Reporting Excess Benefit Transactions to the IRS
There are advantages to proactively reporting excess benefit transactions involving your nonprofit.
A nonprofit engages in an "excess benefit transaction" when it enters into a transaction with a "disqualified person"--such as an officer, director, or key employee--that unreasonably benefits the disqualified person (the "DP"). Excess benefit transactions can take a variety of forms, but by far the most common is paying excessive compensation to DPs such as presidents, CEOs, CFOs, or other highly compensated employees. Other common excess benefit transactions include:
- excessive expense accounts--for example, payments for excessive travel and food expenses or misuse of the nonprofit’s credit card
- personal use of nonprofit property by a DP, such as a car or dwelling
- paying personal expenses for members of a DP’s family
- leasing property from a DP in return for excessive rent
- purchase of goods or services from DPs at above fair market value
- sale of goods or services to DPs at below fair market value, and
- loans to DPs with below market interest rates (or no interest at all).
The IRS can impose monetary penalties--called intermediate sanctions--on the DPs and nonprofit managers who engage in excess benefit transations; and, in severe cases, the nonprofit's tax-exempt status can be revoked.
If your nonprofit discovers an excess benefit transaction with a DP, it should make good faith efforts to correct it. To do this, you must have the disqualified person repay or return the excess benefit, plus interest, and then adopt measures to make sure the same situation doesn’t occur again. The IRS will take into account these efforts in deciding what penalties to impose and especially whether to revoke the nonprofit’s tax exemption.
In addition, you are supposed to report any excess benefit transactions you are aware of on the annual information return your nonprofit files with the IRS each year—Form 990 or Form 990-EZ. The forms require you to disclose and describe any excess benefit transaction that occurred in the current year, and any such transactions that occurred in prior years that it became aware of. Nonprofits filing Form 990 must also indicate on Schedule L whether grants or other payments were given to insiders, and list and describe all business transactions the nonprofit had with insiders (called "interested persons" on the schedule).
IRS intermediate sanctions can only be imposed aganist the individuals involved in an excess benefit transaction--disqualified persons and nonprofit managers. They cannot be imposed against your nonprofit itself. However, if your nonprofit fails to report an excess benefit transaction, it will be subject to an IRS penalty of $20 per day, up to the lesser of $10,000 or 5 percent of its gross receipts. For organizations with gross receipts in excess of $1,000,000, the penalty is $100 per day, up to a maximum of $50,000. Moreover, depending on the circumstances, deliberate noncompliance with the reporting requirements could subject your nonprofit to criminal sanctions for tax fraud or other offenses. In addition, officers, directors, attorneys, accountants, and others involved in preparing and filing the Form 990 or Form 990-EZ could be personally liable for their role in submitting a false tax return.
One benefit of reporting an excess benefit transaction on Form 990 or 990-EZ is that the statute of limitations for assessing intermediate sanctions begins to run. The limitations period is three years after the return was filed, or if the transaction was not adequately reported, up to six years.
Find out more about keeping your nonprofit above-board with Nolo's book, Every Nonprofit's Tax Guide.