[Federal Register Volume 67, Number 15 (Wednesday, January 23, 2002)]
[Rules and Regulations]
[Pages 3076-3099]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-985]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 53, 301, and 602

[TD 8978]
RIN 1545-AY65


Excise Taxes on Excess Benefit Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final 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 by the Taxpayer Bill of Rights 2. Section 4958 imposes 
excise taxes on any transaction that provides excess economic benefits 
to a person in a position to exercise substantial influence over the 
affairs of a public charity or a social welfare organization.

DATES: Effective Date: These regulations are effective January 23, 
2002.
    Applicability Date: These regulations apply as of January 23, 2002.

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 final 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. Responses to these collections of information 
are required to obtain the benefit of the rebuttable presumption that a 
transaction is reasonable or at fair market value.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    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.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S 
Washington, DC 20224, and to the Office of Management and Budget, Attn: 
Desk Officer for the Department of the Treasury, Office of Information 
and Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this 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 Internal Revenue Code (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

[[Page 3077]]

transactions occurring on or after September 14, 1995. Any disqualified 
person who benefits from an excess benefit transaction with an 
applicable tax-exempt organization is liable for a tax of 25 percent of 
the excess benefit. The person is also liable for a tax of 200 percent 
of the excess benefit if the excess benefit is not corrected by a 
certain date. A disqualified person is generally defined as a person in 
a position to exercise substantial influence over the affairs of the 
applicable tax-exempt organization. An applicable tax-exempt 
organization is an organization described in Code section 501(c)(3) or 
(4) and exempt from tax under section 501(a). 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 all 
participating organization managers are liable cannot exceed $10,000 
for any one excess benefit transaction.
    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. A public hearing 
was held on March 16 and 17, 1999. Those proposed regulations were 
revised in response to written and oral comments, and replaced by 
temporary regulations (TD 8920, 66 FR 2144) and a cross-referencing 
notice of proposed rulemaking (REG-246256-96, 66 FR 2173) on January 
10, 2001. A few written comments were received in response to the 
notice of proposed rulemaking of January 10, 2001. A public hearing was 
held July 31, 2001. After consideration of all comments received, the 
January 2001 cross-referencing proposed regulations under section 4958 
are revised and published in final form, and the temporary regulations 
removed. The major areas of the comments and revisions are discussed 
below.

Explanation and Summary of Comments

Tax Paid by Organization Managers

    Organization managers who participate in an excess benefit 
transaction knowingly, willfully, and without reasonable cause, are 
liable for a tax equal to 10 percent of the excess benefit. 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. Oral 
comments at the public hearing objected to this safe harbor, suggesting 
instances of the unreliability of appraisers and accountants. The final 
regulations retain this safe harbor. The IRS and the Treasury 
Department believe that an organization manager who has sought and 
relied upon an appropriate professional opinion has not ``fail[ed] to 
make reasonable attempts to ascertain whether the transaction is an 
excess benefit transaction'', which is a required element of knowing 
for this purpose.
    The temporary regulations provide an additional safe harbor: 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. Several 
comments were received requesting that the safe harbor be modified, 
either to apply if the organization manager ``reasonably believes'' 
that the requirements for the presumption are satisfied, or to 
eliminate the reliance requirement. In response to these comments, the 
final regulations no longer require that the organization manager rely 
on the fact that the requirements of the rebuttable presumption of 
reasonableness are satisfied. The final regulations state that the 
organization manager's participation in a transaction will ordinarily 
not be considered knowing if the appropriate authorized body has met 
the requirements of the rebuttable presumption with respect to the 
transaction. The IRS and the Treasury Department note that the relief 
given by this provision is only a safe harbor, so that failure to 
satisfy its requirements does not necessarily mean that the 
organization manager acted knowingly.

Definition of Applicable Tax-Exempt Organization

    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. A comment was received requesting that the final 
regulations clarify whether section 115 entities are excepted from the 
definition of applicable tax-exempt organization. Because section 115 
exempts certain income, and not the entity itself, the reference in the 
temporary regulations to any governmental entity ``exempt from tax'' 
without regard to section 501(a) is unclear. The final regulations 
provide that for purposes of section 4958, a governmental unit or an 
affiliate of a governmental unit is not an applicable tax-exempt 
organization if it is: (1) Exempt from (or not subject to) taxation 
without regard to section 501(a); or (2) relieved from filing an annual 
return pursuant to the authority of Treasury Regulations under section 
6033.
    Regulations under section 6033 grant the Commissioner authority to 
relieve organizations from filing an annual return required by that 
section in cases where the returns are not necessary for the efficient 
administration of the internal revenue laws. Under this authority, Rev. 
Proc. 95-48 (1995-2 C.B. 418) relieves ``governmental units'' and 
certain ``affiliates of governmental units'' from the annual filing 
requirement. A governmental unit as defined in this revenue procedure 
already falls within the exception provided in the section 4958 
temporary regulations for ``any governmental entity that is exempt from 
(or not subject to) taxation without regard to section 501(a)''. An 
affiliate of a governmental unit that is relieved from filing an annual 
return by Rev. Proc. 95-48 (and thus also excepted from the definition 
of an applicable tax-exempt organization under these section 4958 final 
regulations) includes any organization described in section 501(c) that 
has a ruling or determination from the IRS that: (1) Its income, 
derived from activities constituting the basis for its exemption under 
section 501(c), is excluded from gross income under section 115; (2) it 
is entitled to receive deductible charitable contributions under 
section 170(c)(1) on the basis that the contributions are ``for the use 
of'' governmental units; or (3) it is a wholly owned instrumentality of 
a State for employment tax purposes. An organization described in 
section 501(c) that does not have such a ruling or determination may 
also qualify as an affiliate of a governmental unit for purposes of the 
revenue procedure if: (1) It is either ``operated, supervised, or 
controlled by'' governmental units within the meaning of regulations 
under

[[Page 3078]]

section 509; (2) it possesses at least two affiliation factors listed 
in Rev. Proc. 95-48; and (3) its filing of Form 990, ``Return of 
Organization Exempt From Income Tax'', is not otherwise necessary to 
the efficient administration of the internal revenue laws.
    A comment was also received requesting that the final regulations 
exclude from the definition of applicable tax-exempt organization 
collectively bargained apprenticeship funds subject to the rules of the 
Labor Management Relations Act of 1947 (61 Stat. 157) and the Employee 
Retirement Income Security Act of 1974 (88 Stat. 854) (ERISA). The 
commenter stated that, like governmental entities, these funds seek 
recognition under Code section 501(c)(3) on a strictly voluntary basis, 
and are also eligible for tax exemption under Code section 501(c)(5). 
The commenter also stated that applying section 4958 to these funds 
would provide an unnecessary layer of regulation, because these plans 
already are subject to ERISA.
    The final regulations do not except collectively bargained 
apprenticeship funds from the definition of applicable tax-exempt 
organization. However, in response to this comment, the final 
regulations provide a special exception under section 4958 for 
transactions that are covered by a final individual prohibited 
transaction exemption issued by the Department of Labor. The final 
regulations provide that section 4958 does not apply to any payment 
made pursuant to, and in accordance with, a final individual prohibited 
transaction exemption issued by the Department of Labor under ERISA 
with respect to a transaction involving a plan that is an applicable 
tax-exempt organization. Before granting an individual prohibited 
transaction exemption under ERISA, the Department of Labor must 
determine that the particular transaction is in the interests of the 
plan and its participants, and is protective of the rights of 
participants in the plan. The IRS and the Treasury Department believe 
that the similarity between the ERISA standard (``in the interests of'' 
and ``protective of the rights of'' participants) and the fair market 
value standard of section 4958 warrants this special exception.

Definition of Disqualified Person

    The preamble of the temporary regulations noted that the IRS and 
the Treasury Department considered adopting a special rule with respect 
to so-called donor-advised funds maintained by applicable tax-exempt 
organizations, and requested 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. Several comments were received on this issue. Most of 
the comments objected to treating a donor or advisor to this type of 
fund as a disqualified person based solely on influence over a donor-
advised fund. Others stated that the existing factors contained in the 
temporary regulations were adequate to find disqualified person status 
in appropriate circumstances. One commenter requested that if section 
4958 were to apply to transactions involving donor-advised funds, the 
fair market standard should apply, and requested additional definitions 
and exclusions if the final regulations contained specific rules for 
these types of funds.
    In response to these comments, the final regulations do not adopt a 
special rule regarding any donor or advisor to a donor-advised fund. 
Thus, the general rules of Sec. 53.4958-3 will apply to determine if a 
donor or advisor is a disqualified person.
    Some additional comments were received on other specific rules of 
the disqualified person definition contained in the temporary 
regulations. The final regulations do not change the rules or 
descriptions contained in the definition. However, several of the 
comments are discussed below to explain why the IRS and the Treasury 
Department concluded that changes were not necessary or desirable. 
Other comments suggested changes to the examples. In response to those 
comments, several examples in this section of the final regulations 
were revised from the temporary regulations, as discussed below.
    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). A section 501(c)(4) organization can, however, have 
substantial influence with respect to an organization described in 
section 501(c)(3). A commenter requested that section 501(c)(4) 
organizations be excluded from disqualified person status with respect 
to all applicable tax-exempt organizations.
    The IRS and the Treasury Department decline to expand the exclusion 
for section 501(c)(4) organizations. A section 501(c)(4) organization 
can engage in certain activities (such as political campaign 
activities) that a section 501(c)(3) organization cannot. Accordingly, 
the IRS and the Treasury Department are concerned about transactions in 
which a section 501(c)(3) organization may provide an excess benefit to 
a section 501(c)(4) organization to avoid limitations of section 
501(c)(3).
    Oral comments at the public hearing objected to including, as one 
of the factors tending to show no substantial influence, the fact that 
the person's sole relationship to an applicable tax-exempt organization 
is as a contractor (such as an attorney, accountant, or investment 
manager or advisor) providing professional advice to the organization. 
The commenter suggested that these providers of professional advice 
have a great deal of influence over applicable tax-exempt 
organizations, but choose not to exercise that influence. The IRS and 
the Treasury Department believe that the description of this factor in 
the temporary regulations includes sufficient safeguards to protect the 
organization. Accordingly, the final regulations retain this factor. 
Additionally, being in this category of persons is merely a factor 
tending to show no substantial influence. In appropriate circumstances, 
the IRS could still conclude that a person ostensibly described in this 
category was a disqualified person based on all relevant facts and 
circumstances.
    Another comment objected to the standard of one of the factors 
tending to show substantial influence: that a person's compensation is 
primarily based on revenues derived from activities of the organization 
that the person controls. The commenter suggested that this factor be 
modified to provide that revenues controlled by the person also 
represent a substantial part of the organization's total revenues. The 
IRS and the Treasury Department do not believe that a change is 
necessary. The factor at issue is only one of many factors that may be 
considered, and will be considered in conjunction with all relevant 
facts and circumstances.
    Another comment requested further revision to two factors tending 
to show substantial influence. The first factor states that 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. The second factor states that the person 
manages a discrete segment or activity of the organization that 
represents a substantial portion of the activities, assets, income, or 
expense of the organization, as compared to the organization as a 
whole. The commenter suggested that the first factor is sufficient, and 
requested that the second factor be deleted. Alternatively, the 
commenter requested that the final regulations define the term 
substantial,

[[Page 3079]]

and recommended a safe harbor percentage of 15 percent.
    The IRS and the Treasury Department did not revise these two 
factors tending to show substantial influence. The IRS and the Treasury 
Department do not believe that these two factors are redundant, as they 
address budget and management authority, respectively, and these two 
functions may reside in different persons. In addition, as with any of 
the listed factors, these two factors are considered along with all 
other relevant facts and circumstances.
    In response to a comment regarding the examples of this section, 
the final regulations revise an example that concludes that a hospital 
management company is a disqualified person with respect to the 
applicable tax-exempt organization. The comment stated that the example 
could create confusion because its language does not match neatly with 
the factors tending to show substantial influence listed in the 
temporary regulations. The commenter also pointed out that, under the 
facts of the example, the functions of the management company seemed 
close to those of a president, chief executive officer, or chief 
operating officer, one of the categories of persons who are deemed to 
have substantial influence. The example is revised in the final 
regulations to illustrate that the management company is a disqualified 
person per se, because it has ultimate responsibility for supervising 
the management of the hospital, consistent with the regulatory 
description of the functions of a president, chief executive officer, 
or chief operating officer. By concluding that the management company 
is a disqualified person, this example also addresses a comment 
requesting that final regulations clarify whether only individuals 
could be persons having substantial influence.

Economic Benefit Provided Indirectly

    One comment analyzed examples in the temporary regulations defining 
an indirect excess benefit transaction. The commenter questioned one 
example in which the benefits provided to a disqualified person by an 
applicable tax-exempt organization and an entity controlled by the 
organization are evaluated in the aggregate, and the excess over 
reasonable compensation for the services performed by the disqualified 
person for both entities is treated as an excess benefit. The commenter 
recommended that the example be deleted or revised so that the 
reasonableness of compensation provided by each entity is evaluated 
separately.
    The rules governing an indirect excess benefit transaction are 
intended to prevent an applicable tax-exempt organization from avoiding 
section 4958 by using a controlled entity to provide excess benefits to 
a disqualified person. Thus, for purposes of section 4958, economic 
benefits provided by a controlled entity will be treated as provided by 
the applicable tax-exempt organization. Likewise, the IRS and the 
Treasury Department believe that any services performed by the 
disqualified person for a controlled entity should be taken into 
account in determining the reasonableness of compensation paid by the 
applicable tax-exempt organization. Accordingly, this example is not 
changed in the final regulations. However, the IRS and the Treasury 
Department agree with the commenter that the payment of compensation by 
an applicable tax-exempt organization to a disqualified person for 
services provided to a controlled entity, other than a wholly-owned 
subsidiary, may raise private benefit issues if the other investors in 
the entity do not make a proportional contribution. Accordingly, 
another example in this section is modified to clarify that the 
controlled entity for which the disqualified person performs services 
is a wholly-owned subsidiary of the applicable tax-exempt organization.

Initial Contract Exception

    The temporary regulations provide 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. The temporary regulations include examples to 
illustrate the application of the initial contract rule.
    Several comments were received on this section of the temporary 
regulations, including comments on specific examples. Several 
commentators requested a more liberal definition of initial contract. 
For instance, requests were received to extend the initial contract 
exception to cases where there is other contemporaneous written 
evidence of the terms of employment (but not a binding contract), or 
for the rule to cover cases where the parties agree to substantial 
terms of the person's employment, but where a final contract has not 
been signed before the person begins performing services for the 
organization. As the term binding written contract is governed by State 
law, in some cases that term may in fact be satisfied by an exchange of 
writings indicating the substantial terms of an agreement. However, the 
IRS and the Treasury Department decline to revise the regulatory 
definition of this term from that contained in the temporary 
regulations.
    One commenter at the public hearing requested that the final 
regulations eliminate the initial contract exception. In this 
commenter's view, the Seventh Circuit 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), focused on the wrong moment 
in time to determine insider status (analogous to disqualified person 
status under section 4958). The commenter suggested that a person's 
insider status should be determined at the time payments are made to 
the person. Therefore, the commenter recommended that the IRS and the 
Treasury Department decline to follow the reasoning of the Seventh 
Circuit's decision in the United Cancer Council case in the final 
regulations. Alternatively, the commenter requested that, if the 
initial contract exception is retained in the section 4958 final 
regulations, the IRS and the Treasury Department revise the private 
benefit standard under the section 501(c)(3) regulations to require 
that any private benefit conferred by a transaction must be 
insubstantial relative to the public benefit resulting from the 
transaction (rather than the public benefit resulting from the 
organization's overall activities).
    Although the United Cancer Council case addressed the issue of 
private inurement under the standards of section 501(c)(3) in 
connection with revocation of the organization's tax exemption, the 
temporary regulations address the concerns expressed in the Seventh 
Circuit's opinion in United Cancer Council in the context of section 
4958. The Seventh Circuit concluded that prohibited inurement under 
section

[[Page 3080]]

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 temporary regulations provide that, 
to the extent that an applicable tax-exempt organization and a person 
who is not yet a disqualified person enter into a binding written 
contract that specifies the amounts to be paid to the person (or 
specifies an objective formula for calculating those amounts), those 
fixed payments are not subject to scrutiny under section 4958, even if 
paid after the person becomes a disqualified person. However, the 
initial contract exception does not apply if the contract is materially 
modified or if the person fails to substantially perform his or her 
obligations under the contract. The IRS and the Treasury Department 
believe that the fact that the initial contract is scrutinized again 
when either of these situations occurs provides adequate protection to 
the applicable tax-exempt organization. In addition, the suggested 
revisions to the regulations under section 501(c)(3) are beyond the 
scope of this regulations project.
    Several comments on specific examples in the initial contract 
exception section of the temporary regulations were received. One 
writer commented that in the example involving a hospital management 
company, the structure of the management fee gives the management 
company an incentive to provide charity care regardless of whether the 
hospital has the financial resources to pay for it. The intent of that 
example is merely to illustrate a fixed payment determined by a fixed 
formula specified in the contract, where the formula incorporates an 
amount that is dependent on future specified events, but where no 
person exercises discretion when calculating the amount of a payment 
under the contract. Therefore, the example remains unchanged in the 
final regulations.
    Additional comments were received addressing the example in which 
the same hospital management company also received reimbursements for 
certain expenses in addition to the fixed management fee. The temporary 
regulations provide that any amount paid to a person under a 
reimbursement (or similar) arrangement where discretion is exercised 
with respect to the amount of expenses incurred or reimbursed is not a 
fixed payment for purposes of the section 4958 initial contract 
exception. A request was made to distinguish such reimbursement 
arrangements from payments determined by a fixed formula based on 
revenues from a particular activity, where a person has discretion over 
the extent of the activity. The IRS and the Treasury Department believe 
that reimbursement payments should generally be evaluated for 
reasonableness for purposes of section 4958. Consequently, the example 
is not modified in the final regulations, except to clarify that the 
management fee is a fixed payment, even though the reimbursement 
payments under the contract are not. However, as discussed below, the 
IRS and the Treasury Department also believe that reimbursement 
arrangements that meet the requirements of Sec. 1.62-2(c) (expense 
reimbursements pursuant to an accountable plan) do not raise the same 
concerns as other reimbursement payments, because of the requirements 
to qualify as an accountable plan. Accordingly, the final regulations 
disregard amounts reimbursed to employees pursuant to an accountable 
plan (see the discussion of this topic in this preamble under the 
heading ``Disregarded Economic Benefits''). Because the hospital 
management company in the example is a contractor, and not an employee, 
the expense reimbursements do not fall within this exception for 
expense reimbursements pursuant to an accountable plan.

Disregarded Economic Benefits

    The temporary regulations provide that all fringe benefits excluded 
from income under section 132 (except for certain liability insurance 
premiums, payments or reimbursements) are disregarded for section 4958 
purposes. To provide consistent treatment of benefits provided in cash 
and in kind, the final regulations also disregard expense 
reimbursements paid pursuant to an accountable plan that meets the 
requirements of Sec. 1.62-2(c). Thus, as is the case with section 
132(d) working condition fringe benefits, existing standards under 
section 162 and section 274 will apply to determine whether employee 
expense reimbursements are disregarded for section 4958 purposes, or 
are treated as part of the disqualified person's compensation for 
purposes of determining reasonableness under section 4958.
    Several comments were received requesting that lodging furnished 
for the convenience of the employer (i.e., meeting the requirements of 
section 119) be disregarded for section 4958 purposes. These comments 
suggested that benefits excluded from gross income under section 119 
should be disregarded for purposes of section 4958 because the policy 
rationale underlying section 119 is the same as that underlying section 
132. However, there are differences between the two sections. In 
general, section 132 benefits are subject to nondiscrimination rules or 
are de minimis in amount, which is not the case with section 119 
benefits. The value of housing benefits is potentially much larger than 
many of the section 132 benefits, and therefore a greater potential for 
abuse exists in the section 119 area. Accordingly, the IRS and the 
Treasury Department believe it is appropriate to treat section 119 
benefits differently from section 132 benefits by requiring an 
evaluation for reasonableness.
    The temporary regulations disregard economic benefits provided to a 
donor solely on account of a contribution deductible under section 170 
if two requirements are met. First, any non-disqualified person making 
a contribution above a specified amount to the organization is given 
the option of receiving substantially the same economic benefit. 
Second, the disqualified person and a significant number of non-
disqualified persons in fact make a contribution of at least the 
specified amount. Several comments were received requesting additional 
guidance with respect to these disregarded benefits. One commenter 
asked that the rule be revised to address contributions that are not 
deductible by the donor in the current year because of the percentage 
limitations under section 170(b). That commenter also requested that 
the final regulations provide for situations where no other donor makes 
a comparable contribution to the specific applicable tax-exempt 
organization. In that instance, the commenter requested that the 
benefits be considered in relation to benefits customarily provided by 
similar organizations for that level of contribution. Another commenter 
requested that any benefit provided to a donor be disregarded if the 
value of the benefit does not exceed the value of the donation and the 
donor treats the benefit as a quid pro quo that reduces the donor's 
charitable contribution deduction.
    The IRS and the Treasury Department decline to address situations 
where a disqualified person makes a unique contribution to an 
applicable tax-exempt organization. As a practical matter, an excess 
benefit transaction would never arise in connection with a contribution 
to an applicable tax-exempt organization, where the value of the 
contribution exceeds the value of any benefit the donor receives in 
return.

[[Page 3081]]

However, in response to comments, the final regulations clarify that 
economic benefits made available on equal terms to a disqualified 
person and a significant number of other donors who make charitable 
contributions (within the meaning of section 170) above a specified 
amount may be disregarded for purposes of section 4958, even if the 
disqualified person cannot claim a deduction under section 170 with 
respect to the contribution, because the disqualified person does not 
itemize deductions, or is subject to the percentage limitations under 
section 170(b).

Timing of 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) at the time the parties enter into the contract. 
For non-fixed payments, reasonableness is determined based on all facts 
and circumstances, up to and including circumstances as of the date of 
payment. A comment requested that final regulations clarify that the 
timing for determining the reasonableness of a benefit is not affected 
by the existence of a substantial risk of forfeiture. In response to 
this comment, the final regulations are revised to clarify that the 
general timing rules apply to property subject to a substantial risk of 
forfeiture. Therefore, if the property subject to a substantial risk of 
forfeiture satisfies the definition of fixed payment, reasonableness is 
determined at the time the parties enter into the contract providing 
for the transfer of the property. If the property is not a fixed 
payment, then reasonableness is determined based on all facts and 
circumstances, up to and including circumstances as of the date of 
payment. An example is also added to illustrate how the regular timing 
rules for determining reasonableness for section 4958 purposes apply to 
property that is subject to a substantial risk of forfeiture.

Contemporaneous Substantiation

    The temporary regulations provide that an organization must provide 
written substantiation that is contemporaneous with the transfer of 
benefits at issue in order to provide clear and convincing evidence of 
its intent to treat benefits provided to a disqualified person as 
compensation for services. This requirement may be satisfied by either: 
(1) The organization reporting the economic benefit as compensation on 
an original Federal tax information return, or on an amended Federal 
tax information return filed prior to the commencement of an IRS 
examination of the applicable tax-exempt organization or the 
disqualified person for the taxable year in which the transaction 
occurred; or (2) the recipient disqualified person reporting the 
benefit as income on the person's original Federal tax return, or on 
the person's amended Federal tax return filed prior to the commencement 
of an IRS examination. The final regulations clarify that for an 
amended return filed by a disqualified person to be considered 
contemporaneous substantiation, the person must file an amended return 
prior to the earlier of the following dates: (1) Commencement of an IRS 
examination; or (2) the first documentation in writing by the IRS of a 
potential excess benefit transaction.
    The temporary regulations provide 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. A comment was received requesting that the reference to 
``established procedures'' be deleted.
    The final regulations retain the reference to ``established 
procedures'' because it appears in the legislative history to section 
4958 (See H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 57). 
The IRS will interpret the term established procedures to refer to the 
organization's usual practice for approving compensation, not to 
require an organization to have a formal written procedure for 
approving compensation. For clarity, the final regulations replace the 
term authorized officer with ``officer authorized to approve 
compensation'.
    The final regulations also clarify that written evidence upon which 
the applicable tax-exempt organization based a reasonable belief that a 
benefit was nontaxable can serve as written contemporaneous evidence 
demonstrating that a transfer was approved as compensation, even if the 
organization's belief later proves to be erroneous. The written 
evidence must have been in existence on or before the due date of the 
applicable Federal tax return (including extensions but not 
amendments). The final regulations include an example illustrating this 
rule.
    Finally, the final regulations provide that in no event will an 
economic benefit that a disqualified person obtains by theft or fraud 
be treated as consideration for the performance of services.

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) identifies 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 one or more 
activities of the applicable tax-exempt organization, where the 
transaction results in impermissible inurement under section 501(c)(3) 
or (4). The statute provides, however, that this type of transaction is 
only an excess benefit transaction to the extent provided in 
regulations prescribed by the Secretary.
    The August 1998 proposed regulations provided standards for 
determining when a revenue-sharing transaction constitutes an excess 
benefit transaction. Numerous comments were received on this section of 
the proposed regulations. Commenters offered multiple, often 
conflicting, suggestions and recommendations to address the many issues 
raised with respect to revenue-sharing transactions.
    The temporary regulations reserve the section of the regulations 
governing revenue-sharing transactions. The temporary regulations 
provide that, until specific rules are issued to regulate such 
transactions, all transactions with disqualified persons (regardless of 
whether the person's compensation is computed by reference to revenues 
of the organization) will be evaluated under general rules defining an 
excess benefit transaction in Sec. 53.4958-4T. A written comment was 
received supporting the decision to reserve that section of the 
regulations. However, a speaker at the public hearing objected to the 
lack of specific limits on revenue-sharing transactions in the 
temporary regulations. The speaker would allow only a small percentage 
of a disqualified person's salary to be based on an applicable tax-
exempt organization's revenues.
    Another comment asked whether revenue-sharing transactions that are 
reasonable in amount may nonetheless violate the inurement prohibition, 
so that they jeopardize the organization's tax-exempt status. The 
temporary regulations and these final regulations make clear that the 
general exemption standards of sections 501(c)(3) and (4) still apply. 
Under these standards, inurement may exist even though a disqualified 
person receives a reasonable amount from a revenue-

[[Page 3082]]

sharing arrangement. However, most situations that constitute inurement 
will also violate the general rules of Sec. 53.4958-4 (e.g., exceed 
reasonable compensation).
    The final regulations continue to reserve the separate section 
governing revenue-sharing transactions. The IRS and the Treasury 
Department will continue to monitor these types of transactions, and if 
appropriate, will consider issuing specific rules to regulate them. Any 
later regulations that may become necessary will be issued in proposed 
form.
    The final regulations provide that the general rules of 
Sec. 53.4958-4 apply to all transactions with disqualified persons, 
regardless of whether the amount of the benefit provided is determined, 
in whole or in part, by the revenues of one or more activities of the 
organization.

Rebuttable Presumption That a Transaction Is Not an Excess Benefit 
Transaction

    An informal question was presented with respect to the definition 
of authorized body contained in the temporary regulations for purposes 
of the rebuttable presumption of reasonableness. The IRS was asked 
whether approval by one authorized official of an applicable tax-exempt 
organization could satisfy the requirement of approval by an authorized 
body for purposes of establishing the presumption. Under the regulatory 
definition of authorized body in both the temporary regulations and 
these final regulations, a single individual may constitute either a 
committee of the governing body or a party authorized by the governing 
body to act on its behalf, if State law allows a single individual to 
act in either of these capacities.

Correction

    Several comments were received with respect to the specific 
correction rules contained in the temporary regulations. One commenter 
requested that, in the case of an excess benefit involving a transfer 
of property by an applicable tax-exempt organization to a disqualified 
person, the final regulations be modified to require the return of the 
specific property if the organization wants the property back. The 
commenter suggested that such a rule would be consistent with the 
private foundation self-dealing regulations under section 4941, which 
require rescission of the transaction where possible. Rescission is 
appropriate under section 4941, where most transactions between a 
private foundation and a disqualified person are absolutely prohibited. 
By contrast, section 4958 is intended to ensure that transactions 
between an applicable tax-exempt organization and a disqualified 
person, which are permissible, do not result in an excess benefit to 
the disqualified person. Therefore, no change has been made in the 
final regulations on this point.
    Another commenter requested additional guidance on the rules 
governing correction in the case of an applicable tax-exempt 
organization that has ceased to exist, or is no longer tax-exempt. The 
temporary regulations provide that, in such cases, the correction 
amount may not be paid to an organization that is related to the 
disqualified person. The commenter noted that the ``related to'' 
standard is imprecise. The commenter suggested replacing this standard 
with a requirement that the recipient organization in these instances 
either be a publicly-supported charity with respect to which the 
disqualified person has no authority to make or recommend grants, or an 
organization selected with the consent of the appropriate State 
official.
    In response to this comment, the final regulations require that a 
section 501(c)(3) organization receiving the correction amount be a 
publicly-supported charity that has been in existence as such for a 
continuous period of at least 60 calendar months ending on the 
correction date. The time in existence requirement prevents the 
disqualified person from creating a new organization to receive the 
correction amount. The final regulations also require that the 
organization receiving the correction amount does not allow the 
disqualified person to make or recommend any grants or distributions by 
the organization. The final regulations replace the relatedness 
standard with a requirement that the disqualified person is not also a 
disqualified person with respect to the organization receiving the 
correction amount. Similar requirements, except for the publicly-
supported charity requirement, apply to a section 501(c)(4) 
organization receiving the correction amount.

Factors To Determine Whether Revocation Is Appropriate

    The preamble of the August 1998 proposed regulations listed four 
factors that the IRS will consider in determining whether to revoke an 
applicable tax-exempt organization's exempt 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 of the temporary regulations indicates 
that the IRS will publish guidance regarding the factors that it will 
consider in enforcing the requirements of sections 4958, 501(c)(3), and 
501(c)(4), as it gains more experience in administering section 4958. 
One comment was received recommending several factors in addition to 
the four factors. The IRS continues to consider the suggested additions 
and revisions. Until it publishes a revised or expanded list of 
factors, the IRS will consider all relevant facts and circumstances in 
the administration of section 4958 cases.

Other Substantiation Requirements

    The final regulations add a special rule clarifying that compliance 
with the specific substantiation rules of the regulations does not 
relieve applicable tax-exempt organizations of other rules and 
requirements of the Code, regulations, Revenue Rulings, and other 
guidance issued by the IRS (such as the substantiation rules of 
sections 162 and 274, or Sec. 1.6001-1(a) and (c)).

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. A final regulatory 
flexibility analysis has been prepared for a collection of information 
in this Treasury decision under 5 U.S.C. 604.

Final Regulatory Flexibility Analysis

    These final regulations clarifying section 4958 of the Code (Taxes 
on excess benefit transactions) may have an impact on small 
organizations if those organizations avail themselves of the rebuttable 
presumption of reasonableness described in the regulations (26 CFR 
53.4958-6(a)(2), 53.4958-6(a)(3), 53.4958-6(c)(2), and 53.4958-
6(c)(3)). The rebuttable presumption is available because the 
legislative history of section 4958 (H. REP. 104-506 at 56-7, March 28, 
1996) stated that parties to a transaction should be entitled to rely 
on such a rebuttable presumption that a compensation arrangement or a 
property transaction between certain organizations and disqualified 
persons of the organizations is reasonable or at fair market value. The 
legislative history

[[Page 3083]]

further instructed the Secretary of the Treasury and the IRS to issue 
guidance in connection with the standard for establishing reasonable 
compensation or fair market value that incorporates this presumption.
    The objective for the rebuttable presumption is to allow 
organizations that satisfy the three requirements to presume that 
compensation arrangements and property transactions entered into with 
disqualified persons pursuant to satisfaction of those requirements are 
reasonable or at fair market value. In such cases, the section 4958 
excise taxes can be imposed only if the IRS develops sufficient 
contrary evidence to rebut the probative value of the evidence put 
forth by the parties to the transaction. The legal basis for the 
proposed rule is Code sections 4958 and 7805.
    The final rule affects organizations described in Code sections 
501(c)(3) and (4) (applicable tax-exempt organizations). Some 
applicable tax-exempt organizations may be small organizations, defined 
in 5 U.S.C. 601(4) as any not-for-profit enterprise which is 
independently owned and operated and is not dominant in its field.
    The proposed recordkeeping burden entails obtaining and relying on 
appropriate comparability data and documenting the basis of an 
organization's determination that compensation is reasonable, or a 
property transfer (or transfer of the right to use property) is at fair 
market value. These actions are necessary to meet two of the 
requirements specified in the legislative history for obtaining the 
rebuttable presumption of reasonableness. The skills necessary for 
these actions are of the type required for obtaining and considering 
comparability data, and for documenting the membership and actions of 
the governing board or relevant committee of the organization. 
Applicable tax-exempt organizations that are small entities of the 
class that files Form 990-EZ, ``Short Form Return of Organization 
Exempt From Income Tax'' (i.e., those with gross receipts of less than 
$100,000 and assets of less than $250,000), are unlikely to undertake 
fulfilling the requirements of the rebuttable presumption of 
reasonableness, and therefore will not be affected by the recordkeeping 
burden. All other classes of applicable tax-exempt organizations that 
file Form 990, ``Return of Organization Exempt from Income Tax'', up to 
organizations with assets of $50 million, are likely to be small 
organizations that avail themselves of the rebuttable presumption of 
reasonableness. These classes range from organizations with assets of 
$100,000 to $50 million. The final rule contains a less burdensome safe 
harbor for one of the requirements (obtaining comparability data on 
compensation) for organizations with annual gross receipts of less than 
$1 million. The IRS is not aware of any other relevant Federal rules 
which may duplicate, overlap, or conflict with the final rule. A less 
burdensome alternative for small organizations would be to exempt those 
entities from the requirements for establishing the rebuttable 
presumption of reasonableness. However, it is not consistent with the 
statute to allow organizations to rely on this presumption without 
satisfying some conditions. Satisfaction of the requirements as 
outlined in the legislative history leads to a benefit, but failure to 
satisfy them does not necessarily lead to a penalty. A more burdensome 
alternative would be to require all applicable tax-exempt organizations 
under Code section 4958 to satisfy the three requirements of the 
rebuttable presumption of reasonableness under all circumstances.
    Pursuant to section 7805(f) of the Code, this final 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

    1. The authority citation for part 53 continues to read as follows:

    Authority: 26 U.S.C. 7805.


    1a. Sections 53.4958-0T through 53.4958-8T are removed.

    2. Sections 53.4958-0 through 53.4958-8 are added to read as 
follows:


Sec. 53.4958-0  Table of contents.

    This section lists the major captions contained in Secs. 53.4958-1 
through 53.4958-8.

Section 53.4958-1  Taxes on Excess Benefit Transactions

(a) In general.
(b) Excess benefit defined.
(c) Taxes paid by disqualified person.
(1) Initial tax.
(2) Additional tax on disqualified person.
(i) In general.
(ii) 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) Satisfaction of 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.

Section 53.4958-2  Definition of Applicable Tax-Exempt Organization

(a) Organizations described in section 501(c)(3) or (4) and exempt 
from tax under section 501(a).
(1) In general.
(2) Exceptions from definition of applicable tax-exempt 
organization.
(i) Private foundation.
(ii) Governmental unit or affiliate.
(3) Organizations described in section 501(c)(3).
(4) Organizations described in section 501(c)(4).
(5) Effect of non-recognition or revocation of exempt status.
(b) Special rules.
(1) Transition rule for lookback period.
(2) Certain foreign organizations.

[[Page 3084]]

Section 53.4958-3  Definition of Disqualified Person

(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.

Section 53.4958-4  Excess Benefit Transaction

(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.
(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) Expense reimbursement payments pursuant to accountable plans.
(iii) Certain economic benefits provided to a volunteer for the 
organization.
(iv) Certain economic benefits provided to a member of, or donor to, 
the organization.
(v) Economic benefits provided to a charitable beneficiary.
(vi) Certain economic benefits provided to a governmental unit.
(5) Exception for certain payments made pursuant to an exemption 
granted by the Department of Labor under ERISA.
(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.
(A) In general.
(B) Failure to report due to reasonable cause.
(ii) Other written contemporaneous evidence.
(4) Examples.

Section 53.4958-5  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. [Reserved]

Section 53.4958-6  Rebuttable presumption that a transaction is not 
an excess benefit transaction.

(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.

Section 53.4958-7  Correction

(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.

Section 53.4958-8  Special Rules

(a) Substantive requirements for exemption still apply.
(b) Interaction between section 4958 and section 7611 rules for 
church tax inquiries and examinations.
(c) Other substantiation requirements.


Sec. 53.4958-1  Taxes on excess benefit transactions.

    (a) In general. Section 4958 imposes excise taxes on each excess 
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4) 
between an applicable tax-exempt organization (as defined in section 
4958(e) and Sec. 53.4958-2) and a disqualified person (as defined in 
section 4958(f)(1) and Sec. 53.4958-3). A disqualified person who 
receives an excess benefit from an excess benefit transaction is liable 
for payment of a section 4958(a)(1) excise tax equal to 25 percent of 
the excess benefit. If an initial tax is imposed by section 4958(a)(1) 
on an excess benefit transaction and the transaction is not corrected 
(as defined in section 4958(f)(6) and Sec. 53.4958-7) 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

[[Page 3085]]

(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. 53.4958-7) 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. 53.4958-7, the 200-
percent tax is imposed only on the unpaid portion of the correction 
amount (as described in Sec. 53.4958-7(c)). The tax imposed by section 
4958(b) is payable by any disqualified person who received an excess 
benefit from the excess benefit transaction on which the initial tax 
was imposed by section 4958(a)(1). With respect to any excess benefit 
transaction, if more than one disqualified person is liable for the tax 
imposed by section 4958(b), all such persons are jointly and severally 
liable for that tax.
    (ii) 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. A 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. 53.4958-6(c)(1)) that 
is attempting to invoke the rebuttable presumption of reasonableness 
described in Sec. 53.4958-6 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 this 
paragraph (d), 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 
this paragraph (d), 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

[[Page 3086]]

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) Satisfaction of 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 appropriate authorized body has met the 
requirements of Sec. 53.4958-6(a) 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 of this chapter. 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. 53.4958-4(b)(2).
    (3) Statute of limitations rules. See sections 6501(e)(3) and (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. 53.4958-2  Definition of applicable tax-exempt organization.

    (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).
    (2) Exceptions from definition of applicable tax-exempt 
organization--(i) Private foundation. A private foundation as defined 
in section 509(a) is not an applicable tax-exempt organization for 
section 4958 purposes.
    (ii) Governmental unit or affiliate. A governmental unit or an 
affiliate of a governmental unit is not an applicable tax-exempt 
organization for section 4958 purposes if it is--
    (A) Exempt from (or not subject to) taxation without regard to 
section 501(a); or
    (B) Relieved from filing an annual return pursuant to the authority 
of Sec. 1.6033-2(g)(6).

[[Page 3087]]

    (3) 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--
    (i) Provides the notice described in section 508; or
    (ii) Is described in section 501(c)(3) and specifically is excluded 
from the requirements of section 508 by that section.
    (4) Organizations described in section 501(c)(4). An organization 
is described in section 501(c)(4) for purposes of section 4958 only 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).
    (5) Effect of non-recognition or revocation of exempt status. An 
organization is not described in paragraph (a)(3) or (4) 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 lookback period 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. 53.4958-3  Definition of disqualified person.

    (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

[[Page 3088]]

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 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. 53.4958-2(a)(4), 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 paragraph (b) or (c) of this section 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, or of a particular 
department or function 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 a 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 
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 contribution 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. A finding that a person is 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. 53.4958-4 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

[[Page 3089]]

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 to 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 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. Subject 
to supervision by C's board, M is given broad discretion to manage 
C's day to day operation and has ultimate responsibility for 
supervising the management of the hospital. Because M has ultimate 
responsibility for supervising the management of 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), M is in a position to 
exercise substantial influence over the affairs of A. 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

[[Page 3090]]

a 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, under these facts and circumstances, J 
is not a disqualified person with respect to F.


Sec. 53.4958-4  Excess benefit transaction.

    (a) Definition of excess benefit transaction--(1) In general. An 
excess benefit transaction means any transaction in which an economic 
benefit is provided by an applicable tax-exempt organization directly 
or indirectly to or for the use of any disqualified person, and the 
value of the economic benefit provided exceeds the value of the 
consideration (including the performance of services) received 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. The rules of this section apply 
to all transactions with disqualified persons, regardless of whether 
the amount of the benefit provided is determined, in whole or in part, 
by the revenues of one or more activities of the organization. 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 this paragraph 
(a)(2):

    Example 1. K is an applicable tax-exempt organization for 
purposes of section 4958. L is a wholly-owned taxable subsidiary of 
K. 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

[[Page 3091]]

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 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 (a)(3)(iv) of 
this section, 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 section 401(a), or pursuant 
to an employee benefit program that is subject to and satisfies 
coverage and nondiscrimination rules under the Internal Revenue 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. 53.4958-3 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, 2002, 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. 53.4958-3 immediately prior to 
entering into the January 1, 2002, contract (initial contract). S's 
duties and responsibilities under the contract make S a disqualified 
person with respect to T (see Sec. 53.4958-3(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 2003, 
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

[[Page 3092]]

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 2003, T changes its payroll system, such that T makes biweekly, 
rather than monthly, salary payments to its employees. Beginning in 
2003, 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, 2003, 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 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, 2003, at which time S is a disqualified person within the 
meaning of section 4958(f)(1) and Sec. 53.4958-3. 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. 53.4958-3 
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. 53.4958-3(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. 53.4958-3 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. 53.4958-3(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. 53.4958-3(b)(2)(i)(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). Although the 
management fee itself is a fixed payment not subject to section 
4958, the 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, 2003, 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. 53.4958-3, 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. 53.4958-3 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

[[Page 3093]]

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 paragraph (b)(1)(ii)(B)(2) of this section;
    (ii) Expense reimbursement payments pursuant to accountable plans. 
Amounts paid under reimbursement arrangements that meet the 
requirements of Sec. 1.62-2(c) of this chapter;
    (iii) 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;
    (iv) 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 for which a deduction is 
allowable under section 170 (charitable contribution), regardless of 
whether the donor is eligible to claim the deduction, if--
    (A) Any non-disqualified person paying a membership fee or making a 
charitable 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 persons make a payment or charitable contribution of at 
least the specified amount;
    (v) Economic benefits provided to a charitable beneficiary. An 
economic benefit provided to a person solely because the person is 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
    (vi) 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.
    (5) Exception for certain payments made pursuant to an exemption 
granted by the Department of Labor under ERISA. Section 4958 does not 
apply to any payment made pursuant to, and in accordance with, a final 
individual prohibited transaction exemption issued by the Department of 
Labor under section 408(a) of the Employee Retirement Income Security 
Act of 1974 (88 Stat. 854) (ERISA) with respect to a transaction 
involving a plan (as defined in section 3(3) of ERISA) that is an 
applicable tax exempt organization.
    (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 (whether taxable or tax-exempt) 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 
compensation 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. 53.4958-1(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 (other than expense 
reimbursements pursuant to an accountable plan that meets the 
requirements of Sec. 1.62-2(c)), and the economic benefit of a below-
market loan (within the meaning of section 7872(e)(1)). (For this 
purpose, the economic benefit of a below-market loan is the amount 
deemed transferred to the disqualified person under section 7872(a) or 
(b), regardless of whether section 7872 otherwise applies to the loan).
    (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.

[[Page 3094]]

    (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 any 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. These general timing rules also apply to property subject to a 
substantial risk of forfeiture. Therefore, if the property subject to a 
substantial risk of forfeiture satisfies the definition of fixed 
payment (within the meaning of paragraph (a)(3)(ii) of this section), 
reasonableness is determined at the time the parties enter into the 
contract providing for the transfer of the property. If the property is 
not a fixed payment, then reasonableness is determined based on all 
facts and circumstances up to and including circumstances as of the 
date of 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 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. The facts are the same as in Example 1, except that 
the multi-year employment contract provides, in addition, that G 
will transfer title to a car to H under the condition that if H 
fails to complete x years of service with G, title to the car will 
be forfeited back to G. All relevant information about the type of 
car to be provided (including the make, model, and year) is included 
in the contract. Although ultimate vesting of title to the car is 
contingent on H continuing to work for G for x years, the amount of 
property to be vested (i.e., the type of car) is specified in the 
contract, and no person exercises discretion regarding the type of 
property or whether H will retain title to the property at the time 
of vesting. Under these facts, the car is a fixed payment within the 
meaning of paragraph (a)(3)(ii) of this section. Therefore, the 
reasonableness of H's compensation, including the value of the car, 
is determined based on the circumstances existing at the time G and 
H enter into the employment contract.
    Example 3. 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 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 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. In no event shall an economic 
benefit that a disqualified person obtains by theft or fraud be treated 
as consideration for the performance of services.
    (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 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--(A) 
In general. An applicable tax-exempt organization provides 
contemporaneous written substantiation of its intent to provide an 
economic benefit as compensation if--
    (1) 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, ``Wage and Tax Statement'', or Form 1099, 
``Miscellaneous Income'') or with respect to the organization (e.g.,

[[Page 3095]]

Form 990, ``Return of Organization Exempt From Income Tax''), 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. 53.4958-1(e)); or
    (2) The recipient disqualified person reports the benefit as income 
on the person's original Federal tax return (e.g., Form 1040, ``U.S. 
Individual Income Tax Return''), or on the person's amended Federal tax 
return filed prior to the earlier of the following dates--
    (i) Commencement of an Internal Revenue Service examination 
described in paragraph (c)(3)(i)(A)(1) of this section; or
    (ii) The first documentation in writing by the Internal Revenue 
Service of a potential excess benefit transaction involving either the 
applicable tax-exempt organization or the disqualified person.
    (B) 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).
    (ii) Other written contemporaneous evidence. In addition, other 
written contemporaneous evidence may be used to demonstrate that the 
appropriate decision-making body or an officer authorized to approve 
compensation approved a transfer as compensation for services in 
accordance with established procedures, including but not limited to--
    (A) An approved written employment contract executed on or before 
the date of the transfer;
    (B) Documentation satisfying the requirements of Sec. 53.4958-
6(a)(3) indicating that an authorized body approved the transfer as 
compensation for services on or before the date of the transfer; or
    (C) Written evidence that was in existence on or before the due 
date of the applicable Federal tax return described in paragraph 
(c)(3)(i)(A)(1) or (2) of this section (including extensions but not 
amendments), of a reasonable belief by the applicable tax-exempt 
organization that a benefit was a nontaxable benefit as defined in 
paragraph (c)(2) of this section.
    (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 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.
    Example 3. H is an applicable tax-exempt organization and J is a 
disqualified person with respect to H. J's written employment 
agreement provides for a fixed salary of $y. J's duties include 
soliciting funds for various programs of H. H raises a large portion 
of its funds in a major metropolitan area. Accordingly, H maintains 
an apartment there in order to provide a place to entertain 
potential donors. H makes the apartment available exclusively to J 
to assist in the fundraising. J's written employment contract does 
not mention the use of the apartment. H obtains the written opinion 
of a benefits compensation expert that the rental value of the 
apartment is not includable in J's income by reason of section 119, 
based on the expectation that the apartment will be used for 
fundraising activities. Consequently, H does not report the rental 
value of the apartment on J's Form W-2, which otherwise correctly 
reports J's taxable compensation. J does not report the rental value 
of the apartment on J's individual Form 1040. Later, the Internal 
Revenue Service correctly determines that the requirements of 
section 119 were not satisfied. Because of the written expert 
opinion, H has written evidence of its reasonable belief that use of 
the apartment was a nontaxable benefit as defined in paragraph 
(c)(2) of this section. That evidence was in existence on or before 
the due date of the applicable Federal tax return. Therefore, H has 
demonstrated its intent to treat the use of the apartment as 
compensation for services performed by J.


Sec. 53.4958-5  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. [Reserved]


Sec. 53.4958-6  Rebuttable presumption that a transaction is not an 
excess benefit transaction.

    (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 the 
organization within the meaning of Sec. 53.4958-4(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

[[Page 3096]]

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. 53.4958-4(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. 53.4958-4(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. 53.4958-3(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-
4(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. 53.4958-4(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 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

[[Page 3097]]

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 obtains information indicating 
that the relevant market conditions have not changed materially, and 
possesses no other information indicating 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 performing 
arts organizations 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. 53.4958-4(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. 53.4958-4(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. 53.4958-7  Correction.

    (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.
    (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

[[Page 3098]]

described in Sec. 53.4958-1(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 the undistributed deferred compensation by relinquishing 
any right to receive the excess portion of the undistributed deferred 
compensation (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. 53.4958-1(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. 53.4958-1(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--
    (i) The organization receiving the correction amount is described 
in section 170(b)(1)(A) (other than in section 170(b)(1)(A)(vii) and 
(viii)) and has been in existence and so described for a continuous 
period of at least 60 calendar months ending on the correction date;
    (ii) The disqualified person is not also a disqualified person (as 
defined in Sec. 53.4958-3) with respect to the organization receiving 
the correction amount; and
    (iii) The organization receiving the correction amount does not 
allow the disqualified person (or persons described in Sec. 53.4958-
3(b) with respect to that person) to make or recommend any grants or 
distributions by the organization.
    (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 
organization described in section 501(c)(3) or (4) and exempt from tax 
under section 501(a), provided that the requirements of paragraphs 
(e)(2)(i) through (iii) of this section are satisfied (except that the 
requirement that the organization receiving the correction amount is 
described in section 170(b)(1)(A) (other than in section 
170(b)(1)(A)(vii) and (viii)) shall not apply if the organization is 
described in section 501(c)(4)).
    (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. 53.4958-1(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

[[Page 3099]]

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 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. 53.4958-8  Special rules.

    (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. 53.4958-4(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) Other substantiation requirements. These regulations, in 
Sec. 53.4958-4(c)(3), set forth specific substantiation rules. 
Compliance with the specific substantiation rules of that section does 
not relieve applicable tax-exempt organizations of other rules and 
requirements of the Internal Revenue Code, regulations, Revenue 
Rulings, and other guidance issued by the Internal Revenue Service 
(including the substantiation rules of sections 162 and 274, or 
Sec. 1.6001-1(a) and (c) of this chapter).

PART 301--PROCEDURE AND ADMINISTRATION

    3. The authority citation for part 301 continues to read in part as 
follows:

    Authority: 26 U.S.C. 7805 * * *


Sec. 301.7611-1  [Amended]

    4. In Sec. 301.7611-1, Q-19 and A-19 at the end of the section are 
revised 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.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    5. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    6. In Sec. 602.101, paragraph (b) is amended by removing the entry 
for ``53.4958-6T'' and adding an entry for ``53.4958-6'' 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.
------------------------------------------------------------------------
 
                  *        *        *        *        *
53.4958-6..................................................    1545-1623
 
                  *        *        *        *        *
------------------------------------------------------------------------


    Approved: December 21, 2001.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Mark Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 02-985 Filed 1-22-02; 8:45 am]
BILLING CODE 4830-01-P