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Excise Taxes on Excess Benefit Transactions

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Information about this document as published in the Federal Register.

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AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Temporary regulations.

SUMMARY:

This document contains temporary regulations relating to the excise taxes on excess benefit transactions under section 4958 of the Internal Revenue Code, as well as certain amendments and additions to existing Income Tax Regulations affected by section 4958. Section 4958 was enacted in section 1311 of the Taxpayer Bill of Rights 2. Section 4958 imposes excise taxes on transactions that provide excess economic benefits to disqualified persons of public charities and social welfare organizations (referred to as applicable tax-exempt organizations). Disqualified persons who benefit from an excess benefit transaction with an applicable tax-exempt organization are liable for a tax of 25 percent of the excess benefit. Such persons are also liable for a tax of 200 percent of the excess benefit if the excess benefit is not corrected by a certain date. Additionally, organization managers who participate in an excess benefit transaction knowingly, willfully, and without reasonable cause, are liable for a tax of 10 percent of the excess benefit. The tax for which participating organization managers are liable cannot exceed $10,000 for any one excess benefit transaction.

DATES:

Effective Date: These regulations are effective January 10, 2001.

Applicability Date: These regulations apply as of January 10, 2001 and will cease to apply January 9, 2004.

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FOR FURTHER INFORMATION CONTACT:

Phyllis D. Haney, (202) 622-4290 (not a toll-free number).

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SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these temporary regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1623, in conjunction with the notice of proposed rulemaking published August 4, 1998, 63 FR 41486, REG-246256-96, Failure by Certain Charitable Organizations to Meet Certain Qualification Requirements; Taxes on Excess Benefit Transactions.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books and records relating to the collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

Section 4958 was added to the Code by the Taxpayer Bill of Rights 2, Public Law 104-168 (110 Stat. 1452), enacted July 30, 1996. The section 4958 excise taxes generally apply to excess benefit transactions occurring on or after September 14, 1995. The IRS notified the general public of the new section 4958 excise taxes in Notice 96-46 (1996-2 C.B. 112), which also solicited comments on the new law.

On August 4, 1998, a notice of proposed rulemaking (REG-246256-96) clarifying certain definitions and rules contained in section 4958 was published in the Federal Register (63 FR 41486). The IRS received numerous written comments responding to this notice, including a comment from the public on the collections of information estimates contained therein.

That commentator expressed concern that the purchase of independent compensation surveys is required to certify the reasonableness of certain outside and personnel contracts; and that the proposed regulations place a burden on governing bodies of applicable tax-exempt organizations, increasing the personal risk of members of those governing bodies. The collections of information in the proposed regulations are voluntary on the part of the governing bodies of applicable tax-exempt organizations. Although the collections of information allow the organization to rely on a presumption that a transaction is reasonable or at fair market value, the failure to obtain the collections of information in no way implies that a transaction is unreasonable.

Further, as discussed under Explanation of Provisions of this preamble (under the heading Rebuttable presumption that a transaction is not an excess benefit transaction), the IRS and the Treasury Department believe that any applicable tax-exempt organization may compile its own comparability data rather than obtain an independent survey to satisfy the requirement to obtain appropriate data as to comparability. Therefore, although the comment on Paperwork Reduction Act requirements was considered in the new estimates of the annual burden per recordkeeper and per respondent, these temporary regulations continue to conclude that the estimated annual burden per recordkeeper varies from 3 hours to 308 hours, depending on individual circumstances, with an estimated weighted average of 6 hours, 3 minutes.

A public hearing was held on March 16 and 17, 1999. After consideration of all the comments, the proposed regulations under section 4958 were revised as follows. The major areas of the comments and revisions are discussed below.

Explanation of Provisions

Additional Taxes on Disqualified Person

A disqualified person benefitting from an excess benefit transaction must correct the excess benefit within the taxable period to avoid liability for the 200-percent tax under section 4958(b). The taxable period is defined by section 4958 as the period beginning on the date the transaction occurred and ending on the earlier of the date of mailing a notice of deficiency, or the date on which the 25-percent tax is assessed.

A commentator questioned whether the disqualified person would receive any notice that the IRS was examining a possible excess benefit transaction before either of the events ending the taxable period occur. In fact, a disqualified person would be notified if an examination of that person were opened pursuant to an examination of an applicable tax-exempt organization. The IRS has an obligation under Internal Revenue Code (Code) section 7602(c) to notify taxpayers at the beginning of the examination and collection process that the IRS might contact third parties (such as the organization) about the taxpayer's tax liabilities. Additionally, the IRS follows the procedure of issuing a “first letter of proposed deficiency” allowing the taxpayer an opportunity for administrative review in the IRS Office of Appeals. This first letter is issued 30 days before the notice of deficiency is issued. Consequently, a disqualified person would be aware of any examination of a potential excess benefit transaction before the end of the taxable period.

Although it is also IRS practice to issue a single notice of deficiency for both the 25-percent and 200-percent Start Printed Page 2145section 4958 taxes for which the disqualified person is liable, the abatement rules under section 4961 provide that the 200-percent tax under section 4958(b) is not to be assessed (and if assessed, is to be abated) if the excess benefit is corrected within 90 days after the mailing of the notice of deficiency for that tax.

Correction

Section 4958(f)(6) defines correction as “undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards.” The proposed regulations provide a short, general description of correction, referring to the statutory language. The proposed regulations define correction as repaying an amount of money equal to the excess benefit, plus “any additional amount needed to compensate the organization for the loss of the use of the money or other property” from the date of the excess benefit transaction to the date the excess benefit is corrected. The proposed regulations further allow correction “in certain circumstances” by permitting the disqualified person to return property to the organization and “taking any additional steps necessary to make the organization whole.” Where there is an ongoing contract for services, the proposed regulations provide that the parties need not terminate the contract in order to correct, but the contract “may need to be modified” to avoid future excess benefit transactions.

The IRS received numerous comments and requests for additional guidance relating to correction as defined in the proposed regulations. A number of commentators requested that final regulations state explicitly that correction requires a disqualified person to pay interest on the excess benefit amount, and to specify the rate of interest.

The temporary regulations state that the disqualified person must pay the applicable tax-exempt organization a correction amount in order to correct an excess benefit transaction and prevent imposition of the 200-percent tax. The correction amount equals the sum of the excess benefit and interest on the excess benefit. The amount of the interest charge is determined by multiplying the excess benefit by an interest rate, compounded annually, for the period from the date the excess benefit transaction occurred to the date of correction. The interest rate used for this purpose must be a rate that equals or exceeds the applicable Federal rate (AFR), compounded annually, for the month in which the transaction occurred. The period from the date the excess benefit transaction occurred to the date of correction is used to determine whether the appropriate AFR is the Federal short-term rate, the Federal mid-term rate, or the Federal long-term rate.

Commentators requested that an applicable tax-exempt organization have discretion to determine the appropriate form of correction; for example, payment of money, return of property, or some combination. Alternatively, one commentator requested an explicit rule that monetary payment is always sufficient and that a buy-back or return of property is not required. Another requested clarification that rescission could constitute an appropriate form of correction.

The temporary regulations provide, in general, that a disqualified person corrects an excess benefit only by making a payment in cash or cash equivalents to the applicable tax-exempt organization equal to the correction amount. The disqualified person may, however, with the agreement of the applicable tax-exempt organization, make a payment by returning specific property previously transferred in the excess benefit transaction. In the latter case, the amount of the payment equals the lesser of the fair market value of the property determined on the date the property is returned to the organization, or the fair market value of the property on the date the excess benefit transaction occurred.

Under the temporary regulations, if the payment made by returning the property is less than the correction amount, the disqualified person must make an additional cash payment to the organization of the difference. Conversely, if the payment made by returning the property exceeds the correction amount, the organization may make a cash payment to the disqualified person of the difference. The disqualified person who engaged in the excess benefit transaction with the applicable tax-exempt organization may not participate in the applicable tax-exempt organization's decision whether to accept as a correction payment the return of specific property previously transferred in the excess benefit transaction. An organization may always refuse the return of that property as payment, and require instead that the disqualified person make a payment in cash (or cash equivalents) of the full correction amount.

The temporary regulations provide a special rule relating to the correction of an excess benefit transaction resulting from the vesting of benefits provided under a nonqualified deferred compensation plan. To the extent that such benefits have not been distributed to the disqualified person, the disqualified person may correct the portion of the excess benefit attributable to such undistributed deferred compensation by relinquishing any right to receive such benefits (including any earnings thereon).

The temporary regulations provide five new examples that illustrate acceptable forms of correction. The temporary regulations also clarify that, if the disqualified person makes a payment of less than the full correction amount, the 200-percent tax is imposed only on the unpaid portion of the correction amount.

Another commentator suggested that where an organization failed to establish its intent to treat an economic benefit as consideration for the performance of services, amending an information return, rather than requiring the disqualified person to repay the benefit, should be sufficient to correct the excess benefit transaction, assuming that the total amount of compensation was reasonable. In this regard, the proposed regulations specifically allow the reporting of an economic benefit by an organization on an original or amended Federal tax information return to establish that a benefit was intended as compensation. The proposed regulations and these temporary regulations permit an organization to establish its intent by amending an information return at any time prior to when the IRS commences an examination. Additionally, the temporary regulations explicitly allow the disqualified person to amend the person's Federal tax return to report a benefit as income at any time prior to when the IRS commences an examination of the disqualified person or the applicable tax-exempt organization for the taxable year in which the transaction occurs.

In addition, under the proposed regulations and these temporary regulations, if an organization can show reasonable cause (using existing standards under section 6724) for failing to report an economic benefit as compensation as required under the Code or regulations, then the organization will be treated as clearly indicating its intent to provide an economic benefit as compensation for services. The section 6724 standards include acting in a responsible manner before and after the failure to report occurred, along with either significant Start Printed Page 2146mitigating factors or events beyond the organization's control.

Where the applicable tax-exempt organization provides taxable benefits to a disqualified person, section 4958(c)(1) requires a clear indication that the organization intended to provide the benefits as consideration for the performance of services. Where there is no such clear indication, the value of those benefits generally is an excess benefit, regardless of any claim of reasonableness of the total compensation package. In this case, the regular correction rules apply.

The temporary regulations provide that failure of the organization or the disqualified person to report nontaxable economic benefits (or otherwise document a clear intent) does not result automatically in an excess benefit transaction. This rule is consistent with the legislative history. (H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 57, note 8). These nontaxable benefits must still be taken into account (unless specifically excluded elsewhere in the regulations) when determining whether the total amount of compensation paid to a disqualified person is reasonable. Therefore, only to the extent that total compensation exceeds what is reasonable could a section 4958 excise tax be imposed and correction be required with respect to nontaxable economic benefits.

The temporary regulations provide additional guidance regarding correction where an applicable tax-exempt organization has ceased to exist or is no longer tax-exempt under section 501(a) as an organization described in section 501(c)(3) or (4). The temporary regulations make clear that a disqualified person must correct the excess benefit transaction in either event. In the case of section 501(c)(3) organizations, the disqualified person must pay the correction amount to another organization described in section 501(c)(3) in accordance with the dissolution clause of the applicable tax-exempt organization involved in the excess benefit transaction, provided the other organization is not related to the disqualified person. In the case of section 501(c)(4) organizations, the disqualified person must pay the correction amount to the successor section 501(c)(4) organization or, if there is no tax-exempt successor, to any section 501(c)(3) or section 501(c)(4) organization not related to the disqualified person.

Several commentators requested clarification that a disqualified person is allowed to deduct the payment of a correction amount as a business expense. The issue is beyond the scope of these regulations. The provisions of Subtitle A of the Code govern the deductibility of any part of a correction payment.

Tax Paid by Organization Managers: Reliance on Advice of Counsel

The proposed regulations provide a safe harbor under which a manager's participation in a transaction will ordinarily not be subject to tax under section 4958(a)(2), even though the transaction is subsequently held to be an excess benefit transaction, if the manager fully discloses the factual situation to legal counsel, then relies on the advice of such counsel expressed in a reasoned written legal opinion that a transaction is not an excess benefit transaction. This safe harbor parallels the rules for foundation manager taxes contained in the regulations under section 4941 (taxes on self-dealing) and section 4945 (taxes on taxable expenditures).

A number of commentators suggested that the final regulations expand the advice-of-counsel safe harbor to allow reliance on the advice of other professionals. Specifically mentioned were section 7525 practitioners (Federally authorized tax practitioners), professional tax advisors, and compensation consultants and appraisers with respect to valuation issues. Commentators likewise suggested that parallel revisions should be made to the section 4941 and 4945 regulations.

The temporary regulations expand the safe harbor contained in the proposed regulations. The temporary regulations provide that an organization manager's participation in an excess benefit transaction will ordinarily not be considered knowing to the extent that, after full disclosure of the factual situation to an appropriate professional, the organization manager relies on a reasoned written opinion of that professional with respect to elements of the transaction within the professional's expertise. For this purpose, appropriate professionals are legal counsel (including in-house counsel), certified public accountants or accounting firms with expertise regarding the relevant tax law matters, and independent valuation experts who meet specified requirements. The requirements for appropriate valuation experts are modeled after the section 170 regulations that define qualified appraisers for charitable deduction purposes. Under the section 4958 temporary regulations, the valuation experts must hold themselves out to the public as appraisers or compensation consultants; perform the relevant valuations on a regular basis; be qualified to make valuations of the type of property or services being valued; and include in the written opinion a certification that they meet the preceding requirements. This section 4958 regulations project did not undertake any revisions to the advice-of-counsel safe harbor or the definition of knowing in the section 4941 and 4945 regulations.

The temporary regulations contain an additional safe harbor, providing that an organization manager's participation in a transaction will ordinarily not be considered knowing if the manager relies on the fact that the requirements giving rise to the rebuttable presumption of reasonableness are satisfied with respect to the transaction (for the requirements, see discussion under the heading Rebuttable presumption that a transaction is not an excess benefit transaction of this preamble).

Date of Occurrence

Section 4958 does not specify when an excess benefit transaction occurs. The proposed regulations provide that an excess benefit transaction occurs on the date on which the disqualified person receives the economic benefit from the applicable tax-exempt organization for Federal income tax purposes. The proposed regulations also provide that a transaction consisting of the payment of deferred compensation occurs on the date the deferred compensation is earned and vested. Several comments were received requesting additional guidance about the timing of an excess benefit transaction. Specifically, one commentator requested clarification in the case of multiple payments.

The temporary regulations continue to provide as a general rule that an excess benefit transaction occurs on the date the disqualified person receives the economic benefit for Federal income tax purposes. The temporary regulations contain additional rules for a series of compensation payments or other payments arising pursuant to a single contractual arrangement provided to a disqualified person over the course of the disqualified person's taxable year (or part of a taxable year). In such a case, any excess benefit transaction with respect to these aggregate payments is deemed to occur on the last day of the taxable year (or, if the payments continue for part of the year, the date of the last payment in the series).

The temporary regulations also contain special rules for deferred, contingent, and certain noncash compensation. The temporary Start Printed Page 2147regulations state that in the case of benefits provided pursuant to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. In the case of a transfer of property that is subject to a substantial risk of forfeiture, or in the case of rights to future compensation or property (including benefits under a nonqualified deferred compensation plan), the transaction occurs on the date the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. However, where the disqualified person elects to include an amount in gross income in the taxable year of transfer pursuant to section 83(b), the general rule applies, such that the transaction occurs on the date the disqualified person receives the economic benefit from the applicable tax-exempt organization for Federal income tax purposes. Any excess benefit transaction with respect to benefits under a deferred compensation plan which vest during any taxable year of the disqualified person is deemed to occur on the last day of the disqualified person's taxable year.

The temporary regulations continue to reference the relevant Code sections for statute of limitations rules as they apply to section 4958 excise taxes. Generally, the statute of limitations for section 4958 taxes begins with the filing of the applicable tax-exempt organization's return for the year in which the excess benefit transaction occurred. If the organization discloses an item on its return or on an attached schedule or statement in a manner sufficient to apprise the IRS of the existence and nature of an excess benefit transaction, the three-year limitation on assessment and collection applies. If the transaction is not so disclosed, a six-year limitation on assessment and collection applies, unless an exception listed in section 6501(c) applies.

Definition of Applicable Tax-Exempt Organization

Section 4958(e) defines an applicable tax-exempt organization as “any organization which (without regard to any excess benefit) would be described in paragraph (3) or (4) of section 501(c) and exempt from tax under section 501(a) * * *” (except private foundations). An applicable tax-exempt organization also includes any organization that was described in section 501(c)(3) or (4) and exempt from tax under section 501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the lookback period).

The temporary regulations revise the section defining applicable tax-exempt organizations to clarify that an organization is not described in section 501(c)(3) or (4) for purposes of section 4958 during any period covered by a final determination or adjudication that the organization is not exempt from tax under section 501(a) as an organization described in section 501(c)(3) or (4), so long as that determination or adjudication is not based upon participation in inurement or one or more excess benefit transactions.

A number of commentators requested that the final regulations clarify the status of section 115 governmental entities that voluntarily applied for a determination of their section 501(c)(3) status. Others requested that those governmental entities that applied for section 501(c)(3) exemption before the enactment of section 4958 be exempt from section 4958. In response to these comments, the temporary regulations provide that any governmental entity that is exempt from (or not subject to) taxation without regard to section 501(a) is not an applicable tax-exempt organization for purposes of section 4958.

Definition of Disqualified Person

Section 4958(f)(1) defines a disqualified person with respect to any transaction as “any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization * * *” (and several other categories of related persons). The proposed regulations list the statutory categories of related persons (i.e., certain family members and 35-percent controlled entities) that are treated as disqualified persons for section 4958 purposes. The proposed regulations also list several categories of persons who are treated as disqualified persons by virtue of the functions they perform for, or the interests they hold in, the organization. The proposed regulations further provide that other persons may be treated as disqualified persons depending on all relevant facts and circumstances and list some of the factors to be considered.

Some commentators questioned certain categories of persons who are deemed to have substantial influence under the proposed regulations (e.g., presidents, chief executive officers, treasurers), arguing that these per se categories conflict with a statement in the legislative history that “[a] person having the title of ‘officer, director, or trustee' does not automatically have the status of a disqualified person.” These commentators requested that final regulations adopt an alternative approach of listing these categories as facts and circumstances tending to show that a person has substantial influence over the affairs of an organization. In response to these comments, the temporary regulations clarify that the per se categories of persons who are in a position to exercise substantial influence for section 4958 purposes are defined by reference to the actual powers and responsibilities held by the person and not merely by the person's title or formal position. Thus, for example, it is possible that a person with the mere title of “president” could be treated as not having substantial influence if it is demonstrated that the person, in fact, does not have ultimate responsibility for implementing the decisions of the governing body or for supervising the management, administration, or operation of the organization.

A number of commentators objected to a provision in the proposed regulations under which a person who has or shares authority to sign drafts or to authorize electronic transfer of the organization's funds is treated as a treasurer or chief financial officer who is in a position to exercise substantial influence over the affairs of the organization. Other commentators requested that the final regulations recognize that a person who may authorize transfer of only minimal amounts of the organization's funds should not be treated as a disqualified person solely by reason of that authority.

The temporary regulations clarify that a person who has the powers and responsibilities of a treasurer or chief financial officer is in a position to exercise substantial influence, provided that the person has ultimate responsibility for managing the finances of the organization. As requested by commentators, the temporary regulations delete the provision from the proposed regulations that refers to having, or sharing, authority to sign drafts or to authorize electronic transfer of funds.

The IRS and the Treasury Department considered, but declined to adopt at present, a special rule with respect to so-called “donor advised funds” maintained by an applicable tax-exempt organization. Unlike other segments of an applicable tax-exempt organization, such as an operating department (or division) of the organization, a donor advised fund consists of a segregated fund maintained for the specific purpose of allowing certain persons to provide ongoing advice regarding the Start Printed Page 2148organization's use of amounts contributed by a particular donor (or donors). Although these persons cannot properly have legal control over the segregated fund, they nonetheless are in a position to exercise substantial influence over the amount, timing, or recipients of distributions from the fund. Accordingly, the IRS and the Treasury Department request comments regarding potential issues raised by applying the fair market value standard of section 4958 to distributions from a donor advised fund to (or for the use of) the donor or advisor.

The proposed regulations deem certain persons not to have substantial influence, including any applicable tax-exempt organization described in section 501(c)(3) (i.e., public charities subject to section 4958). Various commentators requested that section 501(c)(4) applicable tax-exempt organizations, section 115 governmental entities, corporations or associations organized as non-profits under the laws of any State, or entities 100-percent controlled by and for the benefit of section 501(c)(3) applicable tax-exempt organizations, be deemed not to exercise substantial influence over the affairs of applicable tax-exempt organizations.

The temporary regulations provide that any organization described in section 501(c)(3) and exempt from tax under section 501(a) (including a private foundation), is not a disqualified person. The temporary regulations do not specifically exclude from disqualified person status section 115 and section 501(c)(4) organizations generally, as requested in comments. However, the temporary regulations state that an organization described in section 501(c)(4) is deemed not to have substantial influence with respect to another applicable tax-exempt organization described in section 501(c)(4). Additionally, the temporary regulations provide that the transfer of economic benefits to a government entity for exclusively public purposes is disregarded for purposes of section 4958.

A number of comments were received on the section of the proposed regulations providing that facts and circumstances govern in all cases where disqualified person status is not explicitly described. Commentators variously requested revision or deletion of the statement that a person with managerial control over a discrete segment of an organization could be in a position to exercise substantial influence over the affairs of the entire organization. Instead of considering this factor in an overall evaluation of the facts and circumstances, the temporary regulations provide that the fact that a “person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization” is a separate factor tending to show substantial influence. The IRS and the Treasury Department believe that, in some circumstances, a person managing a discrete segment or activity of an organization is, in fact, in a position to exercise substantial influence over the organization as a whole.

With respect to the factor that a person is a substantial contributor within the meaning of section 507(d)(2), requests were made to define a substantial contributor as a person contributing more than two percent of the organization's total support; to use a higher threshold, such as the greater of $50,000 or 10 percent of total contributions received; to limit the treatment of substantial contributor status as a factor to a reasonable time (e.g., four years); and to tie substantial contributor status to persons required to be disclosed as such on Form 990 or Schedule A of that form. Additionally, a request was made to specify how the five-year lookback period applies to substantial contributors.

The temporary regulations continue to include as a factor tending to show substantial influence the fact that a person is a substantial contributor, generally as defined in section 507(d)(2)(A). However, the temporary regulations clarify that, to determine whether a person is a substantial contributor for section 4958 purposes, only contributions received by the organization during its current taxable year and the four preceding taxable years are taken into account.

With respect to the factor that a person's compensation is based on revenues derived from activities of the organization that the person controls, a number of commentators requested that a determination of disqualified person status not be based solely on this factor. Several commentators specifically requested clarification of this factor with respect to physicians in particular, and others requested that the factor be deleted altogether. Other commentators requested that the factor be narrowed to situations where the person's compensation is based on revenues from activities that provide over half of the organization's annual revenue, or that the factor be modified to apply only if a person's compensation is based to a significant extent on revenues derived from activities of the organization that the person controls. In response to these comments, the temporary regulations modify the factor to require that the person's compensation is primarily based on revenues derived from activities of the organization that the person controls.

A number of commentators argued that it is inappropriate to include all persons with managerial authority, or persons serving as key advisors to a person with managerial authority, as potential disqualified persons. Additional comments on this issue requested that the final regulations clarify the meaning of managerial authority or delete that factor from the regulations. Others suggested that the term key advisor be limited to those with real, substantial authority, or deleted altogether and replaced by a standard that a person can have managerial authority by virtue of his or her actual impact on the organization's affairs without regard to title or position. In response to these comments, the temporary regulations delete as a factor tending to show substantial influence the fact that a person serves as a key advisor to a manager. Moreover, with respect to managerial authority, the temporary regulations list revised factors tending to show substantial influence, including whether: (1) The person has or shares authority to control or determine a substantial portion of the organization's capital expenditures, operating budget, or compensation for employees; and (2) the person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole.

With respect to factors tending to show that a person does not have substantial influence, one commentator requested that the fact that the person has had no prior involvement or relationship with the organization be added as a factor. Another commentator requested that the independent contractor factor be modified so that all “outside, independent professionals performing services on a strictly fee-for-service arrangement” are presumed not to be disqualified persons. Other commentators requested that additional factors tending to show no substantial influence be added for employees. In this regard, suggested factors included that the person reports to a disqualified person, does not participate in major policy or financial decisions affecting the organization as a whole, or holds a position three or more levels below the governing body. In response to these comments, the temporary regulations provide as a factor tending to show no substantial influence the fact that a Start Printed Page 2149person is an independent contractor (such as an attorney, accountant, or investment manager or advisor) whose sole relationship to the organization is providing professional advice, but who does not have decision-making authority, with respect to transactions from which the independent contractor will not economically benefit either directly or indirectly (aside from customary fees received for the professional advice rendered). In addition, the temporary regulations add as factors tending to show no substantial influence the fact that the direct supervisor of the individual is not a disqualified person, and that the person does not participate in any management decisions affecting the organization as a whole or a substantial, discrete segment or activity of the organization. The temporary regulations also address the issue of persons with no prior involvement with the organization by providing a special exception for initial contracts (see the discussion under the heading Initial Contract Exception in this preamble).

Definition of Excess Benefit Transaction

Section 4958(c)(1) defines the phrase excess benefit transaction as “any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.” The excess benefit is the amount by which the value of the economic benefits provided to (or for the use of) the disqualified person exceeds the value of the consideration received. The proposed regulations further define certain terms in the statutory definition of excess benefit transaction and delineate specific items that either are disregarded or must be taken into account in determining the value of a compensation package. The proposed regulations also prescribe standards for determining fair market value for section 4958 purposes. In response to comments received on these topics, the temporary regulations make numerous changes to the provisions of the proposed regulations that define the phrase excess benefit transaction (as summarized under the next six topic headings).

The IRS and the Treasury Department considered whether embezzled amounts should be viewed as provided by the organization for section 4958 purposes. In this regard, the IRS and the Treasury Department believe that any economic benefit received by a disqualified person (who by definition has substantial influence) from the assets of the organization is provided by the organization even if the transfer of the benefit was not authorized under the regular procedures of the organization.

Economic Benefit Provided Directly or Indirectly

Section 4958(c)(1)(A) provides that an excess benefit transaction may arise when economic benefits are provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person. In this regard, the proposed regulations provide that “[a] benefit may be provided indirectly through the use of one or more entities controlled by or affiliated with the applicable tax-exempt organization. For example, if an applicable tax-exempt organization causes its taxable subsidiary to pay excessive compensation to, or engage in a transaction at other than fair market value with, a disqualified person of the parent organization, the payment of the compensation or the transfer of property is an excess benefit transaction.” This example is based on similar language contained in the legislative history to section 4958 (See H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 56, note 3).

A number of commentators requested further clarification of the definition of indirect excess benefit transactions. Some commentators requested that the final regulations clarify that any compensation disqualified persons receive from unrelated third parties through the acquiescence of the employing applicable tax-exempt organization not be considered in determining reasonable compensation. Another commentator suggested that, as a general rule, an excess benefit may be found to be provided indirectly through an entity controlled by an applicable tax-exempt organization only when the funds or other benefits at issue can clearly be traced to the parent organization. Additionally, a request was received to specify that payment by a subsidiary of excessive compensation does not, by itself, justify the conclusion that the parent organization caused the subsidiary to engage in an excess benefit transaction. Other requests were made to clarify that services received by the applicable tax-exempt organization may include services provided by the disqualified person to one or more other entities controlled by or affiliated with the organization.

Commentators also suggested several clarifications to the phrase “controlled by or affiliated with” for purposes of determining whether an indirect excess benefit transaction has occurred. One commentator suggested that control or affiliation must exist at the time the benefit is authorized or approved, rather than when the benefit is received by the disqualified person. Others suggested that the definition of “controlled by or affiliated with” follow more closely the definition of control under the section 4941 self-dealing regulations or under section 512(b)(13) (including constructive ownership rules contained in section 318). Another commentator suggested defining the term affiliated to mean that organizations share a majority of governing body members or principal officers. Other commentators requested that the final regulations state that approval of a benefit by a board independent of the applicable tax-exempt organization would prevent finding that the organization indirectly provided an excess benefit to a disqualified person. Commentators also requested that the final regulations include examples demonstrating that the mere existence of a relationship between two entities, including a control relationship, is insufficient to justify a conclusion that a benefit has been indirectly provided to a disqualified person unless a purposeful avoidance of section 4958 by conducting a transaction indirectly is shown.

In response to these comments, the temporary regulations clarify that an applicable tax-exempt organization may provide an economic benefit indirectly to a disqualified person either through a controlled entity or through an intermediary. In this regard, the temporary regulations parallel the section 4941 self-dealing regulations, except that the temporary regulations generally adopt the section 512(b)(13) standard for control. (The section 512(b)(13) standard for control considers only the tax-exempt organization's interest in the controlled entity, or the tax-exempt organization's control of a nonstock corporation's directors or trustees. In contrast, the section 4941 regulations' definition of control also considers interests held individually by the directors or trustees of the foundation). The temporary regulations provide that all consideration and benefits exchanged between a disqualified person and an applicable tax-exempt organization, and all entities the organization controls, are taken into account to determine whether there has been an excess benefit transaction.

The temporary regulations provide that an applicable tax-exempt organization provides an economic Start Printed Page 2150benefit indirectly through an intermediary when: (1) An applicable tax-exempt organization provides an economic benefit to a third party (the intermediary); (2) the intermediary provides economic benefits to a disqualified person of the applicable tax-exempt organization; and (3) either (a) there is evidence of an oral or written agreement or understanding that the intermediary will transfer property to a disqualified person; or (b) the intermediary lacks a significant business purpose or exempt purpose of its own for engaging in such a transfer. The temporary regulations also include four new examples illustrating different fact patterns under which economic benefits are provided indirectly to a disqualified person through a controlled entity or through an intermediary.

Initial Contract Exception

The proposed regulations do not provide any special rules for transactions conducted pursuant to the first contract that a previously unrelated person enters into with the applicable tax-exempt organization. Several comments received during the regular comment period requested that a person having no prior relationship with an organization not be considered a disqualified person with respect to the first contractual arrangement with the organization.

After the close of the written comment period for the proposed regulations (November 2, 1998), but before the public hearing (March 16 and 17, 1999), the United States Court of Appeals for the Seventh Circuit issued its decision in United Cancer Council, Inc. v. Commissioner of Internal Revenue, 165 F.3d 1173 (7th Cir. 1999), rev'ing and remanding 109 T.C. 326 (1997). In this case, the Seventh Circuit reversed the Tax Court's finding that a contract between a charity and a previously unrelated fundraising company resulted in private inurement in violation of the charity's tax-exempt status. The Seventh Circuit remanded the case back to the Tax Court to address the question whether the fundraising contract resulted in private benefit in violation of section 501(c)(3).

In United Cancer Council, the Seventh Circuit concluded that prohibited inurement under section 501(c)(3) cannot result from a contractual relationship negotiated at arm's length with a party having no prior relationship with the organization, regardless of the relative bargaining strength of the parties or resultant control over the tax-exempt organization created by the terms of the contract. The transactions at issue in United Cancer Council were conducted prior to the effective date of section 4958. Consequently, United Cancer Council involved interpretations of the general requirements for tax-exempt status under section 501(c)(3), and not questions of disqualified person status or the existence of an excess benefit transaction under section 4958. Nevertheless, at the public hearing and in supplemental comments received after the hearing, commentators referenced the Seventh Circuit decision and requested that the proposed regulations be modified so that section 4958 excise taxes will not be imposed on the first transaction or contract between an applicable tax-exempt organization and a previously unrelated person.

The temporary regulations address the issue raised by United Cancer Council by providing that section 4958 does not apply to any fixed payment made to a person pursuant to an initial contract, regardless of whether the payment would otherwise constitute an excess benefit transaction. For this purpose, an initial contract is defined as a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately prior to entering into the contract. A fixed payment means an amount of cash or other property specified in the contract, or determined by a fixed formula specified in the contract, which is paid or transferred in exchange for the provision of specified services or property. A fixed formula may incorporate an amount that depends upon future specified events or contingencies (e.g., revenues generated by activities of the organization), provided that no person exercises discretion when calculating the amount of a payment or deciding whether to make a payment. As suggested by some commentators, however, the initial contract rule does not apply if the contract is materially modified or if a person fails to substantially perform his or her obligations under the contract.

Thus, under the temporary regulations, to the extent that an applicable tax-exempt organization and a person who is not yet a disqualified person conduct negotiations and specify the amounts to be paid to the person (or specify an objective formula for paying that person), then these fixed payments are not subject to scrutiny under section 4958, even if paid after the person becomes a disqualified person. An initial contract may provide for both fixed and non-fixed (i.e., discretionary) payments. In this case, the fixed payments are not subject to section 4958, while the non-fixed payments will be subject to scrutiny under section 4958 (taking into account all consideration exchanged between the parties). In effect, the initial contract rule contained in the temporary regulations protects from section 4958 liability those payments made pursuant to fixed, objective terms specified in a contract entered into before the person was in a position to exercise substantial influence, yet allows for scrutiny under section 4958 to the extent the contract allows for subsequent discretion to be exercised (which may be subject to influence by the disqualified person) when calculating the amount of a payment or deciding whether to make a payment. The temporary regulations include eleven examples to illustrate the application of the initial contract rule.

Certain Economic Benefits Disregarded for Purposes of Section 4958

For ease of administration, the proposed regulations list several economic benefits that are disregarded for purposes of section 4958. These disregarded items include reimbursements for reasonable expenses of attending meetings of the governing body (but not luxury or spousal travel); certain economic benefits provided to a disqualified person solely as a member of, or volunteer for, the organization; and economic benefits provided to a disqualified person solely as a member of a charitable class. A number of comments recommended modifying these provisions.

With respect to reimbursements for expenses of attending meetings of the governing body (but not luxury travel or spousal travel), suggestions were made to clarify or delete these terms; to provide as an alternative that all travel expenses that are not lavish or extravagant within the meaning of section 162 may be disregarded; to disregard spousal travel expenses in circumstances where the spousal attendance furthers the exempt purposes of the organization or meets the section 274 bona fide business purpose test; and to address the issue of travel expenses by generally disregarding working condition fringe benefits and de minimis fringe benefits described in sections 132(d) and (e). Other commentators requested that any benefits received by a disqualified person should be disregarded if incidental to the organization's achievement of its exempt purposes, such as when disqualified persons attend fundraising dinners or conferences on behalf of the organization.

In response to these comments, the temporary regulations delete the Start Printed Page 2151separate provision that provides that reasonable expenses of attending meetings of the governing body may be disregarded. In place of this provision, the temporary regulations substitute a more general rule providing that all fringe benefits excluded from income under section 132 (except for certain liability insurance premiums, payments or reimbursements, discussed below) are disregarded for section 4958 purposes. This change addresses comments received on the limitation in the proposed regulations with respect to luxury and spousal travel. By referring to fringe benefits excluded from income under section 132, the temporary regulations adopt existing standards under section 162 and section 274 (which are incorporated into section 132) to determine whether payments or reimbursements of travel expenses of an employee or— any other expenses—should be disregarded for section 4958 purposes or, instead, treated as part of the disqualified person's compensation.

With respect to economic benefits provided to a disqualified person solely as a member of, or volunteer for, the organization, the proposed regulations disregard such benefits for section 4958 purposes only if the organization provides the same benefits to members of the general public in exchange for a membership fee of $75 or less per year. Commentators suggested that this provision be expanded in the final regulations to apply to any benefit (without a dollar limitation) provided to a disqualified person solely by virtue of that person being a donor, volunteer, or member, provided that any member of the general public making a comparable contribution receives a similar benefit. Another commentator requested a similar modification, with the additional requirement that a significant number of non-disqualified persons (e.g., 10 or more) actually make a comparable payment to the organization and are given the option of receiving substantially the same benefit.

The temporary regulations continue to disregard for section 4958 purposes economic benefits provided to a volunteer (who is also a disqualified person) if that benefit is provided by the organization to the general public in exchange for a membership fee or contribution of $75 or less per year. In contrast, economic benefits provided to a disqualified person as a member of, or a donor to, an applicable tax-exempt organization are no longer limited by a specific dollar cap. The temporary regulations disregard economic benefits provided to a member of an organization solely on account of the payment of a membership fee, or to a donor solely on account of a contribution deductible under section 170 if: (1) Any non-disqualified person paying a membership fee or making a contribution above a specified amount to the organization is given the option of receiving substantially the same economic benefit; and (2) the disqualified person and a significant number of non-disqualified persons in fact make a payment or contribution of at least the specified amount.

The temporary regulations clarify that section 162 standards apply in determining reasonableness of compensation for section 4958 purposes, taking into account all benefits provided to a person (other than benefits that are specifically disregarded for section 4958 purposes) and the rate at which any deferred compensation accrues. The temporary regulations also provide that the fact that a bonus or revenue-sharing arrangement is subject to a cap is a relevant factor in determining the reasonableness of compensation.

Insurance or Indemnification of Excise Taxes

The legislative history to section 4958 indicates that reimbursements of excise tax liability, or payment of premiums for liability insurance for excess benefit taxes, by an applicable tax-exempt organization constitute an excess benefit unless they are included in the disqualified person's compensation during the year paid and the total compensation package for that person is reasonable. See H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 58. Following this legislative history, the proposed regulations specifically provide that payment of a premium for insurance for section 4958 taxes or indemnification of a disqualified person for these taxes is not an excess benefit transaction if the premium or the indemnification is treated as compensation to the disqualified person when paid, and the total compensation paid to the person is reasonable. However, some commentators read the special rule in conjunction with another section of the proposed regulations—which listed “[t]he amount of premiums paid for liability or any other insurance coverage, as well as any payment or reimbursement by the organization of charges, expenses, fees, or taxes not covered ultimately by the insurance coverage” as an item included in compensation for purposes of section 4958—as potentially mandating that such insurance premium or indemnification payments be treated as taxable income to the disqualified person in order to avoid being characterized as an excess benefit transaction.

Several commentators requested that premiums for liability insurance be disregarded entirely for section 4958 purposes, along with non-compensatory indemnification of members of the governing body and officers against liability in civil proceedings (as described in the private foundation self-dealing regulations under section 4941), or that de minimis costs (e.g., $200) associated with such insurance coverage be disregarded.

Other commentators suggested that a portion of the premium payment be allocated to section 4958 tax coverage, and that only that portion be included in compensation of the disqualified person. Others requested that the portion of a premium allocable to liability insurance coverage for an organization manager who is also a disqualified person to cover the person's potential liability for the manager-level tax under section 4958(a)(2) be considered a working condition fringe under section 132(d). Others requested that benefits under indemnification plans be taken into account for section 4958 purposes only if and when paid.

To clarify the treatment of insurance premiums and reimbursements of excise tax liability, the temporary regulations include a special rule, which includes in a disqualified person's compensation for section 4958 purposes the payment of liability insurance premiums for, or the payment or reimbursement by the organization of: (1) Any penalty, tax, or expense of correction owed under section 4958; (2) any expense not reasonably incurred by the person in connection with a civil judicial or civil administrative proceeding arising out of the person's performance of services on behalf of the applicable tax-exempt organization; and (3) any expense resulting from an act or failure to act with respect to which the person has acted willfully and without reasonable cause. This rule parallels the section 4941 regulations governing the treatment of directors and officers liability insurance and indemnification. As under the section 4941 regulations, however, the temporary regulations provide that insurance premiums and reimbursements may be disregarded if they qualify as de minimis fringe benefits excludable from income under section 132(a)(4).

In addition, the temporary regulations clarify that the inclusion of an item in compensation for section 4958 purposes does not govern its income tax treatment. Thus, the mere fact that a premium or reimbursement payment, or any other benefit, provided to a Start Printed Page 2152disqualified person must be taken into account in determining the reasonableness of that person's total compensation package for section 4958 purposes is not determinative of whether or not that benefit is included in the disqualified person's gross income for income tax purposes.

Timing Rules for Determining Reasonableness

Section 4958(c)(1) defines an excess benefit transaction as a transaction in which the value of an economic benefit provided to a disqualified person exceeds the value of the consideration received (including the performance of services), but the statutory provisions do not directly address the issue of when to value the benefits and consideration exchanged. In this regard, the proposed regulations provide that whether compensation is reasonable is generally determined when the parties enter into the contract for services. The proposed regulations further provide, however, that “where reasonableness of compensation cannot be determined based on circumstances existing at the date when the contract for services was made, then that determination is made based on all facts and circumstances, up to and including circumstances as of the date of payment.” Many commentators objected to the uncertainty created by this additional sentence.

To clarify the issue of the timing of the reasonableness determination, the temporary regulations provide that reasonableness is determined with respect to any fixed payment (as defined for purposes of the initial contract rule discussed above) at the time the parties enter into the contract. However, the temporary regulations provide that the reasonableness of any amounts not fixed in the contract itself or paid pursuant to an objective formula is determined based on all facts and circumstances, up to and including circumstances as of the date of the payment at issue, because determining the amount of such a payment (or whether a payment is made) requires the exercise of discretion after the contract is entered into.

Establishing Intent To Treat Economic Benefit as Consideration for the Performance of Services

The second sentence of section 4958(c)(1)(A) defining excess benefit transaction states that an economic benefit will not be treated as consideration for the performance of services unless the applicable tax-exempt organization clearly indicated its intent to so treat the benefit. The proposed regulations generally require the organization to provide clear and convincing evidence of its intent to treat the benefit as compensation for services when the benefit is paid. Under the proposed regulations, this requirement is satisfied if the organization reports the economic benefit on a federal tax information return filed before the commencement of an IRS examination in which the reporting of the benefit is questioned, or if the recipient disqualified person reports the benefit as income on the person's Form 1040 for the year in which the benefit is received. In addition, an organization is deemed to satisfy the clear and convincing evidence requirement if the organization's failure to report a payment is due to reasonable cause as defined in the section 6724 regulations. The proposed regulations also provide that an organization may use other methods to provide clear and convincing evidence of its intent. The preamble of the proposed regulations explicitly solicited comments on appropriate ways of applying this rule that would not create an unnecessary burden on affected organizations.

A number of comments were received with regard to establishing an organization's intent to treat a benefit as compensation for services. Several commentators suggested that the clear and convincing standard is higher than appropriate. Others requested that organizations not be required to demonstrate intent with respect to specific benefits, such as: reimbursement arrangements that are clearly part of the employment arrangement; de minimis amounts (for example, taxable benefits of up to $500 per year provided to a disqualified person); and certain nontaxable benefits. Other commentators requested that final regulations clarify the appropriate method for substantiating an organization's intent in the case of certain nontaxable benefits and transfers of property subject to section 83. Others requested guidance on how to report compensation paid to a disqualified person on Form 990 if that person is not an officer or director or one of the five highest paid employees. Some commentators suggested that the final regulations allow other methods to establish an intention to treat benefits as compensation, such as a written contract of employment. Commentators also suggested that an organization's reasonable belief that a benefit is nontaxable should constitute reasonable cause for failure to report, or that the reasonable cause standard be expanded to ordinary business care and prudence.

In response to these comments, the temporary regulations modify the requirement that an organization provide clear and convincing evidence of its intent to treat benefits provided to a disqualified person as compensation for services. Consistent with the legislative history, the temporary regulations provide instead that an organization must provide “written substantiation that is contemporaneous with the transfer of benefits at issue.” H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 57, note 8.

The temporary regulations also provide a safe harbor for nontaxable benefits. Under this safe harbor, an applicable tax-exempt organization is not required to indicate its intent to provide an economic benefit as compensation for services if the economic benefit is excluded from the disqualified person's gross income for income tax purposes under chapter 1 of the Internal Revenue Code. Examples of such benefits include: employer-provided health benefits, contributions to a qualified pension, profit-sharing, or stock bonus plan under Internal Revenue Code section 401(a), and benefits described in sections 127 (educational assistance programs) and 137 (adoption assistance programs). The safe harbor is consistent with the legislative history, which indicates that Congress intended to except nontaxable benefits from this contemporaneous substantiation requirement. H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 57, note 8. However, the benefits must still be taken into account (unless specifically disregarded under the regulations) in determining the reasonableness of the disqualified person's compensation for purposes of section 4958.

Consistent with the legislative history, the temporary regulations also clarify that, if a benefit is not reported on a return filed with the IRS, other written contemporaneous evidence (such as an approved written employment contract executed on or before the date of the transfer) may be used to demonstrate that the appropriate decision-making body or an authorized officer approved a transfer as compensation for services in accordance with established procedures.

Transaction in Which the Amount of the Economic Benefit Is Determined in Whole or in Part by the Revenues of One or More Activities of the Organization

Section 4958(c)(2) describes a second type of excess benefit transaction: “any transaction in which the amount of any economic benefit provided to or for the use of a disqualified person is determined in whole or in part by the revenues of 1 or more activities of the organization * * *”, if the transaction Start Printed Page 2153results in inurement under section 501(c)(3) or (4). However, a revenue-sharing transaction is treated as an excess benefit transaction under this special statutory rule only “[t]o the extent provided in regulations prescribed by the Secretary * * *. ”

The proposed regulations provide that whether a revenue-sharing transaction results in inurement, and therefore constitutes an excess benefit transaction, depends upon all relevant facts and circumstances. The proposed regulations provide that, in general, a revenue-sharing transaction may constitute an excess benefit transaction regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of services (or other consideration) rendered, if a disqualified person is permitted to receive additional compensation without providing proportional benefits that contribute to the organization's accomplishment of its exempt purpose.

The proposed regulations consider an improper revenue-sharing transaction, in its entirety, to be an excess benefit subject to section 4958. Special rules governing revenue-sharing transactions, however, will be effective only for transactions occurring on or after the date of publication of final regulations containing such rules. Until special rules for revenue-sharing transactions are adopted in final regulations, these transactions are potentially subject to section 4958 liability under the general rules governing excess benefit transactions, but only to the extent that the value of the economic benefits provided to the disqualified person is shown to exceed the value of the services (or other consideration) received in return.

Numerous comments were received with respect to revenue-sharing transactions. Some commentators did not believe a different standard from that applied to all other transactions (fair market value) should apply, and that the value of consideration provided by a disqualified person in a revenue-sharing transaction should be taken into account in determining the excess benefit in these transactions.

Others objected to the revenue-sharing transaction standard of the proposed regulations, and requested that it be replaced by a standard based on approaches the IRS has taken in prior unpublished rulings. Some commentators requested guidance as to the meaning of proportional benefits or other concepts incorporated in the proposed regulations standard. Others requested that existing contractual arrangements not be subject to this section of the final regulations, or that the effect of the final rules for existing arrangements be phased in. In addition, several commentators requested that the final regulations clarify whether the rebuttable presumption of reasonableness is available for revenue-sharing transactions. In sum, commentators offered multiple, often conflicting, suggestions and recommendations to address the many issues raised with respect to revenue-sharing transactions.

The temporary regulations reserve the separate section governing revenue-sharing transactions. Accordingly, the IRS and the Treasury Department will continue to consider the many comments received on this issue. Any revised regulations that may, in the future, be issued governing revenue-sharing transactions in particular will be issued in proposed form. This will provide an additional opportunity for public comment, and any special rules governing revenue-sharing transactions will become effective only after being published in final form. In the meantime, revenue sharing transactions will be evaluated under the general rules (contained in § 53.4958-4T of the temporary regulations) defining excess benefit transactions, which apply to all transactions with disqualified persons regardless of whether the person's compensation is computed by reference to revenues of the organization.

Rebuttable Presumption That a Transaction is not an Excess Benefit Transaction

Although the statute is silent on this point, the legislative history accompanying section 4958 indicated Congress' intent that the parties to a transaction are entitled to rely on a rebuttable presumption of reasonableness with respect to any transaction with a disqualified person that is approved by a board of directors or trustees (or committee thereof) that: (1) Is composed entirely of individuals unrelated to and not subject to the control of the disqualified person(s) involved in the transaction; (2) obtained and relied upon appropriate data as to comparability; and (3) adequately documented the basis for its determination. If these three requirements are satisfied, the IRS can impose section 4958 taxes only if it develops sufficient contrary evidence to rebut the probative value of the evidence put forth by the parties to the transaction. H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 56-7.

The proposed regulations incorporate this rebuttable presumption and provide guidance regarding the three requirements for invoking the rebuttable presumption. The proposed regulations provide that the presumption established by satisfying the three requirements may be rebutted by additional information showing that the compensation was not reasonable or that the transfer was not at fair market value. Additionally, the proposed regulations provide that, if the reasonableness of compensation cannot be determined based on circumstances existing at the date when a contract for services was made, then the presumption cannot arise until reasonableness of compensation can be determined and the three requirements subsequently are satisfied.

Comments were received on various aspects of the rebuttable presumption of reasonableness. With regard to the requirement that the compensation arrangement or property transfer must be approved by a governing body (or committee) composed entirely of individuals who do not have a conflict of interest with respect to the transaction, one commentator suggested that the final regulations adopt standards consistent with the model conflicts of interest policy published by the IRS. The IRS and the Treasury Department believe that the standards contained in the proposed regulations for determining the absence of a conflict of interest are consistent with the legislative history of section 4958, which requires that the governing body (or committee) be composed entirely of individuals who are free of any conflict of interest, and not merely that its members disclose the existence of any conflict of interest. Accordingly, the temporary regulations retain these standards.

With regard to the requirement that the governing body (or a committee thereof) obtain appropriate data as to comparability, numerous commentators requested that the final regulations expand the acceptable types of comparability data and authorize additional methods for determining fair market value or reasonable compensation. For example, some commentators requested clarification that an organization need not obtain an independent, customized survey, but may rely on an independent salary survey prepared for general publication if that survey contains information specific enough to provide meaningful data for comparison purposes. Other commentators requested that the governing body (or committee) be permitted to rely on compensation surveys compiled by staff members (other than disqualified persons) under the supervision of an independent Start Printed Page 2154director or committee member, rather than incurring the additional cost of obtaining compensation surveys compiled by independent firms. Some commentators requested that the final regulations provide that comparability data is viable for some period of time (e.g., three years).

The temporary regulations continue to require only that the authorized body have sufficient information to determine whether, consistent with the valuation standards in other sections of the regulations, the compensation arrangement is reasonable, or the property transfer is at fair market value. The temporary regulations clarify that a compensation arrangement in its entirety must be evaluated and also provide examples of relevant comparability data. In the case of a compensation arrangement, the temporary regulations provide that relevant information may include a current compensation survey compiled by an independent firm. As in the proposed regulations, this list of relevant comparability data is not exclusive, and the authorized body may rely on other appropriate data. For clarity, the temporary regulations list separately examples of the types of relevant information for compensation arrangements and property transfers. The temporary regulations add competitive bids received from unrelated third parties as another example of relevant information in the case of a property transfer. In response to comments, the temporary regulations revise examples from the proposed regulations and add several examples illustrating appropriate comparability data.

Comments were also received regarding the special rule for compensation paid by small organizations. The proposed regulations allow small organizations (those with annual gross receipts of less than $1 million) to satisfy the requirement of appropriate data as to comparability by obtaining data on compensation paid by five comparable organizations in the same or similar communities for similar services. Some commentators indicated that the $1 million threshold is too low, because organizations having gross receipts above that amount may lack the resources to hire an independent compensation firm. These commentators requested that the ceiling for small organizations be increased from $1 million to $5 million in gross receipts. Others suggested allowing small organizations to obtain data from fewer than five comparable organizations.

The IRS and the Treasury Department believe the general rule regarding appropriate comparability data is flexible enough to permit any organization (not just small organizations) to compile its own comparability data. Therefore, the IRS and the Treasury Department did not believe it was necessary to extend the special safe-harbor rule to organizations with annual gross receipts over $1 million. As requested by commentators, however, the temporary regulations reduce the number of comparables small organizations must obtain for that safe harbor from five to three.

Certain commentators requested that the final regulations provide a mechanism for an applicable tax-exempt organization to satisfy the requirements of the rebuttable presumption of reasonableness with respect to large groups of employees, such as mid-level managers, rather than requiring the governing body to approve the compensation paid to each individual. The IRS and the Treasury Department believe that changes to the definition of disqualified person in the temporary regulations, including eliminating as a factor tending to show substantial influence the fact that a person has any managerial authority, or serves as a key advisor to a manager, reduce the potential burden on the governing body. Moreover, the temporary regulations continue to allow the governing body to delegate responsibility for approving compensation arrangements and property transfers, to the extent permitted under State law. Consistent with the legislative history, the temporary regulations continue to require that the rebuttable presumption requirements be satisfied on an individual basis.

With respect to the requirement that the governing body (or committee) adequately document the basis for its determination, comments were received requesting that the final regulations allow additional time for records to be prepared. In response to these comments, the temporary regulations provide that the records must be prepared by the later of the next meeting of the authorized body or 60 days after final approval of the particular arrangement or transfer. Although one commentator objected to the requirement in the proposed regulations that the governing body (or committee) review and approve the records within a reasonable period of time thereafter, the temporary regulations retain this requirement in order to ensure that the records are accurate and complete.

Several commentators requested that the final regulations permit organizations to establish a rebuttable presumption of reasonableness with respect to deferred or contingent compensation arrangements when the contract for services is entered into if the terms of the arrangement are sufficiently certain (even if the exact dollar amounts are not known) and the governing body (or committee) obtains appropriate data as to comparability. Other commentators simply requested that the final regulations indicate when the board should take the necessary steps to put the presumption in place in the event that reasonableness cannot be determined as of the date the contract is entered into. Consistent with the general rule contained in the temporary regulations regarding the timing of the reasonableness determination, the temporary regulations provide that, with respect to fixed payments (including payments made pursuant to a fixed formula, although the exact dollar amount is not known at the time the contract is entered into), the rebuttable presumption can arise at the time the parties enter into the contract giving rise to the payments. Under a special rule in the temporary regulations, payments pursuant to a qualified pension, profit-sharing, or stock bonus plan under section 401(a) are treated as fixed payments for purposes of section 4958, even if the employer exercises discretion with respect to the plan or program. Therefore, a rebuttable presumption can arise with respect to such payments at the time the parties enter into the contract for services.

In contrast, the temporary regulations provide that the rebuttable presumption generally can arise with respect to a payment that is not a fixed payment (as defined for purposes of the initial contract exception) only after discretion is exercised, the exact amount of the payment is determined (or a fixed formula for calculating the payment is specified), and the three requirements for the presumption subsequently are satisfied. The temporary regulations contain a limited exception to this general rule for certain non-fixed payments which are subject to a cap. Under this exception, an applicable tax-exempt organization may establish the rebuttable presumption, even with respect to non-fixed payments, at the time the contract is entered into if: (1) Prior to approving the contract, the governing body (or committee) obtains appropriate comparability data indicating that a fixed payment of up to a certain amount to a particular disqualified person would represent reasonable compensation; (2) the maximum amount payable under the Start Printed Page 2155contract (including both fixed and non-fixed payment amounts) does not exceed the reasonable compensation figure; and (3) the other requirements for establishing the rebuttable presumption are satisfied. However, the general rules for the timing of the reasonableness determination apply, such that the IRS may rebut the presumption of reasonableness with respect to a non-fixed payment subject to a cap based on all facts and circumstances, up to and including circumstances as of the date of payment.

Some commentators suggested that the final regulations provide specific standards the IRS must meet in order to rebut any presumption established by satisfying the three requirements described above. For example, one commentator suggested that the IRS should be allowed to overcome the presumption only if it is able to produce clear and convincing evidence that the transaction was, in fact, an excess benefit transaction. Another commentator suggested that the IRS should be required to establish that one of the requirements for invoking the presumption has not been met in order to rebut the presumption. Consistent with the legislative history, the temporary regulations provide that, if the rebuttable presumption of reasonableness is established, the IRS may rebut the presumption only if it develops sufficient contrary evidence to rebut the probative value of the comparability data relied upon by the authorized body.

Finally, some commentators requested clarification whether entities controlled by or affiliated with an applicable tax-exempt organization that provide economic benefits to a disqualified person can establish the presumption, even if those entities are not themselves applicable tax-exempt organizations. Consistent with the rules relating to indirect excess benefit transactions, the temporary regulations clarify that an authorized body of an entity controlled by an applicable tax-exempt organization (as defined for purposes of describing indirect transfers of economic benefits) may establish the rebuttable presumption.

Special Rules

The proposed regulations provided several special rules, one of which stated that the procedures of section 7611 will be used in initiating and conducting any inquiry or examination into whether an excess benefit transaction has occurred between a church and a disqualified person. Several comments were received on this rule, including one stating that there is no statutory authority to extend section 7611 protection to churches for section 4958 tax inquiries. Other comments requested that final regulations specify when information from an informant alone is sufficient to form the basis for a reasonable belief on the part of the IRS for purposes of applying this rule, and clarify how section 4958 interacts with the section 7611 exception for records related to the income tax of an individual employed by the church. The temporary regulations do not modify the special rules for churches.

Additional Issues

Section 4958 does not contain provisions governing the relationship of the taxes imposed under that section to revocation of the organization's tax-exempt status under sections 501(c)(3) and (4). With respect to this issue, the legislative history to section 4958 indicates as follows: “In general, the intermediate sanctions are the sole sanction imposed in those cases in which the excess benefit does not rise to a level where it calls into question whether, on the whole, the organization functions as a charitable or other tax-exempt organization. In practice, revocation of tax-exempt status, with or without the imposition of excise taxes, would occur only when the organization no longer operates as a charitable organization.” H. REP. NO. 506, 104th Congress, 2d SESS. (1996), 53, 59, note 15. However, the same legislative history also indicates that “[t]he intermediate sanctions for ‘excess benefit transactions’ may be imposed by the IRS in lieu of (or in addition to) revocation of the organization's tax-exempt status.” Id. at 59 (emphasis added)

In the Comments and Requests for a Public Hearing section of the preamble of the proposed regulations, the IRS and the Treasury Department specifically requested comments concerning the relationship between revocation of tax-exempt status and imposition of section 4958 taxes. Additionally, the preamble of the proposed regulations lists four factors that the IRS will consider in determining whether to revoke an applicable tax-exempt organization's status: (1) Whether the organization has been involved in repeated excess benefit transactions; (2) the size and scope of the excess benefit transaction; (3) whether, after concluding that it has been party to an excess benefit transaction, the organization has implemented safeguards to prevent future recurrences; and (4) whether there was compliance with other applicable laws. The preamble also states that the IRS intends to publish the factors that it will consider in exercising its administrative discretion in guidance issued in conjunction with the issuance of final regulations under section 4958.

A number of commentators requested that the final regulations expressly provide that section 4958 taxes are the principal sanction with respect to excess benefit transactions, in lieu of revocation of the organization's tax-exempt status. Other commentators suggested that the final regulations incorporate factors to be considered by the IRS in deciding whether to impose section 4958 excise taxes or revoke tax-exempt status, or both.

The temporary regulations do not foreclose revocation of tax-exempt status in appropriate cases. The IRS and the Treasury Department believe that to do so would effectively change the substantive standard for tax-exempt status under sections 501(c)(3) and (4). Accordingly, the IRS intends to exercise its administrative discretion in enforcing the requirements of sections 4958, 501(c)(3) and 501(c)(4) in accordance with the direction given in the legislative history. The IRS will publish guidance concerning the factors that it will consider in exercising its discretion as it gains more experience administering the section 4958 regime.

The temporary regulations reiterate that section 4958 does not affect the substantive standards for tax exemption under section 501(c)(3) or (4), including the requirements that the organization be organized and operated exclusively for exempt purposes, and that no part of its earnings inure to the benefit of any private shareholder or individual. Thus, regardless of whether a particular transaction is subject to excise taxes under section 4958, existing principles and rules may be implicated, such as the limitation on private benefit. For example, transactions that are not subject to section 4958 because of the initial contract exception may, under certain circumstances, jeopardize an organizations's tax-exempt status.

Some comments regarding revenue-sharing transactions included requests to address gainsharing arrangements in the final regulations; or to provide that certain transactions are not revenue-sharing arrangements because they do not involve a payment that is contingent on the revenues of (but rather the cost savings to) the organization. As noted earlier, these temporary regulations reserve the separate section governing revenue-sharing transactions. However, because the Office of Inspector General, Department of Health and Human Services, believes the methodology involved in calculating payments under gainsharing arrangements may violate Start Printed Page 2156sections 1128A(b)(1) and (2) of the Social Security Act in situations where patient care may be affected by the cost savings, the IRS will not issue private letter rulings under section 4958 on these arrangements. The Office of Inspector General issued a Special Advisory Bulletin on July 8, 1999, addressing the application of sections 1128A(b)(1) and (2) of the Social Security Act to gainsharing arrangements, entitled “Gainsharing Arrangements and CMPs [Civil Money Penalties] for Hospital Payments to Physicians to Reduce or Limit Services to Beneficiaries”.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. Because no preceding notice of proposed rulemaking is required for this temporary regulation, the provisions of the Regulatory Flexibility Act do not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this temporary regulation will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on business.

Drafting Information

The principal author of these regulations is Phyllis D. Haney, Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS and The Treasury Department participated in their development.

Start List of Subjects

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
End List of Subjects

Amendments to the Regulations

Accordingly, 26 CFR parts 53, 301, and 602 are amended as follows:

Start Part

PART 53—FOUNDATION AND SIMILAR EXCISE TAXES

End Part Start Amendment Part

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

End Amendment Part Start Authority

Authority: 26 U.S.C. 7805.

End Authority Start Amendment Part

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

End Amendment Part
Table of contents (temporary).

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

Taxes on excess benefit transactions (temporary).

(a) In general.

(b) Excess benefit defined.

(c) Taxes paid by disqualified person.

(1) Initial tax.

(2) Additional tax on disqualified person.

(i) In general.

(ii) Taxable period.

(iii) Abatement if correction during the correction period.

(d) Tax paid by organization managers.

(1) In general.

(2) Organization manager defined.

(i) In general.

(ii) Special rule for certain committee members.

(3) Participation.

(4) Knowing.

(i) In general.

(ii) Amplification of general rule.

(iii) Reliance on professional advice.

(iv) Reliance on rebuttable presumption of reasonableness.

(5) Willful.

(6) Due to reasonable cause.

(7) Limits on liability for management.

(8) Joint and several liability.

(9) Burden of proof.

(e) Date of occurrence.

(1) In general.

(2) Special rules.

(3) Statute of limitations rules.

(f) Effective date for imposition of taxes.

(1) In general.

(2) Existing binding contracts.

Definition of applicable tax-exempt organization (temporary).

(a) Organizations described in section 501(c)(3) or (4) and exempt from tax under section 501(a).

(1) In general.

(2) Organizations described in section 501(c)(3).

(3) Organizations described in section 501(c)(4).

(4) Effect of non-recognition or revocation of exempt status.

(b) Special rules.

(1) Transition rule for lookback period.

(2) Certain foreign organizations.

Definition of disqualified person (temporary).

(a) In general.

(1) Scope of definition.

(2) Transition rule for lookback period.

(b) Statutory categories of disqualified persons.

(1) Family members.

(2) Thirty-five percent controlled entities.

(i) In general.

(ii) Combined voting power.

(iii) Constructive ownership rules.

(A) Stockholdings.

(B) Profits or beneficial interest.

(c) Persons having substantial influence.

(1) Voting members of the governing body.

(2) Presidents, chief executive officers, or chief operating officers.

(3) Treasurers and chief financial officers.

(4) Persons with a material financial interest in a provider-sponsored organization.

(d) Persons deemed not to have substantial influence.

(1) Tax-exempt organizations described in section 501(c)(3).

(2) Certain section 501(c)(4) organizations.

(3) Employees receiving economic benefits of less than a specified amount in a taxable year.

(e) Facts and circumstances govern in all other cases.

(1) In general.

(2) Facts and circumstances tending to show substantial influence.

(3) Facts and circumstances tending to show no substantial influence.

(f) Affiliated organizations.

(g) Examples.

Excess benefit transaction (temporary).

(a) Definition of excess benefit transaction.

(1) In general.

(2) Economic benefit provided indirectly.

(i) In general.

(ii) Through a controlled entity.

(A) In general.

(B) Definition of control.

(1) In general.

(2) Constructive ownership.

(iii) Through an intermediary.

(iv) Examples.

(3) Exception for fixed payments made pursuant to an initial contract.

(i) In general. Start Printed Page 2157

(ii) Fixed payment.

(A) In general.

(B) Special rules.

(iii) Initial contract.

(iv) Substantial performance required.

(v) Treatment as a new contract.

(vi) Evaluation of non-fixed payments.

(vii) Examples.

(4) Certain economic benefits disregarded for purposes of section 4958.

(i) Nontaxable fringe benefits.

(ii) Certain economic benefits provided to a volunteer for the organization.

(iii) Certain economic benefits provided to a member of, or donor to, the organization.

(iv) Economic benefits provided to a charitable beneficiary.

(v) Certain economic benefits provided to a governmental unit.

(b) Valuation standards.

(1) In general.

(i) Fair market value of property.

(ii) Reasonable compensation.

(A) In general.

(B) Items included in determining the value of compensation for purposes of determining reasonableness under section 4958.

(C) Inclusion in compensation for reasonableness determination does not govern income tax treatment.

(2) Timing of reasonableness determination.

(i) In general.

(ii) Treatment as a new contract.

(iii) Examples.

(c) Establishing intent to treat economic benefit as consideration for the performance of services.

(1) In general.

(2) Nontaxable benefits.

(3) Contemporaneous substantiation.

(i) Reporting of benefit.

(ii) Other evidence of contemporaneous substantiation.

(iii) Failure to report due to reasonable cause.

(4) Examples.

Transaction in which the amount of the economic benefit is determined in whole or in part by the revenues of one or more activities of the organization (temporary). [Reserved]
Rebuttable presumption that a transaction is not an excess benefit transaction (temporary).

(a) In general.

(b) Rebutting the presumption.

(c) Requirements for invoking rebuttable presumption.

(1) Approval by an authorized body.

(i) In general.

(ii) Individuals not included on authorized body.

(iii) Absence of conflict of interest.

(2) Appropriate data as to comparability.

(i) In general.

(ii) Special rule for compensation paid by small organizations.

(iii) Application of special rule for small organizations.

(iv) Examples.

(3) Documentation.

(d) No presumption with respect to non-fixed payments until amounts are determined.

(1) In general.

(2) Special rule for certain non-fixed payments subject to a cap.

(e) No inference from absence of presumption.

(f) Period of reliance on rebuttable presumption.

Correction (temporary).

(a) In general.

(b) Form of correction.

(1) Cash or cash equivalents.

(2) Anti-abuse rule.

(3) Special rule relating to nonqualified deferred compensation.

(4) Return of specific property.

(i) In general.

(ii) Payment not equal to correction amount.

(iii) Disqualified person may not participate in decision.

(c) Correction amount.

(d) Correction where contract has been partially performed.

(e) Correction in the case of an applicable tax-exempt organization that has ceased to exist, or is no longer tax-exempt.

(1) In general.

(2) Section 501(c)(3) organizations.

(3) Section 501(c)(4) organizations.

(f) Examples.

Special rules (temporary).

(a) Substantive requirements for exemption still apply.

(b) Interaction between section 4958 and section 7611 rules for church tax inquiries and examinations.

(c) Three year duration of these temporary regulations.

Taxes on excess benefit transactions (temporary).

(a) In general. Section 4958 imposes excise taxes on each excess benefit transaction (as defined in section 4958(c) and § 53.4958-4T) between an applicable tax-exempt organization (as defined in section 4958(e) and § 53.4958-2T) and a disqualified person (as defined in section 4958(f)(1) and § 53.4958-3T). A disqualified person who receives an excess benefit from an excess benefit transaction is liable for payment of a section 4958(a)(1) excise tax equal to 25 percent of the excess benefit. If an initial tax is imposed by section 4958(a)(1) on an excess benefit transaction and the transaction is not corrected (as defined in section 4958(f)(6) and § 53.4958-7T) within the taxable period (as defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section), then any disqualified person who received an excess benefit from the excess benefit transaction on which the initial tax was imposed is liable for an additional tax of 200 percent of the excess benefit. An organization manager (as defined in section 4958(f)(2) and paragraph (d) of this section) who participates in an excess benefit transaction, knowing that it was such a transaction, is liable for payment of a section 4958(a)(2) excise tax equal to 10 percent of the excess benefit, unless the participation was not willful and was due to reasonable cause. If an organization manager also receives an excess benefit from an excess benefit transaction, the manager may be liable for both taxes imposed by section 4958(a).

(b) Excess benefit defined. An excess benefit is the amount by which the value of the economic benefit provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person exceeds the value of the consideration (including the performance of services) received for providing such benefit.

(c) Taxes paid by disqualified person—(1) Initial tax. Section 4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on each excess benefit transaction. The section 4958(a)(1) tax shall be paid by any disqualified person who received an excess benefit from that excess benefit transaction. With respect to any excess benefit transaction, if more than one disqualified person is liable for the tax imposed by section 4958(a)(1), all such persons are jointly and severally liable for that tax.

(2) Additional tax on disqualified person—(i) In general. Section 4958(b) imposes a tax equal to 200 percent of the excess benefit in any case in which section 4958(a)(1) imposes a 25-percent tax on an excess benefit transaction and the transaction is not corrected (as defined in section 4958(f)(6) and § 53.4958-7T) within the taxable period (as defined in section 4958(f)(5) and paragraph (c)(2)(ii) of this section). If a disqualified person makes a payment of less than the full correction amount under the rules of § 53.4958-7T, the 200-percent tax is imposed only on the unpaid portion of the correction amount (as described in § 53.4958-7T(c)). The tax imposed by section 4958(b) is payable by any disqualified person who Start Printed Page 2158received an excess benefit from the excess benefit transaction on which the initial tax was imposed by section 4958(a)(1). With respect to any excess benefit transaction, if more than one disqualified person is liable for the tax imposed by section 4958(b), all such persons are jointly and severally liable for that tax.

(ii) Taxable period. Taxable period means, with respect to any excess benefit transaction, the period beginning with the date on which the transaction occurs and ending on the earlier of—

(A) The date of mailing a notice of deficiency under section 6212 with respect to the section 4958(a)(1) tax; or

(B) The date on which the tax imposed by section 4958(a)(1) is assessed.

(iii) Abatement if correction during the correction period. For rules relating to abatement of taxes on excess benefit transactions that are corrected within the correction period, as defined in section 4963(e), see sections 4961(a), 4962(a), and the regulations thereunder. The abatement rules of section 4961 specifically provide for a 90-day correction period after the date of mailing a notice of deficiency under section 6212 with respect to the section 4958(b) 200-percent tax. If the excess benefit is corrected during that correction period, the 200-percent tax imposed shall not be assessed, and if assessed the assessment shall be abated, and if collected shall be credited or refunded as an overpayment. For special rules relating to abatement of the 25-percent tax, see section 4962.

(d) Tax paid by organization managers—(1) In general. In any case in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a tax equal to 10 percent of the excess benefit on the participation of any organization manager who knowingly participated in the excess benefit transaction, unless such participation was not willful and was due to reasonable cause. Any organization manager who so participated in the excess benefit transaction must pay the tax.

(2) Organization manager defined—(i) In general. An organization manager is, with respect to any applicable tax-exempt organization, any officer, director, or trustee of such organization, or any individual having powers or responsibilities similar to those of officers, directors, or trustees of the organization, regardless of title. A person is an officer of an organization if that person—

(A) Is specifically so designated under the certificate of incorporation, by-laws, or other constitutive documents of the organization; or

(B) Regularly exercises general authority to make administrative or policy decisions on behalf of the organization. An independent contractor who acts solely in a capacity as an attorney, accountant, or investment manager or advisor, is not an officer. For purposes of this paragraph (d)(2)(i)(B), any person who has authority merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior, is not an officer.

(ii) Special rule for certain committee members. An individual who is not an officer, director, or trustee, yet serves on a committee of the governing body of an applicable tax-exempt organization (or as a designee of the governing body described in § 53.4958-6T(c)(1)) that is attempting to invoke the rebuttable presumption of reasonableness described in § 53.4958-6T based on the committee's (or designee's) actions, is an organization manager for purposes of the tax imposed by section 4958(a)(2).

(3) Participation. For purposes of section 4958(a)(2) and paragraph (d) of this section, participation includes silence or inaction on the part of an organization manager where the manager is under a duty to speak or act, as well as any affirmative action by such manager. An organization manager is not considered to have participated in an excess benefit transaction, however, where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager's responsibilities to the applicable tax-exempt organization.

(4) Knowing—(i) In general. For purposes of section 4958(a)(2) and paragraph (d) of this section, a manager participates in a transaction knowingly only if the person—

(A) Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction;

(B) Is aware that such a transaction under these circumstances may violate the provisions of federal tax law governing excess benefit transactions; and

(C) Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.

(ii) Amplification of general rule. Knowing does not mean having reason to know. However, evidence tending to show that a manager has reason to know of a particular fact or particular rule is relevant in determining whether the manager had actual knowledge of such a fact or rule. Thus, for example, evidence tending to show that a manager has reason to know of sufficient facts so that, based solely upon such facts, a transaction would be an excess benefit transaction is relevant in determining whether the manager has actual knowledge of such facts.

(iii) Reliance on professional advice. An organization manager's participation in a transaction is ordinarily not considered knowing within the meaning of section 4958(a)(2), even though the transaction is subsequently held to be an excess benefit transaction to the extent that, after full disclosure of the factual situation to an appropriate professional, the organization manager relies on a reasoned written opinion of that professional with respect to elements of the transaction within the professional's expertise. For purposes of section 4958(a)(2) and this paragraph (d), a written opinion is reasoned even though it reaches a conclusion that is subsequently determined to be incorrect so long as the opinion addresses itself to the facts and the applicable standards. However, a written opinion is not reasoned if it does nothing more than recite the facts and express a conclusion. The absence of a written opinion of an appropriate professional with respect to a transaction shall not, by itself, however, give rise to any inference that an organization manager participated in the transaction knowingly. For purposes of this paragraph, appropriate professionals on whose written opinion an organization manager may rely, are limited to—

(A) Legal counsel, including in-house counsel;

(B) Certified public accountants or accounting firms with expertise regarding the relevant tax law matters; and

(C) Independent valuation experts who—

(1) Hold themselves out to the public as appraisers or compensation consultants;

(2) Perform the relevant valuations on a regular basis;

(3) Are qualified to make valuations of the type of property or services involved; and

(4) Include in the written opinion a certification that the requirements of paragraphs (d)(4)(iii)(C)(1) through (3) of this section are met.

(iv) Reliance on rebuttable presumption of reasonableness. An organization manager's participation in a transaction is ordinarily not considered knowing within the meaning of section 4958(a)(2), even though the transaction is subsequently held to be an excess benefit transaction, if the organization manager relies on the fact Start Printed Page 2159that the requirements of § 53.4958-6T(a) are satisfied with respect to the transaction.

(5) Willful. For purposes of section 4958(a)(2) and this paragraph (d), participation by an organization manager is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make the participation willful. However, participation by an organization manager is not willful if the manager does not know that the transaction in which the manager is participating is an excess benefit transaction.

(6) Due to reasonable cause. An organization manager's participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence.

(7) Limits on liability for management. The maximum aggregate amount of tax collectible under section 4958(a)(2) and this paragraph (d) from organization managers with respect to any one excess benefit transaction is $10,000.

(8) Joint and several liability. In any case where more than one person is liable for a tax imposed by section 4958(a)(2), all such persons shall be jointly and severally liable for the taxes imposed under section 4958(a)(2) with respect to that excess benefit transaction.

(9) Burden of proof. For provisions relating to the burden of proof in cases involving the issue of whether an organization manager has knowingly participated in an excess benefit transaction, see section 7454(b) and § 301.7454-2. In these cases, the Commissioner bears the burden of proof.

(e) Date of occurrence—(1) In general. Except as otherwise provided, an excess benefit transaction occurs on the date on which the disqualified person receives the economic benefit for Federal income tax purposes. When a single contractual arrangement provides for a series of compensation or other payments to (or for the use of) a disqualified person over the course of the disqualified person's taxable year (or part of a taxable year), any excess benefit transaction with respect to these aggregate payments is deemed to occur on the last day of the taxable year (or if the payments continue for part of the year, the date of the last payment in the series).

(2) Special rules. In the case of benefits provided pursuant to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. In the case of a transfer of property that is subject to a substantial risk of forfeiture or in the case of rights to future compensation or property (including benefits under a nonqualified deferred compensation plan), the transaction occurs on the date the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. However, where the disqualified person elects to include an amount in gross income in the taxable year of transfer pursuant to section 83(b), the general rule of paragraph (e)(1) of this section applies to the property with respect to which the section 83(b) election is made. Any excess benefit transaction with respect to benefits under a deferred compensation plan which vest during any taxable year of the disqualified person is deemed to occur on the last day of such taxable year. For the rules governing the timing of the reasonableness determination for deferred, contingent, and certain other noncash compensation, see § 53.4958-4T(b)(2).

(3) Statute of limitations rules. See sections 6501(e)(3) and 6501(l) and the regulations thereunder for statute of limitations rules as they apply to section 4958 excise taxes.

(f) Effective date for imposition of taxes—(1) In general. The section 4958 taxes imposed on excess benefit transactions or on participation in excess benefit transactions apply to transactions occurring on or after September 14, 1995.

(2) Existing binding contracts. The section 4958 taxes do not apply to any transaction occurring pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurs. A written binding contract that is terminable or subject to cancellation by the applicable tax-exempt organization without the disqualified person's consent (including as the result of a breach of contract by the disqualified person) and without substantial penalty to the organization, is no longer treated as a binding contract as of the earliest date that any such termination or cancellation, if made, would be effective. If a binding written contract is materially changed, it is treated as a new contract entered into as of the date the material change is effective. A material change includes an extension or renewal of the contract (other than an extension or renewal that results from the person contracting with the applicable tax-exempt organization unilaterally exercising an option expressly granted by the contract), or a more than incidental change to any payment under the contract.

Definition of applicable tax-exempt organization (temporary).

(a) Organizations described in section 501(c)(3) or (4) and exempt from tax under section 501(a)—(1) In general. An applicable tax-exempt organization is any organization that, without regard to any excess benefit, would be described in section 501(c)(3) or (4) and exempt from tax under section 501(a). An applicable tax-exempt organization also includes any organization that was described in section 501(c)(3) or (4) and was exempt from tax under section 501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the lookback period). A private foundation as defined in section 509(a) is not an applicable tax-exempt organization for section 4958 purposes. A governmental entity that is exempt from (or not subject to) taxation without regard to section 501(a) is not an applicable tax-exempt organization for section 4958 purposes.

(2) Organizations described in section 501(c)(3). An organization is described in section 501(c)(3) for purposes of section 4958 only if the organization provides the notice described in section 508, unless the organization otherwise is described in section 501(c)(3) and specifically is excluded from the requirements of section 508 by that section.

(3) Organizations described in section 501(c)(4). An organization is described in section 501(c)(4) for purposes of section 4958 if the organization—

(i) Has applied for and received recognition from the Internal Revenue Service as an organization described in section 501(c)(4); or

(ii) Has filed an application for recognition under section 501(c)(4) with the Internal Revenue Service, has filed an annual information return as a section 501(c)(4) organization under the Internal Revenue Code or regulations promulgated thereunder, or has otherwise held itself out as being described in section 501(c)(4) and exempt from tax under section 501(a).

(4) Effect of non-recognition or revocation of exempt status. An organization is not described in paragraph (a)(2) or (a)(3) of this section during any period covered by a final determination or adjudication that the organization is not exempt from tax under section 501(a) as an organization described in section 501(c)(3) or (4), so long as that determination or adjudication is not based upon participation in inurement or one or more excess benefit transactions. However, the organization may be an applicable tax-exempt organization for that period as a result of the five-year Start Printed Page 2160lookback rule described in paragraph (a)(1) of this section.

(b) Special rules—(1) Transition rule for lookback period. In the case of any excess benefit transaction occurring before September 14, 2000, the lookback period described in paragraph (a)(1) of this section begins on September 14, 1995, and ends on the date of the transaction.

(2) Certain foreign organizations. A foreign organization, recognized by the Internal Revenue Service or by treaty, that receives substantially all of its support (other than gross investment income) from sources outside of the United States is not an organization described in section 501(c)(3) or (4) for purposes of section 4958.

Definition of disqualified person (temporary).

(a) In general—(1) Scope of definition. Section 4958(f)(1) defines disqualified person, with respect to any transaction, as any person who was in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization at any time during the five-year period ending on the date of the transaction (the lookback period). Paragraph (b) of this section describes persons who are defined to be disqualified persons under the statute, including certain family members of an individual in a position to exercise substantial influence, and certain 35-percent controlled entities. Paragraph (c) of this section describes persons in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization by virtue of their powers and responsibilities or certain interests they hold. Paragraph (d) of this section describes persons deemed not to be in a position to exercise substantial influence. Whether any person who is not described in paragraph (b), (c) or (d) of this section is a disqualified person with respect to a transaction for purposes of section 4958 is based on all relevant facts and circumstances, as described in paragraph (e) of this section. Paragraph (f) of this section describes special rules for affiliated organizations. Examples in paragraph (g) of this section illustrate these categories of persons.

(2) Transition rule for lookback period. In the case of any excess benefit transaction occurring before September 14, 2000, the lookback period described in paragraph (a)(1) of this section begins on September 14, 1995, and ends on the date of the transaction.

(b) Statutory categories of disqualified persons—(1) Family members. A person is a disqualified person with respect to any transaction with an applicable tax-exempt organization if the person is a member of the family of a person who is a disqualified person described in paragraph (a) of this section (other than as a result of this paragraph) with respect to any transaction with the same organization. For purposes of the following sentence, a legally adopted child of an individual is treated as a child of such individual by blood. A person's family is limited to—

(i) Spouse;

(ii) Brothers or sisters (by whole or half blood);

(iii) Spouses of brothers or sisters (by whole or half blood);

(iv) Ancestors;

(v) Children;

(vi) Grandchildren;

(vii) Great grandchildren; and

(viii) Spouses of children, grandchildren, and great grandchildren.

(2) Thirty-five percent controlled entities—(i) In general. A person is a disqualified person with respect to any transaction with an applicable tax-exempt organization if the person is a 35-percent controlled entity. A 35-percent controlled entity is—

(A) A corporation in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the combined voting power;

(B) A partnership in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the profits interest; or

(C) A trust or estate in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the beneficial interest.

(ii) Combined voting power. For purposes of this paragraph (b)(2), combined voting power includes voting power represented by holdings of voting stock, direct or indirect, but does not include voting rights held only as a director, trustee, or other fiduciary.

(iii) Constructive ownership rules—(A) Stockholdings. For purposes of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings are taken into account as under section 267(c), except that in applying section 267(c)(4), the family of an individual shall include the members of the family specified in section 4958(f)(4) and paragraph (b)(1) of this section.

(B) Profits or beneficial interest. For purposes of section 4958(f)(3) and this paragraph (b)(2), the ownership of profits or beneficial interests shall be determined in accordance with the rules for constructive ownership of stock provided in section 267(c) (other than section 267(c)(3)), except that in applying section 267(c)(4), the family of an individual shall include the members of the family specified in section 4958(f)(4) and paragraph (b)(1) of this section.

(c) Persons having substantial influence. A person who holds any of the following powers, responsibilities, or interests is in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization:

(1) Voting members of the governing body. This category includes any individual serving on the governing body of the organization who is entitled to vote on any matter over which the governing body has authority.

(2) Presidents, chief executive officers, or chief operating officers. This category includes any person who, regardless of title, has ultimate responsibility for implementing the decisions of the governing body or for supervising the management, administration, or operation of the organization. A person who serves as president, chief executive officer, or chief operating officer has this ultimate responsibility unless the person demonstrates otherwise. If this ultimate responsibility resides with two or more individuals (e.g., co-presidents), who may exercise such responsibility in concert or individually, then each individual is in a position to exercise substantial influence over the affairs of the organization.

(3) Treasurers and chief financial officers. This category includes any person who, regardless of title, has ultimate responsibility for managing the finances of the organization. A person who serves as treasurer or chief financial officer has this ultimate responsibility unless the person demonstrates otherwise. If this ultimate responsibility resides with two or more individuals who may exercise the responsibility in concert or individually, then each individual is in a position to exercise substantial influence over the affairs of the organization.

(4) Persons with a material financial interest in a provider-sponsored organization. For purposes of section 4958, if a hospital that participates in a provider-sponsored organization (as defined in section 1855(e) of the Social Security Act, 42 U.S.C. 1395w-25) is an applicable tax-exempt organization, then any person with a material financial interest (within the meaning of section 501(o)) in the provider-sponsored organization has substantial influence with respect to the hospital.

(d) Persons deemed not to have substantial influence. A person is deemed not to be in a position to exercise substantial influence over the Start Printed Page 2161affairs 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 § 53.4958-2T(a)(3), this category includes any other organization so described.

(3) Employees receiving economic benefits of less than a specified amount in a taxable year. This category includes, for the taxable year in which benefits are provided, any full-or part-time employee of the applicable tax-exempt organization who—

(i) Receives economic benefits, directly or indirectly from the organization, of less than the amount referenced for a highly compensated employee in section 414(q)(1)(B)(i);

(ii) Is not described in § 53.4958-3T(b) or (c) with respect to the organization; and

(iii) Is not a substantial contributor to the organization within the meaning of section 507(d)(2)(A), taking into account only contributions received by the organization during its current taxable year and the four preceding taxable years.

(e) Facts and circumstances govern in all other cases—(1) In general. Whether a person who is not described in paragraph (b), (c) or (d) of this section is a disqualified person depends upon all relevant facts and circumstances.

(2) Facts and circumstances tending to show substantial influence. Facts and circumstances tending to show that a person has substantial influence over the affairs of an organization include, but are not limited to, the following—

(i) The person founded the organization;

(ii) The person is a substantial contributor to the organization (within the meaning of section 507(d)(2)(A)), taking into account only contributions received by the organization during its current taxable year and the four preceding taxable years;

(iii) The person's compensation is primarily based on revenues derived from activities of the organization that the person controls;

(iv) The person has or shares authority to control or determine a substantial portion of the organization's capital expenditures, operating budget, or compensation for employees;

(v) The person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole;

(vi) The person owns a controlling interest (measured by either vote or value) in a corporation, partnership, or trust that is a disqualified person; or

(vii) The person is a non-stock organization controlled, directly or indirectly, by one or more disqualified persons.

(3) Facts and circumstances tending to show no substantial influence. Facts and circumstances tending to show that a person does not have substantial influence over the affairs of an organization include, but are not limited to, the following—

(i) The person has taken a bona fide vow of poverty as an employee, agent, or on behalf, of a religious organization;

(ii) The person is an independent contractor (such as an attorney, accountant, or investment manager or advisor) whose sole relationship to the organization is providing professional advice (without having decision-making authority) with respect to transactions from which the independent contractor will not economically benefit either directly or indirectly (aside from customary fees received for the professional advice rendered);

(iii) The direct supervisor of the individual is not a disqualified person;

(iv) The person does not participate in any management decisions affecting the organization as a whole or a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole; or

(v) Any preferential treatment a person receives based on the size of that person's donation is also offered to all other donors making a comparable contribution as part of a solicitation intended to attract a substantial number of contributions.

(f) Affiliated organizations. In the case of multiple organizations affiliated by common control or governing documents, the determination of whether a person does or does not have substantial influence shall be made separately for each applicable tax-exempt organization. A person may be a disqualified person with respect to transactions with more than one applicable tax-exempt organization.

(g) Examples. The following examples illustrate the principles of this section. Finding a person to be a disqualified person in the following examples does not indicate that an excess benef