The purpose of intermediate sanctions (under section 4958 of the Internal Revenue Code) is to provide another option (other than loss of exemption by the organization) for imposing sanctions when someone in a position of influence with the organization receives excessive economic benefits.
Sound like more boring tax law and inapplicable to your organization? Keep reading.
The law regarding intermediate sanctions under §4958 applies to tax-exempt public charities (501(c)(3)s - but not private foundations) and tax-exempt social welfare organizations (501(c)(4)s). It applies in cases when an excise benefit transaction occurs (I will explain generally what that means in a moment) and imposes a tax penalty on a disqualified person (again, I will explain) who benefit from the transaction, and perhaps on organizational manager(s) who participated in the transaction, knowing that is was improper. A tax of 25% of the excess benefit applies to the disqualified person (which rises to 200% if not corrected within the taxable period), and a tax of 10% of the excess benefit could be imposed on any organizational manager that approved the transaction.
Excess benefit transaction – any transaction in which the economic benefit received by the disqualified person (either directly or indirectly) is in excess of any value (for example, property or services) they provided in return to the organization.
Disqualified Person –
1) any person who was in a position to have substantial influence over the organization at any point in the five years leading up to the transaction. An organizational manager can be a trustee, director, or officer (or someone who has powers or responsibilities similar to a trustee, director, or officer).
2) a family member of one of the above (spouses, ancestors, children, grandchildren, great-grandchildren, and the spouses of children, grandchildren and great-grandchildren, and brothers and sisters of the individual and their spouses.)
3) an entity in which someone in either of the above categories has at least a 35% interest.
Common areas in which intermediate sanctions penalties arise:
- Compensation (argument is that compensation paid was not reasonable for the services provided) – compensation includes all forms of compensation (including benefits)
- Rental arrangements
- Sale of assets
Wait, wait! There is more. The law also outlines areas which are automatic excess benefit transactions. The claim cannot be made that the benefit was provided as compensation (and thus allow for an argument of reasonableness) unless the organization intended for it to be compensation when it was paid. Relevant to this analysis is whether the compensation was approved by the appropriate organizational body/office, and whether the organization has contemporaneous written proof (such as reporting the payment as compensation on an IRS form).
Situations where an automatic excess benefit transaction can arise:
- - Issuance of reimbursements without documentation of the expense by the disqualified person
- - Providing an individual (for personal use) access to real property, cars, bank accounts, cell phones, computers, etc.
- - No-interest loans
- - Payment of spousal travel
Ack! Now what do you do to avoid this?
The organization can implement policies and procedures that address situations in which excess benefit transactions might arise. Such policies would include: a conflict of interest policy that also outlines procedures for addressing transactions with disqualified persons; an executive compensation policy that incorporates “rebuttable presumption” procedures; and implementing procedures around expense reimbursement.