Managers of nonprofit 501c3 organizations know they have to make sure that no one receives “private benefit” from the organization. This means that no one should receive any economic benefit from the organization that exceeds the value of what the organization received in return. This is why nonprofits review salary surveys before setting pay levels and conduct competitive bidding when seeking services.
The IRS is especially concerned that organization insiders not receive any kind of benefit in excess of the value of what such persons are providing to the organization. The IRS calls insiders “disqualified persons.” The definition of a disqualified person is someone who is in a position to exercise substantial influence over the affairs of the organization.
If a disqualified person receives such an “excess benefit,” the IRS may revoke the organization’s tax exempt status. Because this remedy was seen as unduly harsh in some situations, the IRS developed “intermediate sanctions,” whereby the IRS may impose an excise tax on excess benefit transactions instead of revoking the organizations’ tax exempt status.
The excise tax is imposed on both the disqualified person that receives the excess benefit and the board members, officers, or managers that knowingly approved the transaction.
Most of this is not news to nonprofit managers. However, many nonprofits are not aware that if they provide non-monetary compensation to a person who is in a position to exercise substantial influence over the affairs of the organization (a disqualified person), such as the use of a car, reimbursement of personal expenses, etc., the result could be an AUTOMATIC excess benefit transaction. Reg. 53.4958-4(c)(1).
If a nonprofit provides a benefit to a disqualified person as part of the person’s salary and benefits package, the organization must substantiate its intention that this benefit is being provided as part of the person’s compensation at the time the benefit is provided by either reporting the benefit as compensation on the employee’s W-2 or passing a board resolution authorizing the benefit as compensation.
So, nonprofit board members and managers have to look carefully at the benefits they are providing to high level employees and make sure the value of the entire package is included in the employee’s W-2. If this has not happened in previous years, the organization should consider amending the W-2.
How much is the excise tax if the IRS finds an excess benefit?
The person who receives the excess benefit must not only return the excess benefit but must pay an additional 25 percent of the amount of the excess benefit.
If the transaction is not corrected promptly, the recipient must pay a second tax of 200 percent of the excess benefit.
Organization managers (i.e. board members, officers, and high level managers) may be taxed at 10 percent of the excess benefit, up to $20,000 each, if they knew that the transaction involved an excess benefit.