Section 4958(c)(1)(A) of the IRC defines an excess benefit transaction as “any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.” An excess benefit transaction is prohibited and may subject the disqualified person and the directors who knowingly approved such transaction to significant federal excise taxes. IRC§4958(a), (b).
A disqualified person with respect to a transaction is “(A) any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization [including directors of the corporation], (B) a member of the family of an individual described in subparagraph (A), and (C) a 35-percent controlled entity.” IRC §4958(f)(1).
Persons having substantial influence include: voting members of the governing body (e.g., directors, trustees), presidents, chief executive officers, chief operating officers, and chief financial officers, and chief financial officers. Persons deemed not to have substantial influence include: employees who both: (1) receive economic benefits from the organization of less than $95,000 (in 2005), and (2) do not hold executive or voting powers.
Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances. For determining the reasonableness of compensation, all items of compensation are taken into account (with certain exceptions that probably do not apply here), including:
- All forms of cash and non-cash compensation, including salary, fees, bonuses, severance payments, and deferred compensation;
- The payment of liability insurance premiums for, or the payment or reimbursement by the organization of, any penalty, tax, expense or correction owed under IRC Section 4958;
- All other compensatory benefits, whether or not included in gross income for income tax purposes; and
- Taxable and nontaxable fringe benefits, except fringe benefits described in IRC Section 132.
Reasonableness may be determined in part by (1) compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; (2) current compensation surveys compiled by independent firms; and (3) actual written offers from similar institutions competing for the services of the disqualified person.
Payments under a compensation arrangement are presumed to be reasonable if the following three conditions are met: …
- The transaction is approved by an authorized body of the organization which is composed of individuals who do not have a conflict of interest concerning the transaction.
- Prior to making its determination, the authorized body obtained and relied upon appropriate data as to comparability.
- The authorized body adequately documents the basis for its determination concurrently with making that determination. Such documentation should include:
- The terms of the approved transaction and the date approved;
- The members of the authorized body who were present during debate on the transaction that was approved and those who voted on it;
- The comparability data obtained and relied upon by the authorized body and how the data was obtained;
- Any actions by a member of the authorized body having a conflict of interest; and
- Documentation of the basis for the determination before the later of the next meeting of the authorized body or 60 days after the final actions of the authorized body are taken, and approval of records as reasonable, accurate and complete within a reasonable time thereafter.
Relevant comparability data includes, but is not limited to:
- Compensation levels paid by similarly situated organizations, both taxable and non-taxable, for functionally comparable positions;
- The availability of similar services in the geographic area of the applicable tax-exempt organization;
- Current compensation surveys compiled by independent firms; and
- Actual written offers from similar institutions competing for the services of the disqualified person.