[Federal Register Volume 70, Number 174 (Friday, September 9, 2005)]
[Proposed Rules]
[Pages 53599-53604]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-17858]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 53
[REG-111257-05]
RIN 1545-BE37
Standards for Recognition of Tax-Exempt Status if Private Benefit
Exists or If an Applicable Tax-Exempt Organization Has Engaged in
Excess Benefit Transaction(s)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations that clarify the
substantive requirements for tax exemption under section 501(c)(3) of
the Internal Revenue Code (Code). This document also contains
provisions that clarify the relationship between the substantive
requirements for tax exemption under section 501(c)(3) and the
imposition of section 4958 excise taxes.
DATES: Written comments and requests for a public hearing must be
received by December 8, 2005.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-111257-05), room
5203, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
111257-05), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the IRS Internet site at http://www.irs.gov/regs or the Federal
[[Page 53600]]
eRulemaking Portal at http://www.regulations.gov (IRS-REG-111257-05). A
public hearing may be scheduled if requested.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina
Kolomietz, (202) 622-4441; Concerning submission of comments and
requests for a public hearing, Richard Hurst, (202) 622-7180 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. Section 501(c)(3) and the Regulations Thereunder
To be described in section 501(c)(3), an organization must be
organized and operated exclusively for religious, charitable,
scientific, or educational purposes. In addition, no part of the net
earnings of the organization may inure to the benefit of any private
shareholder or individual, no substantial part of the organization's
activities may include attempts to influence legislation, and the
organization may not intervene in political campaigns.
Existing regulations under section 501(c)(3) were adopted in
substantially their present form in 1959. In explaining and clarifying
the statutory requirements, these regulations provide that, to be
described in section 501(c)(3), an organization must be both organized
and operated for exempt purposes. An organization is not operated
exclusively for exempt purposes and, thus, is not described in section
501(c)(3), if any of its net earnings inure to the benefit of a private
shareholder or individual. Sec. 1.501(c)(3)-1(c)(2). The regulations
define private shareholder or individual as referring to persons having
a personal and private interest in the activities of the organization.
Sec. 1.501(a)-1(c).
In addition, an organization is not organized or operated for one
or more of the exempt purposes enumerated in Sec. 1.501(c)(3)-
1(d)(1)(i) and, thus, is not described in section 501(c)(3), if it is
organized or operated for the benefit of private interests such as
designated individuals, the creator or his family, shareholders of the
organization, or persons controlled, directly or indirectly, by such
interests. Sec. 1.501(c)(3)-1(d)(1)(ii).
These proposed regulations amend the regulations under section
501(c)(3), adding several examples to illustrate the requirement in
Sec. 1.501(c)(3)-1(d)(1)(ii) that an organization serve a public
rather than a private interest. The examples illustrate that prohibited
private benefits may involve non-economic benefits as well as economic
benefits. In addition, prohibited private benefit may arise regardless
of whether payments made to private interests are reasonable or
excessive. The examples reflect current law.
B. Section 4958 and the Regulations Thereunder
Section 4958 was added to the Code by the Taxpayer Bill of Rights
2, Public Law 104-168 (110 Stat. 1452, July 30, 1996). Section 4958
imposes certain excise taxes on transactions that provide excess
economic benefits to disqualified persons with respect to public
charities and social welfare organizations described in sections
501(c)(3) and 501(c)(4), respectively. These organizations are
collectively referred to as applicable tax-exempt organizations.
Section 4958(e). An excess benefit is the amount by which the value of
an economic benefit provided by an applicable tax-exempt organization
directly or indirectly to or for the use of a disqualified person
exceeds the value of the consideration (including the performance of
services) received for providing such benefit. Sec. 53.4958-1(b). A
disqualified person is defined as a person who is in a position to
exercise substantial influence over the affairs of an applicable tax-
exempt organization. Section 4958(f)(1). Section 4958(a) imposes the
liability for excise taxes on disqualified persons who receive an
excess benefit from, and on certain organization managers who knowingly
participate in, an excess benefit transaction. Section 4958 imposes no
corresponding sanctions on exempt organizations. The section 4958
excise taxes generally apply to excess benefit transactions occurring
on or after September 14, 1995.
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). Those 1998 proposed
regulations were revised in response to written and oral comments and
replaced by temporary and proposed regulations on January 10, 2001 (TD
8920, 66 FR 2144, and REG-246256-96, 66 FR 2173). Final regulations
under section 4958 were published on January 23, 2002 (TD 8978, 67 FR
3076).
C. History of the Relationship Between Section 4958 Taxes and Tax-
Exempt Status
Section 501(c)(3) and the longstanding regulations thereunder
establish certain tests that an organization must meet to qualify for
tax-exempt status. Sec. 1.501(c)(3)-1(a)(1). Section 4958, by its
terms, does not address the tax-exempt status of applicable tax-exempt
organizations, but instead imposes excise tax liability on disqualified
persons and certain organization managers.
In the 1996 House Report on section 4958, Congress briefly
addressed the relationship between section 4958 and tax-exempt status.
Specifically, the Report stated that these ``intermediate sanctions for
excess benefit transactions may be imposed by the IRS in lieu of (or in
addition to) revocation of the organization's tax-exempt status.'' H.
Rep. No. 104-506, 104th Cong., 2d Sess., at 59 (1996) (emphasis added).
The Report also stated, in a footnote, that, in general, revocation of
tax-exempt status, with or without the imposition of excise taxes,
would occur only if an organization no longer operates as a charitable
organization. H. Rep. No. 104-506, 104th Cong., 2d Sess., at 59, note
15.
In keeping with the differences between section 501(c)(3) and
section 4958, the Treasury Department and the IRS consistently have
taken the position that the imposition of excise taxes under section
4958 does not foreclose revocation of tax-exempt status in appropriate
cases. The 1998 proposed regulations under section 4958 stated that
``[t]he excise taxes imposed by section 4958 do not affect the
substantive statutory standards for tax exemption under section
501(c)(3) or (4).'' Proposed Sec. 53.4958-7(a), (63 FR 41,505). Both
the 2001 temporary and the 2002 final regulations stated that--
Section 4958 does not affect the substantive standards for tax
exemption under section 501(c)(3) or (4), including the requirements
that the organization be organized and operated exclusively for
exempt purposes, and that no part of its 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. (26 CFR 53.4958-8(a)).
The preamble to the 1998 proposed regulations under section 4958
stated that the IRS will exercise its administrative discretion in
enforcing the requirements of sections 4958, 501(c)(3), and 501(c)(4).
The preamble to the 1998 proposed regulations listed the following four
factors the IRS will consider in determining whether an applicable tax-
exempt organization described in section 501(c)(3) continues to be
described in section 501(c)(3) in cases in which section 4958 excise
taxes are also imposed: (1) Whether the organization has been involved
in repeated excess benefit transactions; (2) the size and the scope of
the excess
[[Page 53601]]
benefit transactions; (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. (63 FR 41,488 through
41,489).
The preamble to the 2001 temporary regulations stated that the IRS
intends to publish guidance regarding the factors it will consider as
it gains more experience in administering section 4958. The preamble to
the 2002 final regulations stated that, until such guidance is
published, the IRS will consider all relevant facts and circumstances
in the administration of section 4958 cases. These proposed regulations
amend the regulations under section 501(c)(3) to provide guidance on
certain factors that the IRS will consider in determining whether an
applicable tax-exempt organization described in section 501(c)(3) that
engages in one or more excess benefit transactions continues to be
described in section 501(c)(3).
D. Section 4958 and Application for Recognition of Tax-Exempt Status
Under Section 501(c)(3)
Section 4958 and the regulations thereunder do not apply to
organizations that are not applicable tax-exempt organizations as
defined therein. These proposed regulations amend the regulations under
section 4958 to clarify that the IRS has discretion to refuse to issue
a ruling recognizing exemption under section 501(c)(3) to any applicant
whose purpose or activities violate any provision of section 501(c)(3),
including the inurement prohibition and the limitation on private
benefit, even though such violation could serve as grounds for imposing
section 4958 excise taxes if the applicant's tax-exempt status were
recognized.
E. Proposed Effective Date
These regulations are proposed to be applicable on the date of
publication in the Federal Register of a Treasury Decision adopting
them as final regulations.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to this notice of proposed
rulemaking, and because this notice of proposed rulemaking does not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments (a signed original and
eight (8) copies) that are submitted timely to the IRS. The IRS and the
Treasury Department specifically request comments on the clarity of the
proposed rule and how it may be made easier to understand. All comments
will be available for public inspection and copying.
A public hearing may be scheduled if requested in writing by a
person who timely submits written comments. If a public hearing is
scheduled, notice of the date, time, and place will be published in the
Federal Register.
Drafting Information
The principal authors of these regulations are Galina Kolomietz and
Phyllis 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 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 53
Excise taxes, Foundations, Investments, Lobbying, Reporting and
recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 53 are proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read,
in part, as follows:
Authority: 26 U.S.C. 7805 * * *.
Par. 2. In Sec. 1.501(c)(3)-1, paragraph (d)(1)(iii) is
redesignated as paragraph (d)(1)(iv).
Par. 3. In Sec. 1.501(c)(3)-1, paragraphs (d)(1)(iii) and (g) are
added to read as follows:
Sec. 1.501(c)(3)-(1) Organizations organized and operated for
religious, charitable, scientific, testing for public safety, literary,
or educational purposes, or for the prevention of cruelty to children
or animals.
* * * * *
(d) * * *
(1) * * *
(iii) Examples. The following examples illustrate the requirement
of paragraph (d)(1)(ii) of this section that an organization serve a
public rather than a private interest:
Example 1. (i) O is an educational organization the purpose of
which is to study history and immigration. The focus of O's
historical studies is the genealogy of one family, tracing the
descent of its present members. O actively solicits for membership
only individuals who are members of that one family. O's research is
directed toward publishing a history of that family that will
document the pedigrees of family members. A major objective of O's
research is to identify and locate living descendants of that family
to enable those descendants to become acquainted with each other.
(ii) O's educational activities primarily serve the private
interests of members of a single family rather than a public
interest. Therefore, O is operated for the benefit of private
interests in violation of the restriction on private benefit in
Sec. 1.501(c)(3)-1(d)(1)(ii). Based on these facts and
circumstances, O is not operated exclusively for exempt purposes
and, therefore, is not described in section 501(c)(3).
Example 2. (i) O is an art museum. O's sole activity is
exhibiting art created by a group of unknown but promising local
artists. O is governed by a board of trustees unrelated to the
artists whose work O exhibits. All of the art exhibited is offered
for sale at prices set by the artist. Each artist whose work is
exhibited has a consignment arrangement with O. Under this
arrangement, when art is sold, the museum retains 10 percent of the
selling price to cover the costs of operating the museum and gives
the artist 90 percent.
(ii) The artists in this situation directly benefit from the
exhibition and sale of their art. As a result, the sole activity of
O serves the private interests of these artists. Because O gives 90
percent of the proceeds from its sole activity to the individual
artists, the direct benefits to the artists are substantial and O's
provision of these benefits to the artists is more than incidental
to its other purposes and activities. This arrangement causes O to
be operated for the benefit of private interests in violation of the
restriction on private benefit in Sec. 1.501(c)(3)-1(d)(1)(ii).
Based on these facts and circumstances, O is not operated
exclusively for exempt purposes and, therefore, is not described in
section 501(c)(3).
Example 3. (i) O is an educational organization the purpose of
which is to train individuals in a program developed by P, O's
president. All of the rights to the program are owned by Company K,
a for-profit corporation owned by P. Prior to the existence of O,
the teaching of the program was conducted by Company K. O licenses,
from Company K, the right to use a reference
[[Page 53602]]
to the program in O's name and the right to teach the program, in
exchange for specified royalty payments. Under the license
agreement, Company K provides O with the services of trainers and
with course materials on the program. O may develop and copyright
new course materials on the program but all such materials must be
assigned to Company K without consideration if the license agreement
is terminated. Company K sets the tuition for the seminars and
lectures on the program conducted by O. O has agreed not to become
involved in any activity resembling the program or its
implementation for 2 years after the termination of O's license
agreement.
(ii) O's sole activity is conducting seminars and lectures on
the program. This arrangement causes O to be operated for the
benefit of P and Company K in violation of the restriction on
private benefit in Sec. 1.501(c)(3)-1(d)(1)(ii), regardless of
whether the royalty payments from O to Company K for the right to
teach the program are reasonable. Based on these facts and
circumstances, O is not operated exclusively for exempt purposes
and, therefore, is not described in section 501(c)(3).
* * * * *
(g) Interaction with section 4958--(1) Application process. An
organization that applies for recognition of exemption under section
501(a) as an organization described in section 501(c)(3) must establish
its eligibility under this section. The Commissioner may deny an
application for exemption for failure to establish any of this
section's requirements for exemption. Section 4958 does not apply to
transactions with an organization that has failed to establish that it
satisfies all of the requirements for exemption under section
501(c)(3). See Sec. 53.4958-2 of this chapter.
(2) Substantive requirements for exemption still apply to
applicable tax-exempt organizations described in section 501(c)(3)--(i)
In general. Regardless of whether a particular transaction is subject
to excise taxes under section 4958, the substantive requirements for
tax exemption under section 501(c)(3) still apply to an applicable tax-
exempt organization (as defined in section 4958(e) and Sec. 53.4958-2
of this chapter) described in section 501(c)(3) whose disqualified
persons or organization managers are subject to excise taxes under
section 4958. Accordingly, an organization may no longer meet the
requirements for tax-exempt status under section 501(c)(3) because the
organization fails to satisfy the requirements of paragraph (b), (c) or
(d) of this section. See Sec. 53.4958-8(a) of this chapter.
(ii) Determining whether revocation of tax-exempt status is
appropriate when section 4958 excise taxes also apply. In determining
whether to continue to recognize the tax-exempt status of an applicable
tax-exempt organization (as defined in section 4958(e) and Sec.
53.4958-2 of this chapter) described in section 501(c)(3) that engages
in one or more excess benefit transactions (as defined in section
4958(c) and Sec. 53.4958-4 of this chapter) that violate the
prohibition on inurement under this section, the Commissioner will
consider all relevant facts and circumstances, including, but not
limited to, the following--
(A) The size and scope of the organization's regular and ongoing
activities that further exempt purposes before and after the excess
benefit transaction or transactions occurred;
(B) The size and scope of the excess benefit transaction or
transactions (collectively, if more than one) in relation to the size
and scope of the organization's regular and ongoing activities that
further exempt purposes;
(C) Whether the organization has been involved in repeated excess
benefit transactions;
(D) Whether the organization has implemented safeguards that are
reasonably calculated to prevent future violations; and
(E) Whether the excess benefit transaction has been corrected
(within the meaning of section 4958(f)(6) and Sec. 53.4958-7 of this
chapter), or the organization has made good faith efforts to seek
correction from the disqualified persons who benefited from the excess
benefit transaction.
(iii) All factors will be considered in combination with each
other. Depending on the particular situation, the Commissioner may
assign greater or lesser weight to some factors than to others. The
factors listed in paragraphs (g)(2)(ii)(D) and (E) of this section will
weigh more strongly in favor of continuing to recognize exemption where
the organization discovers the excess benefit transaction or
transactions and takes action before the Commissioner discovers the
excess benefit transaction or transactions. Further, with respect to
the factor listed in paragraph (g)(2)(ii)(E) of this section,
correction after the excess benefit transaction or transactions are
discovered by the Commissioner, by itself, is never a sufficient basis
for continuing to recognize exemption.
(iv) Examples. The following examples illustrate the principles of
paragraph (g)(2)(ii) of this section. For purposes of each example,
assume that O is an applicable tax-exempt organization (as defined in
section 4958(e) and Sec. 53.4958-2 of this chapter) described in
section 501(c)(3) for all relevant periods. The examples are as
follows:
Example 1. (i) O was created as a museum for the purpose of
exhibiting art to the general public. In Years 1 and 2, O engages in
fundraising and in selecting, leasing, and preparing an appropriate
facility for a museum. In Year 3, a new board of trustees is
elected. All of the new trustees are local art dealers. Beginning in
Year 3 and continuing to the present, O uses almost all of its
revenues to purchase art solely from its trustees at prices that
exceed fair market value. O exhibits and offers for sale all of the
art it purchases. O's Form 1023, ``Application for Recognition of
Exemption,'' did not disclose the possibility that O's trustees
would be selling art to O.
(ii) O's purchases of art from its trustees at more than fair
market value constitute excess benefit transactions between an
applicable tax-exempt organization and disqualified persons under
section 4958. Therefore, these transactions are subject to the
appropriate excise taxes provided in that section. In addition, O's
purchases of art from its trustees at more than fair market value
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. Beginning in Year 3, O
does not engage in any regular and ongoing activities that further
exempt purposes because almost all of O's activities consist of
purchasing art from its trustees and exhibiting and offering for
sale all of the art it purchases. The size and scope of the excess
benefit transactions collectively are significant in relation to the
size and scope of any of O's ongoing activities that further exempt
purposes. O has been involved in repeated excess benefit
transactions, namely, purchases of art from its trustees at more
than fair market value. O has not implemented safeguards that are
reasonably calculated to prevent such improper purchases in the
future. The excess benefit transactions have not been corrected, nor
has O made good faith efforts to seek correction from the
disqualified persons who benefited from the excess benefit
transactions (the trustees). The trustees continue to control O's
Board. Based on the application of the factors to these facts, O is
no longer described in section 501(c)(3) effective in Year 3.
Example 2. (i) The facts are the same as in Example 1, except
that in Year 4, O's entire board of trustees resigns, and O no
longer offers all exhibited art for sale. The former board is
replaced with members of the community who are not in the business
of buying or selling art and who have skills and experience running
educational programs and institutions. O promptly discontinues the
practice of purchasing art from current or former trustees, adopts a
written conflicts of interest policy, adopts written art valuation
guidelines, hires legal counsel to recover the excess amounts O had
paid its former trustees, and implements a new program of
educational activities.
(ii) O's purchases of art from its former trustees at more than
fair market value constitute excess benefit transactions
[[Page 53603]]
between an applicable tax-exempt organization and disqualified
persons under section 4958. Therefore, these transactions are
subject to the appropriate excise taxes provided in that section. In
addition, O's purchases of art from its trustees at more than fair
market value violate the proscription against inurement under
section 501(c)(3) and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. In Year 3, O does not
engage in any regular and ongoing activities that further exempt
purposes. However, in Year 4, O elects a new board of trustees
comprised of individuals who have skills and experience running
educational programs and implements a new program of educational
activities. As a result of these actions, beginning in Year 4, O
engages in regular and ongoing activities that further exempt
purposes. The size and scope of the excess benefit transactions that
occurred in Year 3, taken collectively, are significant in relation
to the size and scope of O's regular and ongoing exempt function
activities that were conducted in Year 3. Beginning in Year 4,
however, as O's exempt function activities are established and grow,
the size and scope of the excess benefit transactions that occurred
in Year 3 become less and less significant as compared to the size
and extent of O's regular and ongoing exempt function activities
that began in Year 4 and continued thereafter. O was involved in
repeated excess benefit transactions in Year 3. However, by
discontinuing its practice of purchasing art from its current and
former trustees, by replacing its former board with independent
members of the community, and by adopting a conflicts of interest
policy and art valuation guidelines, O has implemented safeguards
that are reasonably calculated to prevent future violations. In
addition, O has made a good faith effort to seek correction from the
disqualified persons who benefited from the excess benefit
transactions (its former trustees). Based on the application of the
factors to these facts, O continues to meet the requirements for tax
exemption under section 501(c)(3).
Example 3. (i) O conducts educational programs for the benefit
of the general public. Since its formation, O has employed its
founder, C, as its Chief Executive Officer. Beginning in Year 5 of
O's operations and continuing to the present, C caused O to divert
significant portions of O's funds to pay C's personal expenses. The
diversions by C significantly reduced the funds available to conduct
O's ongoing educational programs. The board of trustees never
authorized C to cause O to pay C's personal expenses from O's funds.
Certain members of the board were aware that O was paying C's
personal expenses. However, the board did not terminate C's
employment and did not take any action to seek repayment from C or
to prevent C from continuing to divert O's funds to pay C's personal
expenses. C claimed that O's payments of C's personal expenses
represented loans from O to C. However, no contemporaneous loan
documentation exists, and C never made any payments of principal or
interest.
(ii) The diversions of O's funds to pay C's personal expenses
constituted excess benefit transactions between an applicable tax-
exempt organization and a disqualified person under section 4958.
Therefore, these transactions are subject to the appropriate excise
taxes provided in that section. In addition, these transactions
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O has engaged in regular
and ongoing activities that further exempt purposes both before and
after the excess benefit transactions occurred. However, the size
and scope of the excess benefit transactions engaged in by O
beginning in Year 5, collectively, are significant in relation to
the size and scope of O's activities that further exempt purposes.
Moreover, O has been involved in repeated excess benefit
transactions. O has not implemented any safeguards that are
reasonably calculated to prevent future diversions. The excess
benefit transactions have not been corrected, nor has O made good
faith efforts to seek correction from C, the disqualified person who
benefited from the excess benefit transactions. Based on the
application of the factors to these facts, O is no longer described
in section 501(c)(3) effective in Year 5.
Example 4. (i) O conducts activities that further exempt
purposes. O employs C as its Chief Executive Officer. C, on behalf
of O, entered into a contract with Company K to construct an
addition to O's existing building. The addition to O's building is a
significant undertaking in relation to O's other activities. C owns
all of the voting stock of Company K. Under the contract, O paid
Company K an amount that substantially exceeded the fair market
value of the services Company K provided. When O's board of trustees
approved the contract with Company K, the board did not perform due
diligence that could have made it aware that the contract price for
Company K's services was excessive. Subsequently, but before the IRS
commences an examination of O, O's board of trustees determines that
the contract price was excessive. Thus, O concludes that an excess
benefit transaction has occurred. After the board makes this
determination, it promptly removes C as Chief Executive Officer,
terminates C's employment with O, and hires legal counsel to recover
the excess payments to Company K. In addition, O promptly adopts a
conflicts of interest policy and significant new contract review
procedures designed to prevent future recurrences of this problem.
(ii) The purchase of services by O from Company K at more than
fair market value constitutes an excess benefit transaction between
an applicable tax-exempt organization and disqualified persons under
section 4958. Therefore, this transaction is subject to the
appropriate excise taxes provided in that section. In addition, this
transaction violates the proscription against inurement under
section 501(c)(3) and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O has engaged in regular
and ongoing activities that further exempt purposes both before and
after the excess benefit transaction occurred. Although the size and
scope of the excess benefit transaction were significant in relation
to the size and scope of O's activities that further exempt
purposes, the transaction with Company K was a one-time occurrence.
By adopting a conflicts of interest policy and significant new
contract review procedures and by terminating C, O has implemented
safeguards that are reasonably calculated to prevent future
violations. Moreover, O took corrective actions before the IRS
commenced an examination of O. In addition, O has made a good faith
effort to seek correction from Company K, the disqualified person
who benefited from the excess benefit transaction. Based on the
application of the factors to these facts, O continues to be
described in section 501(c)(3).
Example 5. (i) O is a large organization with substantial assets
and revenues. O conducts activities that further exempt purposes. O
employs C as its Chief Financial Officer. During Year 1, O pays
$2,500 of C's personal expenses. O does not make these payments
under an accountable plan under Sec. 53.4958-4(a)(4) of this
chapter. In addition, O does not report any of these payments on C's
Form W-2, ``Wage and Tax Statement,'' or on a Form 1099-MISC,
``Miscellaneous Income,'' for C for Year 1, and O does not report
these payments as compensation on its Form 990, ``Return of
Organization Exempt From Income Tax,'' for Year 1. Moreover, none of
these payments can be disregarded under section 4958 as nontaxable
fringe benefits and none consisted of fixed payments under an
initial contract under Sec. 53.4958-4(a)(3) of this chapter. C does
not report the $2,500 of payments as income on his individual
federal income tax return for Year 1. O does not repeat this
reporting omission in subsequent years and, instead, reports all
payments of C's personal expenses not made under an accountable plan
as income to C.
(ii) O's payment in Year 1 of $2,500 of C's personal expenses
constitutes an excess benefit transaction between an applicable tax-
exempt organization and a disqualified person under section 4958.
Therefore, this transaction is subject to the appropriate excise
taxes provided in that section. In addition, this transaction
violates the proscription against inurement in section 501(c)(3) and
Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O engages in regular and
ongoing activities that further exempt purposes. The payment of
$2,500 of C's personal expenses represented only a de minimis
portion of O's assets and revenues; thus, the size and scope of the
excess benefit transaction were not significant in relation to the
size and scope of O's activities that further exempt purposes. The
reporting omission that resulted in the excess benefit transaction
in Year 1 is not repeated in subsequent years. Based on the
application of the factors to these facts, O continues to be
described in section 501(c)(3).
(3) Effective date. The rules in paragraph (g) of this section will
apply with respect to excess benefit
[[Page 53604]]
transactions occurring after the date of publication in the Federal
Register of a Treasury Decision adopting these rules as final
regulations.
PART 53--FOUNDATION AND SIMILAR EXCISE TAXES
Par. 3. The authority citation for part 53 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805.
Par. 4. In Sec. 53.4958-2, paragraph (a)(6) is added to read as
follows:
Sec. 53.4958-2 Definition of applicable tax-exempt organization.
(a) * * *
(6) Examples. The following examples illustrate the principles of
this section, which defines an applicable tax-exempt organization for
purposes of section 4958:
Example 1. O is a nonprofit corporation formed under state law.
O filed its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). In its
application, O described its plans for purchasing property from some
of its directors at prices that would exceed fair market value.
After reviewing the application, the IRS determined that because of
the proposed property purchase transactions, O failed to establish
that it met the requirements for an organization described in
section 501(c)(3). Accordingly, the IRS denied O's application.
While O's application was pending, O engaged in the purchase
transactions described in its application at prices that exceeded
the fair market value of the property. Although these transactions
would constitute excess benefit transactions under section 4958,
because the IRS never recognized O as an organization described in
section 501(c)(3), O was never an applicable tax-exempt organization
under section 4958. Therefore, these transactions are not subject to
the excise taxes provided in section 4958.
Example 2. O is a nonprofit corporation formed under state law.
O files its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). The IRS
issues a favorable determination letter in Year 1 that recognizes O
as an organization described in section 501(c)(3). Subsequently, in
Year 5 of O's operations, O engages in certain transactions that
constitute excess benefit transactions under section 4958 and
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2). The IRS examines the Form 990,
``Return of Organization Exempt From Income Tax'', that O filed for
Year 5. After considering all the relevant facts and circumstances
in accordance with Sec. 1.501(c)(3)-1(g), the IRS concludes that O
is no longer described in section 501(c)(3) effective in Year 5. The
IRS does not examine the Forms 990 that O filed for its first four
years of operations and, accordingly, does not revoke O's exempt
status for those years. Although O's tax-exempt status is revoked
effective in Year 5, under the lookback rules in Sec. 53.4958-
2(a)(1) and Sec. 53.4958-3(a)(1) of this chapter, for a period of
five years prior to the excess benefit transactions that occurred in
Year 5, O was an applicable tax-exempt organization and O's
directors were disqualified persons as to O. Therefore, the
transactions between O and its directors during Year 5 are subject
to the appropriate excise taxes provided in section 4958.
* * * * *
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 05-17858 Filed 9-8-05; 8:45 am]
BILLING CODE 4830-01-P