Excess Benefit Transactions - Final Regulations Issued
On March 28, 2008, the IRS finally issued the long-awaited final regulations on Section 4958 excess benefit transactions. The regulations provide examples intended to clarify when a transaction will result in revocation of exempt status. These regulations also address the issue of private benefit, which can serve as another independent basis for revocation of exempt status.

The main "take-away" from these regulations is that you will be much better off if you take corrective action before the IRS gets involved and, if you do get audited, you are unlikely to have your exempt status revoked if you had safeguards in place and you followed those safeguards.

1. Private Benefit
As you know, all 501(c)(3) organizations must exist primarily for the benefit of the public. If there is an impermissable amount of benefit (economic or otherwise) that is received by private persons, then the organization risks revocation of their exempt status. The IRS declined to provide quantitative measures of the amount of private benefit that would jeopardize exempt status – this is determined on a case by case basis.

The regulations emphasize the following:

(a) A transaction which has fair market and arms' length terms can still result in impermissable private benefit and exempt status revocation.

For example, where an educational organization's principal purpose is to offer training to the public (a proper public purpose) based on patented/trademarked methods designed by a company owned by a trustee of the organization's advisory board, the organization will be found to improperly benefit that trustee even though the organization pays fair market royalties to the trustee's company. Significant conditions which tilt this more toward private vs. public benefit are:

• The Trustee's company provided all teaching materials and trainers


• The organization signed a non competition agreement


• Any new materials created by the organization must be assigned to the trustee's company upon termination of the license

(b) Private benefit need not be economic.

For example, if the organization's principal purpose is to conduct geneological research, but the research pertains only to one family, then that family impermissably benefits and the organization has no public purpose. The principal business purpose here must be designed for broad public benefit.

2. Excess Benefit (EB)

(a) Proactive Measures Are Given Considerable Favor.

The regulations identify five factors that the IRS will consider in determining whether a particular EB transaction merits exempt status revocation. Generally, the factors look to the size, scope and frequency of EB transactions, as compared to the scope of the organization's regular and ongoing transactions which benefit the public. In addition, the IRS considers the measures taken by the organization to correct or prevent EB transactions. Not all factors need be present and the weight to be given them will vary at the discretion of the IRS agent. Of the five factors, two in particular will carry significant weight and should be the regular course of business for any organization:

• Correct the EB transaction before the IRS discovers it; and


• Implement safeguards reasonably calculated to prevent EB transactions, for example:


• Adopt a Conflict of Interest (COI) Policy and regularly monitor transactions for COI


• Adopt valuation guidelines for major acquisitions or lease/license arrangements


• Adopt an "accountable plan" for all employee reimbursements


• Adopt guidelines for reviewing significant new contracts


• Adopt written procedures for setting executive compensation modeled after the rebuttable presumption of reasonableness (found at Regulation 53.4958-6). Ensure also that the persons/committee deciding compensation are disinterested. Make sure data relied upon is comparable (same geographic area, same type of service, same size of organization, same population served, same duties, etc.). Compensation committees should consult Example 6 under subpart (f) of the new regulations.

(b) Removal of a Disqualified Person.

If the organization removes the disqualified person who received the EB, this may not be enough to save exempt status. The IRS considers all other facts and circumstances. Conversely, the Regulation now confirms that removal of the disqualified person is not a prerequisite to retaining exempt status.

You can view the new regulations at http://edocket.access.gpo.gov/2008/E8-6305.htm

If you have questions regarding this Client Alert, please contact Wendy S. Pearson at 206-622-5511.