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The Basics: Intermediate Sanctions and Excess Benefit Transactions
Intermediate sanctions sound fairly scary. In reality, regulations and penalties are equally scary, so the name is appropriate. Intermediate sanction regulations and penalties exist to stop abuses by disqualified persons in 501(c)(3), 501(c)(4) and 501(c)(29) organizations. To understand intermediate sanctions, you first need to have a basic understanding of excess benefit transactions.
An excess benefit transaction occurs when there is an economic benefit provided by an organization to a disqualified person that exceeds the consideration received. Some common examples of excess benefits are:
• Unreasonable compensation
• Improper expense reimbursements
• Sale of property to a disqualified person at less than fair market value
Excess benefit transactions only apply to disqualified persons. A disqualified person is anyone in a position to exercise substantial influence over an organization over the five-year period before the date of the excess benefit transaction. The person does not have to exercise influence, but simply have the authority to use it. Included in the definition of disqualified person is such person’s family members and any entity such person owns a thirty-five percent (35%) interest.
Certain individuals are automatically deemed disqualified individuals. Those include voting members of the board, the president, treasurer, or other named officers of the organization. Further, regardless of title, deemed officers of the organization would include those individuals responsible for carrying out the decisions of the board or those who share the ultimate responsibility of management of the organization or finances of the organization. Documentation of responsibilities of such individuals is important in identifying who would be considered a disqualified person.
Other factors that would indicate a person has substantial influence over the organization, with or without being a named officer, include:
• The person is a founder or substantial contributor.
• The person’s compensation is based on revenues that person controls.
• The person has some authority to determine a substantial portion of the organization’s budget.
• The person manages a segment of the organization that represents a substantial portion of the organization’s activities.
The moment an excess benefit transaction occurs, intermediate sanctions commence. The excise tax on the disqualified person begins at twenty-five percent (25%). Even with the imposition of the tax, the transaction must be corrected by returning the full amount of the transaction, plus interest, to the organization. If the excess benefit is not corrected within the appropriate timeframe, a two-hundred percent (200%) penalty is imposed. Further, a ten percent (10%) penalty can be imposed on any organization manager that knowingly and willfully participates in the excess benefit transaction. It is important to note that the excise taxes are imposed on the individual. The organization cannot pay the tax; however, the IRS would have the power to revoke the tax-exempt status of the organization in addition to or instead of assessing the penalty.