Armanino Blog

What Gets You In Trouble With Attorneys General: Part 2 Excess Benefit Transactions

by Tom Schulte
September 12, 2016

In the first part of this two-part series, we looked at failing to properly register your nonprofit as one of the quickest ways to raise ire with your state attorney general. For part two, we review a key compliance issue for charitable organizations—excess benefit transactions.

These transactions are known by a variety of names including “excess benefit transactions,” “private inurement” and “private benefit.” But nothing sends a state attorney general on the warpath quicker than an individual in your organization receiving more benefit from a transaction than your organization. And “excess benefit” could be anything from an Executive Director’s disproportionate benefits package to a board member’s office supply company overcharging for copier paper.

The IRS doesn't take these self-serving transactions lightly, either. Not only is the person who receives the excess benefit penalized but so are the people who authorized the transaction.

It’s an Inside Job

At the heart of an excess benefit transaction are the actions of a “disqualified” or “interested” person. This insider is someone who was in a position to exercise substantial influence over the affairs of the organization. In other words, key executives and voting members of the board. In addition, certain “related parties” may be considered insiders including family members and businesses in which an insider has more than a 35% interest.

Don’t Fall In

Trouble can come in many forms, but the red flag should go up for your nonprofit when looking at these areas in particular:

  • Compensation: Do salary and benefits of your executives exceed the fair value of the services rendered?
  • Property: Has someone on the board purchased or leased property from the organization at less than fair value—or sold or leased property to the organization at greater than fair value?
  • Loans: Has an insider borrowed money from the organization on terms that are less than their fair value—or lent money to the organization with terms that are greater than fair value?
  • Purchases: If your nonprofit is purchasing goods and services from a disqualified person—or a company controlled by a disqualified person—are you paying above-market prices?

“How Much Trouble Can We Get In?”

A lot.

An excise tax of 25% of the excess benefit is levied on the person receiving the benefit. The IRS can also impose a 200% penalty if the excess benefit transaction is not corrected quickly enough. A 10% tax can also be imposed on any officer or director who knowingly participated in the transaction, such as by voting to approve the excess benefit transaction. Commonly known as “intermediate sanctions,” these penalties fall just short of revoking an organization's nonprofit status.

You’ll also be required to disclose transactions subject to intermediate sanctions on your IRS Form 990—including the names of those involved, a description of the transaction, whether the excess benefit transaction was corrected and the amount of excise taxes paid.

Will You Pass the Test?

The good news is that nonprofits can reduce the risk of intermediate sanctions with some straightforward policies and procedures. A good place to start is with a strong code of ethics and a conflict of interest policy that establish expectations of lawful conduct.

You might also establish procedures to identify interested persons within the organization. That includes providing a way for them to disclose any related parties on transactions, such as family members or business interests. Also, carefully document any transactions with insiders and ensure correct tax reporting for transactions that are potentially subject to the excise tax.

Finally, periodically remind board members and other insiders of the law and how they can reduce their exposure.

Contact your local Armanino nonprofit expert for answers to your questions about excess benefit transactions including best practices for protecting your organization.

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