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Steep Penalties for Excess Benefit Transactions

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In recent years, the IRS has increased its audits of not-for-profit organizations. One of the hot-button topics is asset protection, which includes monitoring private inurement and private benefit transactions by persons who control not-for-profit organizations or who are related in some manner. A nonprofit that is found to have violated the private inurement or private benefit rules faces the ultimate penalty of revocation of its tax-exempt status by the IRS.  In addition, a disqualified person (anyone who is or was in a position to exercise substantial influence over the affairs of the organization within the last five years and is on the receiving end of a beneficial transaction) is subject to an initial tax of 25% of the amount of the excess benefit. If not corrected before the IRS mails a notice for deficiency for the tax, the disqualified person is subject to an additional fine of 200% of the excess.

The private inurement rule is limited to circumstances where the benefits accrue to the organization’s insiders, such as a founder, his or her family, an employee, a board member, a related corporation or even an individual fundraiser; whereas application of the private benefits rule is unlimited.  This means it also extends to outsiders who incur benefit and who may be specific individuals or fundraisers, a class of individuals, a for-profit corporation or a joint venture.  In terms of financial gains, however, a de minimis or incidental amount of private benefit is permissible, while no amount of private inurement is tolerated.

Protection of nonprofit assets, financial as well as reputational, begins with good governance and should include the following:

  • The process for determining the compensation of officers, directors, trustees, key employees and others in a position to exercise substantial influence over the affairs of the organization by persons knowledgeable in compensation matters and who have no financial interest in the determination;
  • A written conflict of interest policy and procedures for monitoring compliance;
  • A written document retention and destruction policy;
  • A written whistleblower policy; and
  • Written policies and procedures for evaluating participation in joint ventures, for-profit entities and sophisticated investments.

How can your organization further protect itself to limit its exposure to IRS examination or tax-exemption revocation?  Here’s a list of measures you should take:

  • If you have not already done so, consider adopting the aforementioned key components of good governance as prescribed by the IRS.
  • Review your procedures for determining the compensation and benefits for officer and directors.
  • Ensure that your conflict-of-interest and document retention policies are strictly followed.
  • Maintain a current list of disqualified persons and related parties.

If you have any questions regarding the IRS private inurement and benefits rules, or would like assistance with the adoption of any of the governance documents noted above, please feel free contact me at 609-689-9700.

The author of this article, Christine Thomas, is a former employee of Mercadien. 

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