acted willfully and without reasonable
cause; and
(3) All other compensatory benefits, whether or not included in
gross income for income tax purposes, including payments to welfare
benefit plans, such as plans providing medical, dental, life insurance,
severance pay, and disability benefits, and both taxable and nontaxable
fringe benefits (other than fringe benefits described in section 132),
including expense allowances or reimbursements, and foregone interest
on loans.
(C) Inclusion in compensation for reasonableness determination does
not govern income tax treatment. The determination of whether any item
listed in paragraph (b)(1)(ii)(B) of this section is included in the
disqualified person's gross income for income tax purposes is made on
the basis of the provisions of chapter 1 of Subtitle A of the Internal
Revenue Code, without regard to whether the item is taken into account
for purposes of determining reasonableness of compensation under
section 4958.
(2) Timing of reasonableness determination--(i) In general. The
facts and circumstances to be taken into consideration in determining
reasonableness of a fixed payment (within the meaning of paragraph
(a)(3)(ii) of this section) are those existing on the date the parties
enter into the contract pursuant to which the payment is made. However,
in the event of substantial non-performance, reasonableness is
determined based on all facts and circumstances, up to and including
circumstances as of the date of payment. In the case of a payment that
is not a fixed payment under a contract, reasonableness is determined
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 payment is questioned be considered in making a
determination of the reasonableness of the payment.
(ii) Treatment as a new contract. For purposes of paragraph
(b)(2)(i) of this section, a written binding contract that provides
that the contract is terminable or subject to cancellation by the
applicable tax-exempt organization without the other party's consent
and without substantial penalty to the organization is treated as a new
contract as of the earliest date that any such termination or
cancellation, if made, would be effective. Additionally, if the parties
make a material change to a contract (within the meaning of paragraph
(a)(3)(v) of this section), it is treated as a new contract as of the
date the material change is effective.
(iii) Examples. The following examples illustrate the timing of the
reasonableness determination under the rules of this paragraph (b)(2):
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 G. H's new multi-year employment contract
provides for payment of a salary and provision of specific benefits
pursuant to a qualified pension plan under Internal Revenue Code
section 401(a) and an accident and health plan that meets the
requirements of section 105(h)(2). The contract provides that H's
salary will be adjusted by the increase in the Consumer Price Index
(CPI) for the prior year. The contributions G makes to the qualified
pension plan are equal to the maximum amount G is permitted to
contribute under the rules applicable to qualified plans. Under
these facts, all items comprising H's total compensation are treated
as fixed payments within the meaning of paragraph (a)(3)(ii) of this
section. Therefore, the reasonableness of H's compensation is
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. On January 2, N's governing body enters
into a new one-year employment contract with K, its executive
director, who is a disqualified person with respect to N. The
contract provides that K will receive a specified amount of salary,
contributions to a qualified pension plan under Internal Revenue
Code section 401(a), and other benefits pursuant to a section 125
cafeteria plan. In addition, the contract provides that N's
governing body may, in its discretion, declare a bonus to be paid to
K at any time during the year covered by the contract. K's salary
and other specified benefits constitute fixed payments within the
meaning of paragraph (a)(3)(ii) of this section. Therefore, the
reasonableness of those economic benefits is determined on the date
when the contract was made. However, because the bonus payment is
not a fixed
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payment within the meaning of paragraph (a)(3)(ii) of this section,
the determination of whether any bonus awarded to N is reasonable
must be made based on all facts and circumstances (including all
payments and consideration exchanged between the parties), up to and
including circumstances as of the date of payment of the bonus.
(c) Establishing intent to treat economic benefit as consideration
for the performance of services--(1) In general. An economic benefit is
not 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. Except as
provided in paragraph (c)(2) of this section, an applicable tax-exempt
organization (or entity controlled by an applicable tax-exempt
organization, within the meaning of paragraph (a)(2)(ii)(B) of this
section) is treated as clearly indicating its intent to provide an
economic benefit as compensation for services only if the organization
provides written substantiation that is contemporaneous with the
transfer of the economic benefit at issue. If an organization fails to
provide this contemporaneous substantiation, any services provided by
the disqualified person will not be treated as provided in
consideration for the economic benefit for purposes of determining the
reasonableness of the transaction.
(2) Nontaxable benefits. For purposes of section 4958(c)(1)(A) and
this section, an applicable tax-exempt organization is not required to
indicate its intent to provide an economic benefit as compensation for
services if the economic benefit is excluded from the disqualified
person's gross income for income tax purposes on the basis of the
provisions of chapter 1 of Subtitle A of the Internal Revenue Code.
Examples of these benefits include, but are not limited to, employer-
provided health benefits and contributions to a qualified pension,
profit-sharing, or stock bonus plan under Internal Revenue Code section
401(a), and benefits described in sections 127 and 137. However, except
for economic benefits that are disregarded for purposes of section 4958
under paragraph (a)(4) of this section, all compensatory benefits
(regardless of the federal income tax treatment) provided by an
organization in exchange for the performance of services are taken into
account in determining the reasonableness of a person's compensation
for purposes of section 4958.
(3) Contemporaneous substantiation--(i) Reporting of benefit. An
applicable tax-exempt organization provides contemporaneous written
substantiation of its intent to provide an economic benefit as
compensation if--
(A) The organization reports the economic benefit as compensation
on an original Federal tax information return with respect to the
payment (e.g., Form W-2 or 1099) or with respect to the organization
(e.g., Form 990), or on an amended Federal tax information return filed
prior to the commencement of an Internal Revenue Service examination of
the applicable tax-exempt organization or the disqualified person for
the taxable year in which the transaction occurred (as determined under
Sec. 53.4958-1T(e)); or
(B) The recipient disqualified person reports the benefit as income
on the person's original Federal tax return (e.g., Form 1040), or on
the person's amended Federal tax return filed prior to the commencement
of an Internal Revenue Service examination described in paragraph
(b)(3)(i)(A) of this section.
(ii) Other evidence of contemporaneous substantiation. In addition,
other written contemporaneous evidence may be used to demonstrate that
the appropriate decision-making body or an authorized officer approved
a transfer as compensation for services in accordance with established
procedures, including an approved written employment contract executed
on or before the date of the transfer, or documentation satisfying the
requirements of Sec. 53.4958-6T(a)(3) indicating that an authorized
body approved the transfer as compensation for services on or before
the date of the transfer.
(iii) Failure to report due to reasonable cause. 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 of Sec. 301.6724-1 of this chapter), then the
organization will be treated as having clearly indicated its intent to
provide an economic benefit as compensation for services. 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).
(4) Examples. The following examples illustrate the requirement
that an organization contemporaneously substantiate its intent to
provide an economic benefit as compensation for services, as defined in
paragraph (c) of this section:
Example 1. G is an applicable tax-exempt organization for
purposes of section 4958. G hires an individual contractor, P, who
is also the child of a disqualified person of G, to design a
computer program for it. G executes a contract with P for that
purpose in accordance with G's established procedures, and pays P
$1,000 during the year 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
will be treated as providing contemporaneous written substantiation
of its intent to provide the $1,000 paid to P as compensation for
the services P performed under the contract by virtue of either the
Form 1099 filed with the Internal Revenue Service reporting the
amount, or by virtue of the written contract executed between G and
P.
Example 2. 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 G. D receives a bonus at the
end of the year. G's accounting department determines that the bonus
is to be reported on D's Form W-2. Due to events beyond G's control,
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 is made aware of the error
during an Internal Revenue Service examination. 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 (within the meaning of Sec. 301.6724-1 of this
chapter) for failing to report D's bonus, G will be treated as
providing contemporaneous written substantiation of its intent to
provide the bonus as compensation for services when paid.
Sec. 53.4958-5T Transaction in which the amount of the economic
benefit is determined in whole or in part by the revenues of one or
more activities of the organization (temporary). [Reserved]
Sec. 53.4958-6T Rebuttable presumption that a transaction is not an
excess benefit transaction (temporary).
(a) In general. Payments under a compensation arrangement are
presumed to be reasonable, and a transfer of property, or the right to
use property, is presumed to be at fair market value, if the following
conditions are satisfied--
(1) The compensation arrangement or the terms of the property
transfer are Approved in advance by an authorized body of the
applicable tax-exempt organization (or an entity controlled by
[[Page 2168]]
the organization with the meaning of Sec. 53.4958-4T(a)(2)(ii)(B))
composed entirely of individuals who do not have a conflict of interest
(within the meaning of paragraph (c)(1)(iii) of this section) with
respect to the compensation arrangement or property transfer, as
described in paragraph (c)(1) of this section;
(2) The authorized body obtained and relied upon appropriate data
as to comparability prior to making its determination, as described in
paragraph (c)(2) of this section; and
(3) The authorized body adequately documented the basis for its
determination concurrently with making that determination, as described
in paragraph (c)(3) of this section.
(b) Rebutting the presumption. If the three requirements of
paragraph (a) of this section are satisfied, then the Internal Revenue
Service may rebut the presumption that arises under paragraph (a) of
this section only if it develops sufficient contrary evidence to rebut
the probative value of the comparability data relied upon by the
authorized body. With respect to any fixed payment (within the meaning
of Sec. 53.4958-4T(a)(3)(ii)), rebuttal evidence is limited to evidence
relating to facts and circumstances existing on the date the parties
enter into the contract pursuant to which the payment is made (except
in the event of substantial nonperformance). With respect to all other
payments (including non-fixed payments subject to a cap, as described
in paragraph (d)(2) of this section), rebuttal evidence may include
facts and circumstances up to and including the date of payment. See
Sec. 53.4958-4T(b)(2)(i).
(c) Requirements for invoking rebuttable presumption--(1) Approval
by an authorized body--(i) In general. An authorized body means--
(A) The governing body (i.e., the board of directors, board of
trustees, or equivalent controlling body) of the organization;
(B) A committee of the governing body, which may be composed of any
individuals permitted under State law to serve on such a committee, to
the extent that the committee is permitted by State law to act on
behalf of the governing body; or
(C) To the extent permitted under State law, other parties
authorized by the governing body of the organization to act on its
behalf by following procedures specified by the governing body in
approving compensation arrangements or property transfers.
(ii) Individuals not included on authorized body. For purposes of
determining whether the requirements of paragraph (a) of this section
have been met with respect to a specific compensation arrangement or
property transfer, an individual is not included on the authorized body
when it is reviewing a transaction if that individual meets with other
members only to answer questions, and otherwise recuses himself or
herself from the meeting and is not present during debate and voting on
the compensation arrangement or property transfer.
(iii) Absence of conflict of interest. A member of the authorized
body does not have a conflict of interest with respect to a
compensation arrangement or property transfer only if the member--
(A) Is not a disqualified person participating in or economically
benefitting from the compensation arrangement or property transfer, and
is not a member of the family of any such disqualified person, as
described in section 4958(f)(4) or Sec. 53.4958-3T(b)(1);
(B) 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 property transfer;
(C) Does not receive compensation or other payments subject to
approval by any disqualified person participating in or economically
benefitting from the compensation arrangement or property transfer;
(D) Has no material financial interest affected by the compensation
arrangement or property transfer; and
(E) Does not approve a transaction providing economic benefits to
any disqualified person participating in the compensation arrangement
or property transfer, who in turn has approved or will approve a
transaction providing economic benefits to the member.
(2) Appropriate data as to comparability--(i) In general. An
authorized body 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-
4T(b), the compensation arrangement in its entirety is reasonable or
the property transfer is at fair market value. In the case of
compensation, 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; current compensation surveys
compiled by independent firms; and actual written offers from similar
institutions competing for the services of the disqualified person. In
the case of property, relevant information includes, but is not limited
to, current independent appraisals of the value of all property to be
transferred; and offers received as part of an open and competitive
bidding process.
(ii) Special rule for compensation paid by small organizations. For
organizations with annual gross receipts (including contributions) of
less than $1 million reviewing compensation arrangements, the
authorized body will be considered to have appropriate data as to
comparability if it has data on compensation paid by three 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) Application of special rule for small organizations. For
purposes of determining whether the special rule for small
organizations described in paragraph (c)(2)(ii) of this section
applies, an organization may calculate its annual gross receipts based
on an average of its gross receipts during the three prior taxable
years. If any applicable tax-exempt organization is controlled by or
controls another entity (as defined in Sec. 53.4958-4T(a)(2)(ii)(B)),
the annual gross receipts of such organizations must be aggregated to
determine applicability of the special rule stated in paragraph
(c)(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. In
all examples, compensation refers to the aggregate value of all
benefits provided in exchange for services. The examples are as
follows:
Example 1. Z is a university that is an applicable tax-exempt
organization for purposes of section 4958. Z is negotiating a new
contract with Q, its president, because the old contract will expire
at the end of the year. In setting Q's compensation for its
president at $600x per annum, the executive committee of the Board
of Trustees relies solely on a national survey of compensation for
university presidents that indicates university presidents receive
annual compensation in the range of $100x to $700x; this survey does
not divide its data by any criteria, such as the number of students
served by the institution, annual revenues, academic ranking, or
geographic location. Although many members of the executive
committee have significant business experience, none of the members
has any particular expertise in higher education compensation
matters. Given the failure of
[[Page 2169]]
the survey to provide information specific to universities
comparable to Z, and because no other information was presented, the
executive committee's decision with respect to Q's compensation was
not based upon appropriate data as to comparability.
Example 2. The facts are the same as Example 1, except that the
national compensation survey divides the data regarding compensation
for university presidents into categories based on various
university-specific factors, including the size of the institution
(in terms of the number of students it serves and the amount of its
revenues) and geographic area. The survey data shows that university
presidents at institutions comparable to and in the same geographic
area as Z receive annual compensation in the range of $200x to
$300x. The executive committee of the Board of Trustees of Z relies
on the survey data and its evaluation of Q's many years of service
as a tenured professor and high-ranking university official at Z in
setting Q's compensation at $275x annually. The data relied upon by
the executive committee constitutes appropriate data as to
comparability.
Example 3. X is a tax-exempt hospital that is an applicable tax-
exempt organization for purposes of section 4958. Before renewing
the contracts of X's chief executive officer and chief financial
officer, X's governing board commissioned a customized 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 taxable and tax-exempt 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 annual 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 4. The facts are the same as Example 3, except that one
year later, X is negotiating a new contract with its chief executive
officer. The governing board of X has no information indicating that
the relevant market conditions have changed or that the results of
the prior year's survey are no longer valid. Therefore, X may
continue to rely on the independent compensation survey prepared for
the prior year in setting annual compensation under the new
contract.
Example 5. 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 of directors of W relies on data
compiled from a telephone survey of three other unrelated repertory
theaters of similar size in similar communities. A member of the
board drafts a brief written summary of the annual compensation
information obtained from this informal survey. The annual
compensation 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 authorized body must note--
(A) The terms of the transaction that was approved and the date it
was approved;
(B) The members of the authorized body who were present during
debate on the transaction that was approved and those who voted on it;
(C) The comparability data obtained and relied upon by the
authorized body and how the data was obtained; and
(D) Any actions taken with respect to consideration of the
transaction by anyone who is otherwise a member of the authorized body
but who had a conflict of interest with respect to the transaction.
(ii) If the authorized body determines that reasonable compensation
for a specific arrangement or fair market value in a specific property
transfer is higher or lower than the range of comparability data
obtained, the authorized body must record the basis for its
determination. For a decision to be documented concurrently, records
must be prepared before the later of the next meeting of the authorized
body or 60 days after the final action or actions of the authorized
body are taken. Records must be reviewed and approved by the authorized
body as reasonable, accurate and complete within a reasonable time
period thereafter.
(d) No presumption with respect to non-fixed payments until amounts
are determined--(1) In general. Except as provided in paragraph (d)(2)
of this section, in the case of a payment that is not a fixed payment
(within the meaning of Sec. 53.4958-4T(a)(3)(ii)), the rebuttable
presumption of this section arises only after the exact amount of the
payment is determined, or a fixed formula for calculating the payment
is specified, and the three requirements for the presumption under
paragraph (a) of this section subsequently are satisfied. See
Sec. 53.4958-4T(b)(2)(i).
(2) Special rule for certain non-fixed payments subject to a cap.
If the authorized body approves an employment contract with a
disqualified person that includes a non-fixed payment (such as a
discretionary bonus) subject to a specified cap, the authorized body
may establish a rebuttable presumption with respect to the non-fixed
payment at the time the employment contract is entered into if--
(i) Prior to approving the contract, the authorized body obtains
appropriate comparability data indicating that a fixed payment of up to
a certain amount to the particular disqualified person would represent
reasonable compensation;
(ii) The maximum amount payable under the contract (taking into
account both fixed and non-fixed payments) does not exceed the amount
referred to in paragraph (d)(2)(i) of this section; and
(iii) The other requirements for the rebuttable presumption of
reasonableness under paragraph (a) of this section are satisfied.
(e) 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 neither creates any inference that the transaction is an excess
benefit transaction, nor exempts or relieves 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.
(f) Period of reliance on rebuttable presumption. Except as
provided in paragraph (d) of this section with respect to non-fixed
payments, the rebuttable presumption applies to all payments made or
transactions completed in accordance with a contract, provided that the
provisions of paragraph (a) of this section were met at the time the
parties entered into the contract.
Sec. 53.4958-7T Correction (temporary).
(a) In general. An excess benefit transaction is corrected by
undoing the excess benefit to the extent possible, and taking any
additional measures necessary to place the applicable tax-exempt
organization involved in the excess benefit transaction in a financial
position not worse than that in which it would be if the disqualified
person were dealing under the highest fiduciary standards. Paragraph
(b) of this section describes the acceptable forms of correction.
Paragraph (c) of this section defines the correction amount. Paragraph
(d) of this section describes correction where a contract has been
partially performed. Paragraph (e) of this section describes correction
where the applicable tax-exempt organization involved in the
transaction has ceased to exist or is no longer tax-exempt. Paragraph
(f) of this section provides examples illustrating correction.
[[Page 2170]]
(b) Form of correction--(1) Cash or cash equivalents. Except as
provided in paragraphs (b)(3) and (4) of this section, a disqualified
person corrects an excess benefit only by making a payment in cash or
cash equivalents, excluding payment by a promissory note, to the
applicable tax-exempt organization equal to the correction amount, as
defined in paragraph (c) of this section.
(2) Anti-abuse rule. A disqualified person will not satisfy the
requirements of paragraph (b)(1) of this section if the Commissioner
determines that the disqualified person engaged in one or more
transactions with the applicable tax-exempt organization to circumvent
the requirements of this correction section, and as a result, the
disqualified person effectively transferred property other than cash or
cash equivalents.
(3) Special rule relating to nonqualified deferred compensation. If
an excess benefit transaction results, in whole or in part, from the
vesting (as described in Sec. 53.4958-1T(e)(2)) of benefits provided
under a nonqualified deferred compensation plan, then, to the extent
that such benefits have not yet been distributed to the disqualified
person, the disqualified person may correct the portion of the excess
benefit resulting from such undistributed deferred compensation by
relinquishing any right to receive such benefits (including any
earnings thereon).
(4) Return of specific property--(i) In general. A disqualified
person may, with the agreement of the applicable tax-exempt
organization, make a payment by returning specific property previously
transferred in the excess benefit transaction. In this case, the
disqualified person is treated as making a payment equal to the lesser
of--
(A) The fair market value of the property determined on the date
the property is returned to the organization; or
(B) The fair market value of the property on the date the excess
benefit transaction occurred.
(ii) Payment not equal to correction amount. If the payment
described in paragraph (b)(4)(i) of this section is less than the
correction amount (as described in paragraph (c) of this section), the
disqualified person must make an additional cash payment to the
organization equal to the difference. Conversely, if the payment
described in paragraph (b)(4)(i) of this section exceeds the correction
amount (as described in paragraph (c) of this section), the
organization may make a cash payment to the disqualified person equal
to the difference.
(iii) Disqualified person may not participate in decision. Any
disqualified person who received an excess benefit from the excess
benefit transaction may not participate in the applicable tax-exempt
organization's decision whether to accept the return of specific
property under paragraph (b)(4)(i) of this section.
(c) Correction amount. The correction amount with respect to an
excess benefit transaction equals the sum of the excess benefit (as
defined in Sec. 53.4958-1T(b)) and interest on the excess benefit. The
amount of the interest charge for purposes of this section is
determined by multiplying the excess benefit by an interest rate,
compounded annually, for the period from the date the excess benefit
transaction occurred (as defined in Sec. 53.4958-1T(e)) to the date of
correction. The interest rate used for this purpose must be a rate that
equals or exceeds the applicable Federal rate (AFR), compounded
annually, for the month in which the transaction occurred. The period
from the date the excess benefit transaction occurred to the date of
correction is used to determine whether the appropriate AFR is the
Federal short-term rate, the Federal mid-term rate, or the Federal
long-term rate. See section 1274(d)(1)(A).
(d) Correction where contract has been partially performed. If the
excess benefit transaction arises under a contract that has been
partially performed, termination of the contractual relationship
between the organization and the disqualified person is not required in
order to correct. However, the parties may need to modify the terms of
any ongoing contract to avoid future excess benefit transactions.
(e) Correction in the case of an applicable tax-exempt organization
that has ceased to exist, or is no longer tax-exempt--(1) In general. A
disqualified person must correct an excess benefit transaction in
accordance with this paragraph where the applicable tax-exempt
organization that engaged in the transaction no longer exists or is no
longer described in section 501(c)(3) or (4) and exempt from tax under
section 501(a).
(2) Section 501(c)(3) organizations. In the case of an excess
benefit transaction with a section 501(c)(3) applicable tax-exempt
organization, the disqualified person must pay the correction amount,
as defined in paragraph (c) of this section, to another organization
described in section 501(c)(3) and exempt from tax under section 501(a)
in accordance with the dissolution clause contained in the constitutive
documents of the applicable tax-exempt organization involved in the
excess benefit transaction, provided that the other organization is not
related to the disqualified person.
(3) Section 501(c)(4) organizations. In the case of an excess
benefit transaction with a section 501(c)(4) applicable tax-exempt
organization, the disqualified person must pay the correction amount,
as defined in paragraph (c) of this section, to a successor section
501(c)(4) organization or, if no tax-exempt successor, to any section
501(c)(3) or other section 501(c)(4) organization not related to the
disqualified person.
(f) Examples. The following examples illustrate the principles of
this section describing the requirements of correction:
Example 1. W is an applicable tax-exempt organization for
purposes of section 4958. D is a disqualified person with respect to
W. W employed D in 1999 and made payments totaling $12t to D as
compensation throughout the taxable year. The fair market value of
D's services in 1999 was $7t. Thus, D received excess compensation
in the amount of $5t, the excess benefit for purposes of section
4958. In accordance with Sec. 53.4958-1T(e)(1), the excess benefit
transaction with respect to the series of compensatory payments
during 1999 is deemed to occur on December 31, 1999, the last day of
D's taxable year. In order to correct the excess benefit transaction
on June 30, 2002, D must pay W, in cash or cash equivalents,
excluding payment with a promissory note, $5t (the excess benefit)
plus interest on $5t for the period from the date the excess benefit
transaction occurred to the date of correction (i.e., December 31,
1999, to June 30, 2002). Because this period is not more than three
years, the interest rate D must use to determine the interest on the
excess benefit must equal or exceed the short-term AFR, compounded
annually, for December, 1999 (5.74%, compounded annually).
Example 2. X is an applicable tax-exempt organization for
purposes of section 4958. B is a disqualified person with respect to
X. On January 1, 2000, B paid X $6v for Property F. Property F had a
fair market value of $10v on January 1, 2000. Thus, the sales
transaction on that date provided an excess benefit to B in the
amount of $4v. In order to correct the excess benefit on July 5,
2005, B pays X, in cash or cash equivalents, excluding payment with
a promissory note, $4v (the excess benefit) plus interest on $4v for
the period from the date the excess benefit transaction occurred to
the date of correction (i.e., January 1, 2000, to July 5, 2005).
Because this period is over three but not over nine years, the
interest rate B must use to determine the interest on the excess
benefit must equal or exceed the mid-term AFR, compounded annually,
for January, 2000 (6.21%, compounded annually).
Example 3. The facts are the same as in Example 2, except that B
offers to return Property F. X agrees to accept the return of
Property F, a decision in which B does not participate. Property F
has declined in value since the date of the excess benefit
transaction. On July 5, 2005, the property has
[[Page 2171]]
a fair market value of $9v. For purposes of correction, B's return
of Property F to X is treated as a payment of $9v, the fair market
value of the property determined on the date the property is
returned to the organization. If $9v is greater than the correction
amount ($4v plus interest on $4v at a rate that equals or exceeds
6.21%, compounded annually, for the period from January 1, 2000, to
July 5, 2005), then X may make a cash payment to B equal to the
difference.
Example 4. The facts are the same as in Example 3, except that
Property F has increased in value since January 1, 2000, the date
the excess benefit transaction occurred, and on July 5, 2005, has a
fair market value of $13v. For purposes of correction, B's return of
Property F to X is treated as a payment of $10v, the fair market
value of the property on the date the excess benefit transaction
occurred. If $10v is greater than the correction amount ($4v plus
interest on $4v at a rate that equals or exceeds 6.21%, compounded
annually, for the period from January 1, 2000, to July 5, 2005),
then X may make a cash payment to B equal to the difference.
Example 5. The facts are the same as in Example 2. Assume that
the correction amount B paid X in cash on July 5, 2005, was $5.58v.
On July 4, 2005, X loaned $5.58v to B, in exchange for a promissory
note signed by B in the amount of $5.58v, payable with interest at a
future date. These facts indicate that B engaged in the loan
transaction to circumvent the requirement of this section that
(except as provided in paragraph (b)(3) or (4) of this section), the
correction amount must be paid only in cash or cash equivalents. As
a result, the Commissioner may determine that B effectively
transferred property other than cash or cash equivalents, and
therefore did not satisfy the correction requirements of this
section.
Sec. 53.4958-8T Special rules (temporary).
(a) Substantive requirements for exemption still apply. Section
4958 does not affect the substantive standards for tax exemption under
section 501(c)(3) or (4), including the requirements that the
organization be organized and operated exclusively for exempt purposes,
and that no part of its net earnings inure to the benefit of any
private shareholder or individual. Thus, regardless of whether a
particular transaction is subject to excise taxes under section 4958,
existing principles and rules may be implicated, such as the limitation
on private benefit. For example, transactions that are not subject to
section 4958 because of the initial contract exception described in
Sec. 53.4958-4T(a)(3) may, under certain circumstances, jeopardize the
organization's tax-exempt status.
(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.
(c) Three year duration of these temporary regulations. Sections
53.4958-1T through 53.4958-8T will cease to apply on January 9, 2004.
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. In Sec. 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 Sec. 301.7422-1, paragraph (a) introductory text,
paragraph (c) introductory text and paragraph (d) are amended by adding
the reference ``4958,'' immediately after the reference ``4955,''.
Sec. 301.7454-2 [Amended]
Par. 9. In Sec. 301.7454-2, paragraph (a) is amended by adding the
language ``or whether an organization manager (as defined in section
4958(f)(2) has ``knowingly'' participated in an excess benefit
transaction (as defined in section 4958(c),'' immediately after
``4945''.
Sec. 301.7611-1 [Amended]
Par. 10. In Sec. 301.7611-1, the Table of contents is amended by:
1. Adding ``Application to Section 4958. . . . . . . 19''
immediately after ``Effective Date. . . . . . . 18''.
2. Adding an undesignated centerheading and Q-19 and A-19 at the
end of the section 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.
[[Page 2172]]
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 11. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 12. In Sec. 602.101, paragraph (b) is amended by adding an
entry to the table in numerical order to read as follows:
Sec. 602.101 OMB control numbers.
* * * * *
(b) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
* * * * *
53.4958-6T.............................................. 1545-1623
* * * * *
------------------------------------------------------------------------
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: December 19, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 01-256 Filed 1-9-01; 8:45 am]
BILLING CODE 4830-01-P