The IRS released final regulations that clarify (i) the substantive requirements for tax exemption under section 501(c)(3) of the Internal Revenue Code; and (ii) the relationship between the substantive requirements for tax exemption under section 501(c)(3) and the imposition of section 4958 excise taxes on excess benefit transactions. The regulations became effective March 28, 2008.
Another change made by the final regulations is the addition of new paragraph (f), which discusses the interaction with section 4958. (Note that the former paragraph (f) is redesignated as paragraph (g).) Generally, the regulations make clear that an organization may be subject to revocation of its exempt status as a 501(c)(3) organization at the same time its disqualified persons are subject to excise taxes under section 4958. The IRS will consider the following facts and circumstances, among others, in determining whether to revoke exempt status of an applicable organization that engages in an excess benefit transaction:
- The size and scope of the organization’s regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred;
- The size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization’s regular and ongoing activities that further exempt purposes;
- Whether the organization has been involved in multiple excess benefit transactions with one or more persons;
- Whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and
- Whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6) and section 53.4958-7), or the organization has made good faith efforts to seek correction from disqualified person(s) who benefited from the excess benefit transaction.
The examples illustrating the application of the above factors in the decision to revoke 501(c)(3) status place great weight on the implementation of safeguards reasonably calculated to prevent future excess benefit transactions. The fact patterns in the examples include an art museum that purchases art from its trustees at more than fair market value; an organization whose CEO diverts charitable funds to pay his or her own personal expenses; an organization that sells its building to a company owned by its CEO for less than fair market value; a large organization that pays $2,500 of its CFO’s personal expenses, but not pursuant to an accountable plan and without reporting such payment as income; and a large organization that pays excessive compensation to its top executives despite following the rebuttable presumption procedures. In the last fact pattern, the board renegotiates salaries to ensure that they are just and reasonable but does not seek avoidance of the employment contracts or correction of the excess benefit amounts. Nevertheless, the organization’s tax-exempt status would not be revoked.
The Final Regulations are available here.