Article Archives >> Lead Stories >> April 1-16, 2004

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IRS to Launch Compliance Initiative

On Excess Benefit Transactions

Examiners will pursue "automatic" violations

even where payments are reasonable

The Internal Revenue Service will undertake a new compliance initiative in an attempt to convince nonprofits that it is serious about the enforcement of excess benefit transaction penalties.

According to a report by Tax Analysts , IRS attorney Leonard J. Henzke, Jr. told a District of Columbia Bar Association committee on March 17 that the IRS will begin calling hundreds of exempt organizations to ask them to explain their tax returns and various reporting positions, including in particular how they determine executive compensation.

Under the relatively new provisions of Section 4958 of the Code, an insider, such as an officer, director or key employee, at a Section 501(c)(3) charity or 501(c)(4) civic association is liable for an excess benefit tax if the insider gets more from the organization than the value of the goods or services provided in return. (See Ready Reference Page No. 63 , April 2003.) The rules were passed primarily to deal with excessive compensation but apply to any economic transaction.

Henzke said the IRS is frustrated with the obvious inaccuracies in Form 990 tax returns and will begin asking organizations about questionable items, incomplete answers, or failure to respond to the questions on line 89 of the Form asking whether the organization has engaged in excess benefit transactions during the year.

He emphasized that nonprofits must report excess benefits transactions for the year in which they are discovered, even if the event took place several years before.

The IRS has not given public notice of its imposition of excess benefit taxes in many cases and some practitioners have complained that it has not appeared that the IRS is serious about rules. The IRS has said it is unable to report on individual cases under taxpayer confidentiality provisions of the Tax Code, but Henzke and others have begun to speak more publicly about the issue.

The IRS also published a special article in its 2004 Continuing Professional Education text on "automatic" excess benefit transactions. The text emphasizes the IRS position that various benefits, such as the reimbursement of unsubstantiated expenses, may be an automatic violation of the rules, and taxable to the beneficiary, even where the total payments would be reasonable if treated as compensation when made.

The IRS says that benefits must be treated as compensation when made, unless clearly exempt from treatment as compensation under general tax rules or an "accountable plan" for reimbursement of expenses. An organization which gets caught on a payment that has not been treated as compensation when made will not be able to argue later that it was part of reasonable compensation. (We will provide a Ready Reference Page on the CPE text in our next issue.)

Henzke said the new initiative would include publishing a new Internal Revenue Manual section on the statute and possibly a voluntary compliance program.

YOU NEED TO KNOW

Although lawyers have been warning their clients about excess benefit tax issues for several years, the lack of visible enforcement by the IRS has often made it difficult to convince boards or executives to take it all very seriously. The "automatic" violation approach, which was released only in January and without fanfare, is slowly penetrating the consciousness of the sector.

The insider caught with the automatic violation will have to pay ordinary income tax on the unreported income, pay the 25% excess benefit tax, repay the excess to the organization or perhaps pay the 200% second tier tax if not repaid in time, and probably pay a penalty for failure to report or for late reporting. This kind of potential liability will probably make people pay more attention.

Article Archives >> Lead Stories >> April 1-16, 2004