Publications

Compensation packages for executives of tax-exempt organizations can raise private inurement issues and are also subject to tax regulations governing benefits, including nonqualified deferred compensation, that do not apply to taxable employers. It’s a thorny world out there. Tread carefully.

Private Inurement
Section 501(c)(3) of the Internal Revenue Code provides that a corporation, trust or association may qualify for exemption as a charitable or educational organization only if, among other things, no part of its net earnings inures to the benefit of any private individual. “Private inurement” can occur when an influential insider (e.g., an executive) gets a benefit or something of value from the organization and does not give fair value in return.

An egregious private inurement problem can result in revocation of an organization’s tax exemption. More commonly, the Internal Revenue Service will seek to impose “intermediate sanctions,” a set of federal penalty taxes under IRC § 4958, on individuals who receive too great a benefit from a tax-exempt organization and on those who knowingly approve the excessive benefits. The key here is that intermediate sanctions penalize the insiders who benefit from control of the tax-exempt organization (and those who abet them) without penalizing the organization itself (by revoking its exempt status).

The tax on the organization’s managers or directors who knowingly approve the excess benefit is 10 percent of the excess amount, capped at $20,000 per excess benefit “transaction.” The liability of the managers and directors who knowingly approve the excess transaction is joint and several – that is, each is liable for the full excise tax. The tax on the insider who gets too great a benefit is 25 percent of the excess amount, plus 200 percent of the excess amount if it is not corrected within a prescribed amount of time.

Compensation for purposes of intermediate sanctions is defined broadly and includes base salary, bonuses, health care and other welfare and fringe benefits, employer-provided housing, retirement benefits and severance, among other elements.