Be on the Lookout for Excess Benefit Transactions

When transactions occur that are unrelated to direct payment, such as regarding property or the use of assets, you may think that the private benefit lines get fuzzier. Not so. Before you engage in any transaction with a nonprofit organization, ask yourself, “Am I a disqualified person?” Here are three ways to tell:

  1. You are (or were within five years prior to the transaction) in a position to exercise influence formally or informally over the organization. (Even without the title, if a person performs the duties of the president, CEO, COO, CFO, treasurer or any voting member – they are considered disqualified.)
  2. You are related to someone who meets the criteria above.
  3. Your entity is at least 35% owned by a person or persons that meet the above criteria.

Outside of normal compensation, if a disqualified person receives a benefit that exceeds what the disqualified person gives to the nonprofit organization, then an excess benefit transaction occurs. Examples of excess benefit transactions include loans to a disqualified person (or entity), use of the organizations assets (both physical and intellectual), and the sale or transfer of property.  An excess benefit transaction may also occur if the organization purchases life insurance on a key employee, but the beneficiary is a family member  of the disqualified person– not the organization itself.  If a disqualified person receives payment of any kind that exceeds the market value for the duties they perform, that excess may be subject to excess benefit rules.

Avoid penalties for excess benefit transactions

If you think that you or someone you know had an excess benefit transaction with your organization, it’s important to reverse the transaction as much as possible. Property or monies must be returned to the organization to avoid stiff penalties for both the person and the organization. If discovered during an audit, the disqualified person will be initially taxed 25% of the value of the transaction. If no correction occurs within the tax period to reverse the transaction, then the stakes get higher with a 200% additional tax. At this point, the organizational managers who participated in the transaction may also be penalized. If the organizational manager can prove that the transaction wasn’t intentional, then no tax will likely apply. However, if it is found that the manager knew the transaction was an excess benefit, then that person will be taxed up to 10% of the value, with a $20,000 maximum per occurrence.

Talk with your attorney or accountant before engaging in any type of transaction where you are both a disqualified person and a beneficiary.