Final 501(c)(3) Regulations Issued
Effective March 28, 2008, the Internal Revenue Service issued final regulations clarifying the substantive requirements for tax exemption under section 501(c)(3) and the imposition of section 4958 excise taxes on excess benefit transactions.
These final regulations are the final form of proposed regulations issued September 9, 2005. In general, the factors described in the proposed regulation have been finalized without major revisions.
In determining whether to continue to recognize the tax-exempt status of an applicable organization that engages in one or more excess benefit transactions, the IRS states that it will consider all relevant facts and circumstances, including, but not limited to, the following:
A. 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;
B. 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;
C. Whether the organization has been involved in multiple excess benefit transactions with one or more
persons;
D. Whether the organization has implemented safeguards that are reasonably calculated to prevent
excess benefit transactions; and
E. Whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6)
and § 53.4958–7), or the organization has made good faith efforts to seek correction from the
disqualified person(s) who benefited from the excess benefit transaction.
It is important to note several points clarified in the final regulations:
- All factors will be recognized in combination with one another and the IRS Commissioner may weight
any one factor more or less heavily than any other factor; - The factors listed will weigh more heavily in favor of the continuation of exempt recognition if the
organization discovers the excess benefit transaction and takes corrective action prior to the
Commissioner making a similar finding; - Taking corrective action after an excess benefit transaction is discovered by the Commissioner is not
a sufficient basis for continuing to recognize exemption and the reasons underlying an organizations
failure to seek correction will be examined; - The removal of a disqualified person in such an event is NOT a necessary condition to retain
exempt status; - “Multiple excess benefit transactions” (in paragraph C above) refer to both repeated instances of
the same (or substantially similar) excess benefit transactions, regardless of whether they
benefitted the same or different persons, and also the presence of more than one excess benefit
transaction.
There continues to be no safe harbor with respect to what the IRS would consider “significant” or “de minimus” as it depends on facts and circumstances. However, the examples provide some insight. For the majority of our clients, the most applicable examples are 5 and 6, whereby in Ex. 5 an insignificant amount (relative to the size and scope of the exempt activities of the organization) of personal expenses paid for by the organization, but not properly reported by the recipient, would be treated as an excess benefit transaction and subject to penalties. Ex. 6 outlines sensitivity surrounding the use of appropriate comparability data.
In summation, the consistent theme throughout the examples is that the Board should be comprised of independent directors to whom the requirements of running a 501(c)(3) are known and that proper policies and procedures be implemented and followed. In the event that such policies are in place and excess benefit transactions still occur, the organization should be diligent and proactive in correcting, to the extent possible, such excess benefit transactions.
The Final Regulations can be viewed on the IRS website.