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For many years the Internal Revenue Service had only one main weapon to enforce the various rules and requirements applicable to organizations exempt from federal income tax: revoking tax-exempt status. But the IRS found many situations in which revocation of exemption was too dire a penalty for relatively minor transgressions of exempt organizations. Therefore, the IRS sought a penalty-intermediate sanctions-positioned somewhere between no penalty at all and revocation of exemption. As part of the 1996 Taxpayer Bill of Rights 2, Congress enacted an intermediate sanctions rule imposing penalties on excess benefit transactions by some types of tax-exempt organizations. On January 23, 2002, the final regulations implementing the law were issued. The law and regulations apply to all organizations exempt from taxation under section 501(c)(3), other than private foundations, and under Section 501(c)(4). In this article, Lauren W. Bright explains the ramifications of the intermediate sanctions rules.
EDITED BY JERALD A. JACOBS
Intermediate sanctions regulations impose penalties on what the Internal Revenue Service (IRS) considers excess-benefit transactions of most 501(c)(3) and all 501(c)(4) organizations. Understanding the regulations will help leaders of these organizations avoid such penalties.
Background basics
Intermediate sanctions may be imposed by the IRS on any "disqualified person" who receives an "excess benefit" from a "covered organization." In the event that an excess benefit, such as unreasonably high compensation, is paid to a disqualified person, the excess benefit must be corrected to the extent possible and any necessary additional steps must be taken to restore the organization to a financial position no worse than it would have been had the excess-benefit transaction not occurred. The intermediate sanctions rules generally apply to excess-benefit transactions occurring on or after September 14, 1995. However, the rules do not apply to written contracts in...