Why Excess Benefit Transactions Are Out-of-Bounds

December 15, 2021 HoganTaylor

Emily was a dedicated board member of her community’s most prominent social-services charity. But her commitment to the cause and the nonprofit’s programs didn’t prevent her from inadvertently violating the rule against excess benefit transactions. This happened when the organization wanted to build a new facility and bought land from her even though similar, and potentially cheaper, property was available from nonaffiliated sellers. Emily made only a minimal profit, but the IRS took notice and began investigating the deal.

You may know that your not-for-profit needs to avoid excess benefit transactions, but are you sure you know what they are? A full understanding can help your nonprofit avoid Emily’s and her charity’s mistake.

Don’t let insiders profit

First, it’s important to understand the concept of private inurement. A private benefit is any payment or transfer of assets made, directly or indirectly, by your nonprofit that’s 1) beyond reasonable compensation for the services provided or the goods sold to your organization, or 2) for services or products that don’t further your tax-exempt purpose. If any of your net earnings inure to the benefit of an individual, the IRS won’t view your nonprofit as operating primarily to further its tax-exempt purpose.

The private inurement rules extend the private benefit prohibition to “insiders” or “disqualified persons” — generally any officer, director, individual or organization who is in a position to exert significant influence over your nonprofit’s activities and finances. The rule also covers their family members and organizations they control. A violation occurs when a transaction that ultimately benefits the insider is approved.

Remember your “purpose”

Of course, the rules don’t prohibit all payments, such as salaries and wages, to an insider. You simply need to make sure that any payment is reasonable relative to the services or goods provided. In other words, the payment must be made with your nonprofit’s tax-exempt purpose in mind.

To ensure you can later prove that any transaction was reasonable and made for a valid exempt purpose, formally document all payments made to insiders. Also ensure that board members understand their duty of care. This refers to a board member’s responsibility to act in good faith, in your organization’s best interest, and with such care that proper inquiry, skill and diligence has been exercised in the performance of duties.

Possible repercussions

Violators of the rule face excise taxes and the loss of exempt status — although the latter is rare. Bad PR and loss of community support are also major risks. Contact us if you’re unsure about a pending transaction or want us to help educate your stakeholders.

How HoganTaylor Can Help

The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact the Jack Murray, CPA, Nonprofit Practice Lead, at jmurray@hogantaylor.com.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.

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