Bulletin No. 1998–34

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Bulletin No. 1998–34

August 24, 1998

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

T.D.8777, page 4.

ADMINISTRATIVE

Rev. Proc. 98–45, page 8.

Final regulations under section 465 of the Code relate to

qualified nonrecourse financing.

Low-income housing tax credit. This procedure publishes

the amounts of unused housing credit carryovers allocated to

qualified states under section 42(h)(3)(D) of the Code for calendar year 1998.

EMPLOYEE PLANS

Notice 98–38, page 7.

Notice 98–44, page 7.

Weighted average interest rate update. This notice

sets forth for determining for August 1998 the weighted

average interest rate and the resulting permissible range

of interest rates used to calculate current liability for purposes of the full funding limitation of section 412(c)(7) of

the Code as amended by the Omnibus Budget Reconciliation Act of 1987 and by the Uruguay Round Agreements

Act (GATT).

EXEMPT ORGANIZATIONS

Announcement 98–80, page 32.

A list is given of organizations now classified as private

foundations.

REG-246256–96, page 9.

Proposed regulations under section 4958 of the Code relate to the excise taxes on excess benefit transactions.

Finding Lists begin on page 35.

Department of the Treasury

Internal Revenue Service

SRLY notice. The Treasury Department and the Service are

considering an approach to simplify Separate Return Limitation Year (SRLY) rules applicable to consolidated groups. Comments are requested about the advisability of adopting this

approach. The new approach would base the SRLY limitation

on an expectation of the amount of income to be generated

using the methodology of section 382 of the Code.

Announcement 98–77, page 30.

Comments are requested on proposed training materials

discussing the application of section 119 of the Code to the

provision of employee meals in the hospitality industry.

Announcement 98–78, page 30.

The Service announces a settlement initiative allowing hospitality industry taxpayers to resolve issues relating to the provision of employee meals.

Announcement 98–79, page 31.

The public hearing for proposed regulation REG–209682–94,

1998–17 I.R.B. 20, is changed to September 10, 1998.

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Mission of the Service

ucts and services; and perform in a manner warranting

the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect

the proper amount of tax revenue at the least cost; serve

the public by continually improving the quality of our prod-

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

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Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis

and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

3

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 465–Qualified

Nonrecourse Financing

26 CFR 1.465–27: Qualified nonrecourse financing.

T.D. 8777

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Qualified Nonrecourse Financing

Under Section 465(b)(6)

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations on certain issues regarding qualified nonrecourse financing under

section 465(b)(6). These final regulations

affect individuals and C corporations for

which the stock ownership requirement of

section 542(a)(2) is satisfied. These regulations provide guidance on certain issues

relating to section 465(b)(6).

DATES: Effective date: These regulations are effective August 4, 1998.

Applicability dates: See Effective

Dates under Supplementary Information

of the preamble.

FOR FURTHER INFORMATION CONTACT: Jeff Erickson at (202) 622-3070

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document amends 26 CFR part 1

to provide rules regarding qualified nonrecourse financing under section

465(b)(6). Section 465 limits a taxpayer’s

loss deduction for an activity to the taxpayer’s amount at risk in the activity at

the close of the taxable year. A taxpayer’s

amount at risk generally includes the

amount of any cash and the adjusted tax

basis of any property contributed by the

taxpayer to the activity plus any amounts

borrowed for use in the activity to the extent the taxpayer is personally liable for

repayment. For the activity of holding

August 24, 1998

real property, section 465(b)(6) provides

that a taxpayer may include as an amount

at risk the taxpayer’s share of any qualified nonrecourse financing that is secured

by real property used in the activity of

holding real property, even though the

taxpayer is not personally liable for repayment of the financing.

On August 13, 1997, the IRS published

in the Federal Register (62 FR 43295

[REG–105160–97, 1997–37 I.R.B. 22]) a

notice of proposed rulemaking regarding

section 465(b)(6). A number of comments were received on the proposed regulations. The public hearing scheduled

for December 10, 1997, was canceled because no one requested to speak. After

considering the written comments, the

proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

I. Secured by Real Property

A. Proposed Rule

Section 465(b)(6)(A) provides that

qualified nonrecourse financing must be

secured by real property used in the activity of holding real property. The proposed

regulations provided that a financing can

be a qualified nonrecourse financing if, in

addition to the real property used in the

activity of holding real property, the financing is secured by other property that

is incidental to the activity of holding real

property (incidental property).

B. Discussion of Comments

A commentator recommended that the

final regulations clarify the term incidental property. Another commentator asked

that the IRS and Treasury define incidental property as any property with a value

of not more than 15 percent of the value

of the real property held by the borrowing

partnership. A third commentator explained that real estate partnerships often

hold assets in addition to real property

and incidental property. This commentator was concerned that only financings

held by partnerships that own only real

estate assets could satisfy the proposed

regulations. Under the final regulations,

if the total gross fair market value of

property that is neither real property used

4

in the activity of holding real property nor

incidental property is less than 10 percent

of the total gross fair market value of all

the property securing the financing, such

other property is ignored in determining

whether the financing satisfies the secured-by-real-property requirement.

Another commentator asked for a lookthrough rule for partnerships that own an

interest in another partnership to determine the character of the assets securing a

qualified nonrecourse financing. The

final regulations adopt this suggestion by

requiring a borrower (whether or not a

partnership) to determine the character of

its assets by treating itself as owning directly its proportional share of the assets

in any partnership in which it owns (directly or indirectly through a chain of

partnerships) an equity interest. If a borrower pledges a partnership interest as security for a financing, the partnership assets attributable to the borrower ’s

proportional share of the partnership’s assets will be treated as security for the financing.

Commentators also asked under what

circumstances qualified nonrecourse financing will be treated as secured by real

property. Because this issue is closely-related to the determination of whether the

personal liability of a partnership will be

disregarded, those issues are addressed

together and are discussed in II. Personal

Liability of this preamble.

A commentator suggested that the final

regulations adopt a rule to allocate a single debt obligation among multiple

brother-sister partnerships when the

obligation is secured by the assetsof more

than one partnership. The IRS and Treasury believe this issue is beyond the scope

of these regulations.

II. Personal Liability

A. Proposed Rule

Section 465(b)(6)(B)(iii) provides that,

except to the extent provided in regulations, no person may be personally liable

for repayment of a qualified nonrecourse

financing. The proposed regulations provided that the personal liability of a partnership (including a limited liability company that is treated as a partnership) is

disregarded in determining whether a fi-

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nancing is a qualified nonrecourse financing if the entity’s only assets are real

property used in the activity of holding

real property or both real property and

other property that is incidental to the activity of holding real property, and no

other person is liable for the financing.

B. Discussion of Comments

Commentators focused on how the proposed regulations apply to tiered partnership structures—when a partnership (the

upper-tier partnership) owns a partnership

interest in another partnership (the lowertier partnership). These commentators

questioned whether the personal liability

of an upper-tier partnership that holds, directly or indirectly, only real property or

incidental property should disqualify a financing under section 465(b)(6). As

mentioned in I. Secured by Real Property

of this preamble, commentators also requested guidance as to the situations in

which a nonrecourse financing will be

treated as secured by real property.

In order to address these comments, the

final regulations adopt a three-part test.

Under the final regulations, the personal

liability of any partnership will be disregarded and, provided certain other requirements are satisfied, the financing

will be treated as qualified nonrecourse financing secured by real property if (i) the

only persons personally liable to repay the

financing are partnerships; (ii) each partnership with personal liability holds only

property that is permitted as security for

qualified nonrecourse financing (applying

a look-through rule for lower-tier partnerships); and (iii) in exercising its remedies

to collect on the financing in a default or

default-like situation, the lender may proceed only against property that is permitted as security for qualified nonrecourse

financing and that is held by the partnership or partnerships (applying a lookthrough rule for lower-tier partnerships).

Similar principles apply in determining

the treatment of financing incurred by an

entity that is disregarded for federal tax

purposes under §301.7701–3 of the Procedure and Administration Regulations.

The final regulations contain three examples illustrating the application of these

rules to tiered partnerships and one example addressing a situation that involves a

disregarded entity.

1998–34 I.R.B.

III. Other Issues

A commentator asked that the final regulations clarify whether an entity is disregarded for purposes of section 465(b)(6)

if that entity is disregarded as separate

from its owner under §301.7701–3. An

entity that is disregarded as an entity separate from its owner under §301.7701–3

is disregarded under section 465(b)(6).

Certain rules that apply to financings involving disregarded entities are discussed

above.

Commentators also raised several other

issues, including the treatment of publicly

traded financing, that are beyond the

scope of these regulations.

IV. Effective Dates

The final regulations are effective for

any financing incurred on or after August

4, 1998. In response to comments, however, the final regulations include a provision allowing taxpayers to apply the regulations retroactively for financing incurred

before August 4, 1998. If a taxpayer

chooses to apply these regulations retroactively to financing incurred before August

4, 1998, the IRS will require the taxpayer

to reduce the amounts at risk as a result of

the application of the regulations to taxable years ending before August 4, 1998,

only to the extent the application increases

the losses allowed for such years.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not

apply to these regulations, and because

the regulation does not impose a collection of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Therefore, a

Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f), the

notice of proposed rulemaking preceding

these regulations was submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment on

its impact on small business.

Drafting Information

The principal author of these regulations is Jeff Erickson, Office of the Assis-

5

tant Chief Counsel (Passthroughs and

Special Industries), IRS. However, other

personnel from the offices of

the IRS and Treasury Department participated in their development.

* * * * *

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR Part 1 is

amended as follows:

PART 1–INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding an entry in

numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

§1.465–27 also issued under 26 U.S.C.

465(b)(6)(B)(iii). * * *

Par. 2. Section 1.465–27 is added to

read as follows:

§1.465–27 Qualified nonrecourse

financing.

(a) In general. Notwithstanding any

provision of section 465(b) or the regulations under section 465(b), for an activity

of holding real property, a taxpayer is

considered at risk for the taxpayer’s share

of any qualified nonrecourse financing

which is secured by real property used in

such activity.

(b) Qualified nonrecourse financing secured by real property—(1) In general.

For purposes of section 465(b)(6) and this

section, the term qualified nonrecourse financing means any financing—

(i) Which is borrowed by the taxpayer

with respect to the activity of holding real

property;

(ii) Which is borrowed by the taxpayer

from a qualified person or represents a

loan from any federal, state, or local government or instrumentality thereof, or is

guaranteed by any federal, state, or local

government;

(iii) For which no person is personally

liable for repayment, taking into account

paragraphs (b)(3), (4), and (5) of this section; and

(iv) Which is not convertible debt.

(2) Security for qualified nonrecourse

financing—(i) Types of property. For a

taxpayer to be considered at risk under

section 465(b)(6), qualified nonrecourse

financing must be secured only by real

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property used in the activity of holding

real property. For this purpose, however,

property that is incidental to the activity

of holding real property will be disregarded. In addition, for this purpose,

property that is neither real property used

in the activity of holding real property nor

incidental property will be disregarded if

the aggregate gross fair market value of

such property is less than 10 percent of

the aggregate gross fair market value of

all the property securing the financing.

(ii) Look-through rule for partnerships.

For purposes of paragraph (b)(2)(i) of this

section, a borrower shall be treated as

owning directly its proportional share of

the assets in a partnership in which the

borrower owns (directly or indirectly

through a chain of partnerships) an equity

interest.

(3) Personal liability; partial liability.

If one or more persons are personally liable for repayment of a portion of a financing, the portion of the financing for

which no person is personally liable may

qualify as qualified nonrecourse financing.

(4) Partnership liability. For purposes

of section 465(b)(6) and this paragraph

(b), the personal liability of any partnership for repayment of a financing is disregarded and, provided the requirements

contained in paragraphs (b)(1)(i), (ii), and

(iv) of this section are satisfied, the financing will be treated as qualified nonrecourse financing secured by real property

if—

(i) The only persons personally liable

to repay the financing are partnerships;

(ii) Each partnership with personal liability holds only property described in

paragraph (b)(2)(i) of this section (applying the principles of paragraph (b)(2)(ii)

of this section in determining the property

held by each partnership); and

(iii) In exercising its remedies to collect

on the financing in a default or defaultlike situation, the lender may proceed

only against property that is described in

paragraph (b)(2)(i) of this section and that

is held by the partnership or partnerships

(applying the principles of paragraph

(b)(2)(ii) of this section in determining

the property held by the partnership or

partnerships).

(5) Disregarded entities. Principles

similar to those described in paragraph

(b)(4) of this section shall apply in deter-

August 24, 1998

mining whether a financing of an entity

that is disregarded for federal tax purposes under §301.7701–3 of this chapter

is treated as qualified nonrecourse financing secured by real property.

(6) Examples. The following examples

illustrate the rules of this section:

Example 1. Personal liability of a partnership;

incidental property. (i) X is a limited liability company that is classified as a partnership for federal tax

purposes. X engages only in the activity of holding

real property. In addition to real property used in the

activity of holding real property, X owns office

equipment, a truck, and maintenance equipment that

it uses to support the activity of holding real property. X borrows $500 to use in the activity. X is personally liable on the financing, but no member of X

and no other person is liable for repayment of the financing under local law. The lender may proceed

against all of X’s assets if X defaults on the financing.

(ii) Under paragraph (b)(2)(i) of this section, the

personal property is disregarded as incidental property used in the activity of holding real property.

Under paragraph (b)(4) of this section, the personal

liability of X for repayment of the financing is disregarded and, provided the requirements contained in

paragraphs (b)(1)(i), (ii), and (iv) of this section are

satisfied, the financing will be treated as qualified

nonrecourse financing secured by real property.

Example 2. Bifurcation of a financing. The facts

are the same as in Example 1, except that A, a member of X, is personally liable for repayment of $100

of the financing. If the requirements contained in

paragraphs (b)(1)(i), (ii), and (iv) of this section are

satisfied, then under paragraph (b)(3) of this section,

the portion of the financing for which A is not personally liable for repayment ($400) will be treated

as qualified nonrecourse financing secured by real

property.

Example 3. Personal liability; tiered partnerships. (i) UTP1 and UTP2, both limited liability

companies classified as partnerships, are the only

general partners in Y, a limited partnership. Y borrows $500 with respect to the activity of holding real

property. The financing is a general obligation of Y.

UTP1 and UTP2, therefore, are personally liable to

repay the financing. Under section 752, UTP1’s

share of the financing is $300, and UTP2’s share is

$200. No person other than Y, UTP1, and UTP2 is

personally liable to repay the financing. Y, UTP1,

and UTP2 each hold only real property.

(ii) Under paragraph (b)(4) of this section, the

personal liability of Y, UTP1, and UTP2 to repay the

financing is disregarded and, provided the requirements of paragraphs (b)(1)(i), (ii), and (iv) of this

section are satisfied, UTP1’s $300 share of the financing and UTP2’s $200 share of the financing will

be treated as qualified nonrecourse financing secured by real property.

Example 4. Personal liability; tiered partnerships. The facts are the same as in Example 3, except

that Y’s general partners are UTP1 and B, an individual. Because B, an individual, is also personally

liable to repay the $500 financing, the entire financing fails to satisfy the requirement in paragraph

(b)(1)(iii) of this section. Accordingly, UTP1’s $300

share of the financing will not be treated as qualified

nonrecourse financing secured by real property.

6

Example 5. Personal liability; tiered partnerships. The facts are the same as in Example 3, except

that Y is a limited liability company and UTP1 and

UTP2 are not personally liable for the debt. However, UTP1 and UTP2 each pledge property as security for the loan that is other than real property used

in the activity of holding real property and other

than property that is incidental to the activity of

holding real property. The fair market value of the

property pledged by UTP1 and UTP2 is greater than

10 percent of the sum of the aggregate gross fair

market value of the property held by Y and the aggregate gross fair market value of the property

pledged by UTP1 and UTP2. Accordingly, the financing fails to satisfy the requirement in paragraph

(b)(1)(iii) of this section by virtue of its failure to

satisfy paragraph (b)(4)(iii) of this section. Therefore, the financing is not qualified nonrecourse financing secured by real property.

Example 6. Personal liability; Disregarded entity. (i) X is a single member limited liability company that is disregarded as an entity separate from

its owner for federal tax purposes under

§301.7701–3 of this chapter. X owns certain real

property and property that is incidental to the activity of holding the real property. X does not own any

other property. For federal tax purposes, A, the sole

member of X, is considered to own all of the property held by X and is engaged in the activity of holding real property through X. X borrows $500 and

uses the proceeds to purchase additional real property that is used in the activity of holding real property. X is personally liable to repay the financing,

but A is not personally liable for repayment of the financing under local law. The lender may proceed

against all of X’s assets if X defaults on the financing.

(ii) X is disregarded so that the assets and liabilities of X are treated as the assets and liabilities of A.

However, A is not personally liable for the $500 liability. Provided that the requirements contained in

paragraphs (b)(1)(i), (ii), and (iv) of this section are

satisfied, the financing will be treated as qualified

nonrecourse financing secured by real property with

respect to A.

(c) Effective date. This section is effective for any financing incurred on or after

August 4, 1998. Taxpayers, however,

may apply this section retroactively for financing incurred before August 4, 1998.

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved July 16, 1998.

Donald C. Lubick,

Assistant Secretary of

the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on

August 3, 1998, 8:45 a.m., and published in the issue

of the Federal Register for August 4, 1998, 63 F.R.

41420)

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Part III. Administrative, Procedural, and Miscellaneous

SRLY Notice

Notice 98–38

In 1991, the Treasury Department and

the Internal Revenue Service issued proposed regulations concerning the application of the separate return limitation year

(SRLY) rules to net operating loss and

capital loss carryovers and carrybacks,

and built-in deductions. On June 27,

1996, these regulations, substantially unchanged, were re-proposed and issued as

temporary regulations in T.D. 8677,

1996–2 C.B. 119. On January 12, 1998 in

T.D. 8751, 1998–10 I.R.B. 23, (modified

only as to effective date on March 16,

1998 in T.D. 8766, 1998–16 I.R.B. 17)

the Treasury Department and the Service

published regulations extending the principles of the new temporary regulations to

certain tax credits and related attributes.

In addition, T.D. 8751 eliminated the application of the SRLY rules to foreign tax

credits and overall foreign losses.

Comments have been received in response to each set of proposed regulations. The preamble to the temporary regulations stated that all of the comments

would be considered in finalizing the temporary SRLY regulations. Many of the

comments asserted that the amendment to

§382 of the Internal Revenue Code in

1986 adequately addressed Congressional

concerns regarding loss trafficking.

Therefore, some commentators argued,

the SRLY rules should be eliminated in

whole or in part because the SRLY rules

have become superfluous, add unwarranted complexity to the consolidated return system, and are easily avoided.

Other commentators have argued that the

SRLY rules should be retained.

Treasury and the Service have considered these arguments and believe that limitations on the extent to which a consolidated group can use attributes arising in a

separate return limitation year remain

necessary to protect the integrity of both

the separate return system and the consolidated return system. Treasury and the

Service, however, are concerned about

any complexity in applying the current

SRLY rules, particularly with respect to

situations where both the SRLY rules and

§ 382 apply.

Accordingly, Treasury and the Service

1998–34 I.R.B.

are considering, inter alia, an approach

that would replace the current SRLY limitation with an approach modeled on §

382. While the temporary regulations

base the SRLY limitation on the income

actually generated by the SRLY member

(or SRLY subgroup), the approach under

consideration would base the limitation

on an expectation of the amount of income to be generated. In other words, applying the methodology of § 382, the limitation would be determined based on the

value of the member’s or subgroup’s

stock at the time it joins the consolidated

group, with appropriate adjustments (such

as adjustments for recognized built-in

gains) to reflect adjustments that would

be made under § 382.

Most instances in which a corporation

becomes a member of a consolidated

group involve an ownership change as defined in § 382(g). In those cases, current

law requires taxpayers to calculate two

separate loss limitations — the SRLY limitation and the § 382 limitation. By making the SRLY limitation the same as the §

382 limitation, the proposed approach

would remove the need to make two sets

of calculations, thereby greatly simplifying the loss limitation rules applicable to

consolidated groups.

In addition, adoption of this approach

would address concerns raised that the

SRLY rules are easily avoided through the

use of stuffing transactions (e.g., transferring income producing assets to the SRLY

member).

Treasury and the Service request comments about the advisability of adopting

this approach. In particular, comments

are requested with respect to the following:

1. Possible approaches to limit the use

of loss carrybacks;

2. The application of this approach to

credits (including foreign tax credits) and

overall foreign losses arising in separate

return limitation years;

3. The interaction of this approach

with the operation of § 382(l)(5) (relating

to corporations in a Title 11 or similar

case);

4. Determination of the effect on an

ongoing SRLY subgroup limitation when

a member of the subgroup leaves the consolidated group;

7

5. Whether special valuation rules will

be required to apply the § 382 mechanism

in situations where there is no § 382 ownership change; and

6. Possible transition rules for corporations that joined a consolidated group before the effective date of any new regulations adopting this proposed approach.

Any regulations adopting a new

method of determining the SRLY limitation would be initially issued as a notice

of proposed rulemaking. Treasury and

the Service would provide taxpayers and

their representatives another comment period before regulations adopting such an

approach are finalized. The existing temporary regulations will apply at least to

taxable years ending on or before December 31, 1998.

Comments should be sent to:

CC:DOM:CORP:R (Notice 98–38), room

5228, Internal Revenue Service, P.O. Box

7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, comments

may

be

hand

delivered

to

CC:DOM:CORP:R (Notice 98–38),

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW,

Washington, DC. Alternatively, taxpayers

may transmit comments electronically via

the IRS Internet site at http://www/irs.ustreas.gov/prod/tax-regs/comments.htm1.

To be considered, comments should be received by November 15, 1998.

FOR FURTHER INFORMATION CONTACT: David Kessler or Roy Hirschhorn,

of the Office of the Assistant Chief Counsel (Corporate), at (202) 622-7770 (not a

toll-free number).

Weighted Average Interest Rate

Update

Notice 98–44

Notice 88–73 provides guidelines for

determining the weighted average interest

rate and the resulting permissible range of

interest rates used to calculate current liability for the purpose of the full funding

limitation of § 412(c)(7) of the Internal

Revenue Code as amended by the Omnibus Budget Reconciliation Act of 1987

and as further amended by the Uruguay

Round Agreements Act, Pub. L. 103–465

(GATT).

August 24, 1998

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8/19/98 1:34 PM

Page 8

The average yield on the 30-year Treasury Constant Maturities for July 1998 is

5.68 percent.

The following rates were determined

for the plan years beginning in the month

shown below.

Month

Year

Weighted

Average

August

1998

6.51

Drafting Information

The principal author of this notice is

Donna Prestia of the Employee Plans Division. For further information regarding

this notice, call (202) 622-6076 between

2:30 and 3:30 p.m. Eastern time (not a

toll-free number). Ms. Prestia’s number

is (202) 622-7473 (also not a toll-free

number).

26 CFR 601.105: Examination of returns and

claims for refund, credit, or abatement;

determination of correct tax liability.

(Also Part I, § 42; 1.42–14.)

Rev. Proc. 98–45

SECTION 1. PURPOSE

This revenue procedure publishes the

amounts of unused housing credit carryovers allocated to qualified states under §

42(h)(3)(D) of the Internal Revenue Code

for calendar year 1998.

SECTION 2. BACKGROUND

Rev. Proc. 92–31, 1992–1 C.B. 775, provides guidance to state housing credit

agencies of qualified states on the procedure for requesting an allocation of unused

August 24, 1998

housing credit carryovers under §

42(h)(3)(D). Section 4.06 of Rev. Proc.

92–31 provides that the Internal Revenue

Service will publish in the Internal Revenue Bulletin the amount of unused housing credit carryovers allocated to qualified

90% to 106%

Permissible

Range

90% to 110%

Permissible

Range

5.86 to 6.90

5.86 to 7.16

states for a calendar year from a national

pool of unused credit authority (the National Pool). This revenue procedure publishes these amounts for calendar year

1998.

SECTION 3. PROCEDURE

The unused housing credit carryover

amount allocated from the National Pool

by the Secretary to each qualified state for

calendar year 1998 is as follows:

Qualified State

Amount Allocated

Alabama

Alaska

Arizona

California

Colorado

Delaware

Florida

Georgia

Idaho

Illinois

Indiana

Iowa

Kansas

Kentucky

Maine

Maryland

Massachusetts

$ 22,393

3,158

23,617

167,305

20,185

3,795

75,979

38,814

6,274

61,679

30,404

14,787

13,455

20,262

6,440

26,412

31,721

8

Qualified State

Michigan

Minnesota

Mississippi

Missouri

Nebraska

Nevada

New Jersey

New Mexico

New York

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rhode Island

South Carolina

South Dakota

Tennessee

Texas

Utah

Vermont

Virginia

Washington

Amount Allocated

50,677

24,296

14,160

28,009

8,591

8,695

41,754

8,970

94,038

38,498

3,323

57,998

17,198

16,815

62,322

5,117

19,495

3,826

27,832

100,789

10,676

3,054

34,915

29,087

SECTION 4. EFFECTIVE DATE

This revenue procedure is effective for

allocations of housing credit dollar

amounts attributable to the National Pool

component of a qualified state’s housing

credit ceiling for calendar year 1998.

DRAFTING INFORMATION

The principal author of this revenue

procedure is Christopher J. Wilson of the

Office of Assistant Chief Counsel

(Passthroughs and Special Industries).

For further information regarding this

revenue procedure, contact Mr. Wilson on

(202) 622-3040 (not a toll-free call).

1998–34 I.R.B.

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Page 9

Part IV. Items of General Interest

Notice of Proposed Rulemaking

Failure by Certain Charitable

Organizations To Meet Certain

Qualification Requirements;

Taxes on Excess Benefit

Transactions

REG–246256–96

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains

proposed regulations relating to the excise

taxes on excess benefit transactions under

section 4958 of the Internal Revenue

Code (Code), as well as certain amendments and additions to existing Income

Tax Regulations affected by section 4958.

Section 4958 was enacted in section 1311

of the Taxpayer Bill of Rights 2. Section

4958 generally is effective for transactions occurring on or after September 14,

1995. Section 4958 imposes excise taxes

on transactions that provide excess economic benefits to disqualified persons of

public charities and social welfare organizations. The proposed regulations clarify

certain definitions and rules contained in

section 4958.

DATES: Written comments and requests

for a teleconference must be received by

November 2, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–246256–96),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM: CORP:T:R

(REG–246256–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution

Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting

the “Tax Regs” option on the IRS Home

Page, or by submitting comments directly

to the IRS Internet site at http://www.irs.us

treas.gov/prod/tax _regs/comments.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Phyllis D. Haney of the Office of Associate

Chief Counsel (Employee Benefits and

Exempt Organizations), (202) 622-4290;

1998–34 I.R.B.

concerning submissions, LaNita

VanDyke, (202) 622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed rulemaking have been submitted to the Office of Management and Budget for

review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.

3507(d)). Comments on the collections

of information should be sent to the Office of Management and Budget, Attn:

Desk Officer for the Department of Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503,

with copies to the Internal Revenue

Service, Attn: IRS Reports Clearance

Officer, OP:FS:FP, Washington, DC

20224. Comments on the collection of

information should be received by October 5, 1998. Comments are specifically

requested concerning:

Whether the proposed collections of information are necessary for the proper

performance of the functions of the Internal Revenue Service, including

whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collections of

information (see below);

How the quality, utility, and clarity of the

information to be collected may be enhanced;

How the burden of complying with the

proposed collections of information may

be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and

costs of operation, maintenance, and purchase of service to provide information.

The collections of information in this proposed regulation are in 26 CFR

§§53.4958–6(a)(2), 53.4958–6(a)(3),

53.4958–6(d)(2), and 53.4958–6(d)(3).

This information is required for an applicable tax-exempt organization to avail itself of a rebuttable presumption that payments under a compensation arrangement

between the organization and a disquali-

9

fied person are reasonable, or a transfer of

property, right to use property, or any

other benefit or privilege between the organization and a disqualified person is at

fair market value. This information will

be used by the organization’s governing

body, or committee thereof, to document

the basis for its determination that compensation was reasonable or any other

benefit was at fair market value. The collections of information are required to obtain the benefit of this rebuttable presumption of reasonableness. The likely

recordkeepers are nonprofit institutions.

Estimated total annual recordkeeping burden: 910,083 hours.

The estimated annual burden per recordkeeper varies from 3 hours to 308 hours,

depending on individual circumstances,

with an estimated weighted average of 6

hours, 3 minutes.

Estimated number of recordkeepers:

150,427

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

Books or records relating to a collection

of information must be retained as long as

their contents may become material in the

administration of any internal revenue

law. Generally, tax returns and tax return

information are confidential, as required

by 26 U.S.C. 6103.

Background

This document provides rules regarding section 4958 excise taxes on excess

benefit transactions. Section 4958 was

added to the Code by the Taxpayer Bill of

Rights 2, Public Law 104–168 (110 Stat.

1452), enacted July 30, 1996. The section

4958 excise taxes generally apply to excess benefit transactions occurring on or

after September 14, 1995. They do not

apply, however, to any benefit arising

from a transaction pursuant to any written

contract that was binding on September

13, 1995, and continued in force through

the time of the transaction.

An excess benefit transaction subject to

tax under section 4958 is any transaction

in which an economic benefit provided by

an applicable tax-exempt organization to,

or for the use of, any disqualified person

August 24, 1998

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Page 10

exceeds the value of consideration received by the organization in exchange

for the benefit. An excess benefit transaction also includes certain revenue-sharing

transactions. An applicable tax-exempt

organization is any organization described in section 501(c)(3) (except private foundations) or section 501(c)(4) at

the time of the excess benefit transaction

or at any time during the five-year period

ending on the date of the transaction. The

excess benefit is generally the excess of

the value of the benefit provided to a disqualified person over the value of the consideration received by the organization.

A disqualified person is any person

who was, at any time during the 5-year

period ending on the date of the excess

benefit transaction, in a position to exercise substantial influence over the affairs

of the organization. A disqualified person

also includes any family member of a person described in the preceding sentence or

any entity in which at least 35 percent of

the control or beneficial interest is held by

such a person.

There are three taxes under section

4958. Disqualified persons are liable for

the first two taxes, which are imposed as

follows: Pursuant to section 4958(a)(1), a

tax of 25 percent of the excess benefit

must be paid by any disqualified person

who benefits from an excess benefit transaction with an applicable tax-exempt organization. Pursuant to section 4958(b), a

tax of 200 percent of the excess benefit

must be paid by any disqualified person

who benefits from an excess benefit transaction if that transaction is not corrected

before the earlier of either the date a deficiency notice is mailed with respect to the

25 percent tax or the date the 25 percent

tax is assessed. Certain organization

managers are liable for the third tax,

which is imposed as follows: Pursuant to

section 4958(a)(2), a tax of 10 percent of

the excess benefit must be paid by any organization manager who participates in an

excess benefit transaction knowingly,

willfully, and without reasonable cause.

An organization manager is an officer, director, or trustee of the organization, or

any individual having powers or responsibilities similar to those of an officer, director, or trustee. The tax that must be

paid by participating organization managers for any one excess benefit transaction cannot exceed $10,000.

August 24, 1998

The IRS notified the general public of

the new section 4958 excise taxes in Notice 96–46 (1996–2 C.B. 112). Notice

96–46 also solicited comments to be used

in drafting these proposed regulations.

Comments Received Pursuant to

Notice 96–46

In response to its request for comments

in Notice 96–46, the IRS received 28

comment letters addressing a variety of

topics pertaining to section 4958. Some

general comments requested that in applying the section 4958 excise taxes the

IRS avoid creating administrative burdens

on the vast majority of charities and only

scrutinize a narrowly targeted group of

charities prone to abuse the inurement

prohibition. Most comments, however,

focused on specific definitions or other

statutory language in section 4958. A

brief summary of the most frequently

made suggestions follows. All of the

comments were given consideration in

preparing these proposed regulations.

Commentators made suggestions regarding the definition of disqualified person, including applying a facts and circumstances test that annunciates only

general principles; using a test that does

not treat all of an organization’s officers

as necessarily being disqualified persons;

deferring to an organization’s own internal good-faith identification of disqualified persons; treating certain donors as

disqualified persons under standards similar to those for private foundation substantial contributors; clarifying that a

donor is not in a position to exercise substantial influence over the affairs of an organization solely by reason of having

made a large donation; including as disqualified persons those persons who provide advice and consultation to organizations regarding potential excess benefit

transactions; providing that a person does

not become a disqualified person with respect to a transaction as a result of the

transaction (thus a person who negotiated

a compensation arrangement in good faith

before entering into an employment relationship would not become a disqualified

person by virtue of the negotiation); and

excluding certain independent contractors

from disqualified person status.

Commentators on the tax to be paid by

organization managers who participate in

an excess benefit transaction knowingly,

10

willfully, and without reasonable cause

suggested the following: defining organization manager narrowly; using the principles of the regulations under sections

4946 and 4955 in defining organization

manager; excluding in-house counsel and

independent contractors (attorneys, accountants, etc.) from the definition; using

an organization’s bylaws as the source of

determining whether an individual is an

officer, director, or trustee; excluding

managers who voted against an excess

benefit transaction from joint and several

liability for any 10% tax associated with

the transaction; using the definitions in

current section 4946 private foundation

regulations for knowing, willful, and reasonable cause; allowing managers to rely

on advice of legal counsel to prove their

participation in a transaction was due to

reasonable cause, and expanding the category of persons qualified to render opinions with this effect. Although the proposed regulations provide that only

advice of counsel in a reasoned written

legal opinion protects organization managers in this regard, the IRS invites further comments on this topic. The IRS

also requests that such comments address

whether, to be consistent on this point,

other regulations (e.g., §53.4941 and

§53.4945) should be amended as well.

Numerous comments were received on

determining reasonable compensation for

services and fair market value in sale or

exchange transactions. Commentators

asked the IRS to use existing law standards under section 162 for determining

reasonable compensation and to provide

special standards for new organizations in

the start-up phase of operations. With respect to compensation, some commentators also requested objective standards or

charts of reasonable compensation

amounts; others requested that the regulations not impose strict dollar limitations

on what would constitute reasonable compensation.

Several commentators made suggestions regarding the requirement that an organization must demonstrate its intent to

treat economic benefits as compensation

in order to treat the benefit as being provided in exchange for services. These

suggestions included using a facts and circumstances test to determine whether an

organization clearly indicated its intent to

treat a benefit as compensation; consider-

1998–34 I.R.B.

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Page 11

ing certain small amounts inadvertently

not included in a disqualified person’s reported compensation as de minimis and

not triggering section 4958 taxes; and allowing a reasonable cause exception

under which items that were not reported

as compensation could still be treated as

provided in exchange for services.

A number of commentators requested

that the definition of an excess benefit

transaction exclude the provision of certain types of benefits to a disqualified person. These benefits included economic

benefits made available to the general

public on at least as favorable a basis;

economic benefits that are de minimis

fringe benefits under section 132; reimbursements for expenses of administration of an organization; and incidental

benefits.

Commentators provided a wide range

of suggestions on the subject of which

revenue-sharing arrangements should

constitute excess benefit transactions.

Suggestions included incorporating existing IRS unpublished guidance in a safe

harbor rule; using the principles of Rev.

Rul. 69–383 (1969–2 C.B. 113), to determine whether a particular plan of compensation results in prohibited inurement

or private benefit; limiting the category of

revenue-sharing arrangements that constitute excess benefit transactions to

arrangements based on the organization’s

revenues only; and applying regulations

on revenue-sharing arrangements

prospectively, with transition rules for existing arrangements.

Many comments were received on the

rebuttable presumption of reasonableness

that is described in the legislative history

as arising when a board of directors approves certain compensation arrangements or other transactions. The following suggestions were submitted in

multiple comments: that the presumption

apply when an applicable organization’s

board approves general guidelines for entering into transactions with disqualified

persons rather than voting on each individual transaction; that the regulations require a determination of reasonableness at

the time the organization makes a payment to a disqualified person; that the presumption apply when approval is given

by a compensation committee that is not

composed exclusively of directors or

trustees; that the board or committee be

1998–34 I.R.B.

considered independent if members recuse themselves when they have conflicts

of interest; that the regulations clarify

whether a joint compensation committee

composed of representatives from several

affiliated organizations would be a committee of each of the respective boards;

that the regulations allow an organization’s board to delegate the responsibility

for setting compensation to an independent committee; that the regulations use

examples to define what is an independent firm that can produce salary surveys

that will serve as appropriate data on

comparability; that the regulations clarify

that the rebuttable presumption is a safe

harbor and no negative inference should

be drawn if an organization does not avail

itself of that safe harbor; and that the regulations clarify that compensation outside

the range of comparables is not per se unreasonable. Some church representatives

submitted comments noting that the religious beliefs of some churches and some

state laws regarding churches prevent

churches from benefitting from the rebuttable presumption of reasonableness because of the identity of the parties required to approve compensation

arrangements or other transactions.

While these proposed regulations do not

provide a special exception for churches

from the requirements that must be met to

give rise to the rebuttable presumption,

they do provide churches with a special

rule stating that the procedures of section

7611 will be used in initiating and conducting any inquiry or examination into

whether an excess benefit transaction has

occurred between a church and a disqualified person. For purposes of this rule, the

reasonable belief required to initiate a

church tax inquiry is satisfied if there is a

reasonable belief that a section 4958 tax is

due from a disqualified person with respect to a transaction involving a church.

Several comments were received on the

relationship between revocation of taxexempt status and the taxes imposed

under section 4958, recommending that

the regulations follow the legislative history on this question. The IRS intends to

exercise its administrative discretion in

enforcing the requirements of sections

4958, 501(c)(3) and 501(c)(4) in accordance with the direction given in the legislative history. The legislative history

specifically provides that the IRS may

11

still revoke the tax-exempt status of an organization for violating the inurement

proscription, with or without imposition

of section 4958 excise taxes. It further

provides that, in practice, the excise taxes

imposed by section 4958 will be the sole

sanction imposed in those cases in which

the excess benefit does not rise to a level

where it calls into question whether, on

the whole, the organization functions as a

charitable or other tax-exempt organization. In determining whether an excess

benefit transaction rises to such a level,

factors relating to the organization’s general pattern of compliance with the requirements of section 501(c)(3) or (4) and

other applicable Federal and State laws

will be taken into account. These factors

would include whether the organization

has been involved in repeated excess benefit transactions; the size and scope of the

excess benefit transaction; whether, after

concluding that it has been party to an excess benefit transaction, the organization

has implemented safeguards to prevent

future recurrences; and whether there was

compliance with other applicable laws.

The IRS intends to publish the factors that

it will consider in exercising its administrative discretion in guidance issued in

conjunction with the issuance of final regulations under section 4958.

Explanation of Provisions

Overview

This document contains proposed regulations that add new regulations under

section 4958, and that amend and add to

existing Income Tax and Excise Tax Regulations under sections 4963, 6213, 6501,

7422, and 7611. The explanation of these

proposed regulations is grouped into two

parts: the substantive section 4958 regulations, and regulations under the provisions amended to reflect various effects of

the enactment of section 4958 on abatement, Tax Court petitions, statute of limitations, refund actions, and church tax inquiries and examinations. The proposed

§53.4958 regulations are described in

more detail in this preamble under Section I, Taxes on excess benefit transactions, immediately below. The proposed

amendments and additions to regulations

under various procedural and administrative provisions affected by the enactment

of section 4958 are described in Section

August 24, 1998

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II, Amendment of regulations under various procedural and administrative provisions, below.

I. Taxes on excess benefit transactions

The proposed regulations describe the

three taxes imposed under section 4958

on excess benefit transactions between an

applicable tax-exempt organization and a

disqualified person. Two of the taxes are

paid by certain disqualified persons who

benefit economically from a transaction,

and the other tax is paid by certain organization managers who participate in the

transaction knowingly, willfully, and

without reasonable cause.

A disqualified person who receives an

excess benefit from a transaction is liable

for a tax equal to 25 percent of the excess

benefit. If the excess benefit is not corrected within the taxable period, that disqualified person is then liable for a tax of

200 percent of the excess benefit. Taxable period is defined as the period beginning on the date the transaction occurs

and ending on the earlier of the date of

mailing a notice of deficiency for the 25

percent tax or the date on which the 25

percent tax is assessed.

Correction is defined in the proposed

regulations as undoing the excess benefit

to the extent possible, and taking any additional measures necessary to place the

organization in a financial position not

worse than that in which it would be if the

disqualified person had been dealing

under the highest fiduciary standards.

Correction of the excess benefit occurs if

the disqualified person repays the applicable tax-exempt organization an amount of

money equal to the excess benefit, plus

any additional amount needed to compensate the organization for the loss of the

use of the money or other property during

the period commencing on the date the

excess benefit transaction occurs and ending on the date the excess benefit is corrected. Correction may also be accomplished, in certain circumstances, by

returning property to the organization and

taking any additional steps necessary to

make the organization whole. If the excess benefit transaction consists of the

payment of compensation for services

under a contract that has not been completed, termination of the employment or

independent contractor relationship between the organization and the disquali-

August 24, 1998

fied person is not required in order to correct. However, the terms of any ongoing

compensation arrangement may need to

be modified to avoid future excess benefit

transactions. If the excess benefit is corrected within the correction period, then

under the rules of section 4961 the 200

percent tax under section 4958(b) is not

assessed. If the excess benefit is corrected within the correction period and it

is established to the satisfaction of the

Secretary that the excess benefit transaction was due to reasonable cause and not

to willful neglect, then under the rules of

section 4962 the 25 percent tax under section 4958(a)(1) will be abated.

Each organization manager who participated in the excess benefit transaction,

knowing that it was such a transaction,

unless such participation was not willful

and was due to reasonable cause, is liable

for a tax equal to 10 percent of the excess

benefit, not to exceed an aggregate

amount of $10,000 with respect to any

one excess benefit transaction. An organization manager is, with respect to any

applicable tax-exempt organization, any

officer, director, or trustee of such organization, or any individual having powers

or responsibilities similar to those of officers, directors, or trustees of the organization. Independent contractors, acting in a

capacity as attorneys, accountants, and investment managers and advisors, are not

officers. Any person who has authority

merely to recommend particular administrative or policy decisions, but not to implement them without approval of a superior, is not an officer. An individual who is

not an officer, director, or trustee, yet

serves on a committee of the governing

body of an applicable tax-exempt organization that is invoking the rebuttable presumption of reasonableness (described

later in this section) based on the committee’s action, however, is an organization

manager for purposes of the 10 percent

tax.

The definitions provided in the proposed regulations for the terms participation, knowing, willful, and due to reasonable cause with respect to organization

managers for section 4958 purposes parallel the definitions of those terms used

with respect to foundation managers in

the section 4941 regulations. If an organization manager, after full disclosure of

the factual situation to legal counsel (in-

12

cluding in-house counsel) relies on the

advice of such counsel expressed in a reasoned written legal opinion that a transaction is not an excess benefit transaction

under section 4958, that manager’s participation in such transaction will ordinarily

not be considered knowing or willful, and

will ordinarily be considered due to reasonable cause, even if the transaction is

subsequently held to be an excess benefit

transaction.

With respect to any specific excess

benefit transaction, if more than one person is liable for any of the taxes imposed

by section 4958, all persons with respect

to whom a particular tax is imposed are

jointly and severally liable for that tax.

For instance, if more than one disqualified person benefits from the same transaction, all the benefitting disqualified persons are jointly and severally liable for

the respective section 4958(a)(1) or (b)

taxes on that transaction. Where an organization manager also receives an excess

benefit from an excess benefit transaction, the manager may be liable for both

taxes imposed by section 4958(a).

Except as otherwise provided in the

proposed regulations, a transaction occurs

on the date on which a disqualified person

receives an economic benefit from the applicable tax-exempt organization for federal income tax purposes. In the case of

payment of deferred compensation, the

transaction occurs on the date the deferred

compensation is earned and vested.

The proposed regulations cross-reference sections 6501(e)(3) and 6501(l) and

the regulations thereunder, as amended,

for statute of limitations rules for section

4958 excise taxes. Thus, the statute of

limitations for imposition of tax under

section 4958 generally begins to run as of

the date the applicable tax-exempt organization files its return (Form 990) for the

year in which the excess benefit transaction occurred.

The proposed regulations provide that

the taxes imposed on excess benefit transactions apply to transactions occurring on

or after September 14, 1995. However,

these taxes do not apply to a transaction

pursuant to a written contract that was

binding on September 13, 1995, and at all

times thereafter before the transaction occurred. A written binding contract that is

terminable or subject to cancellation by

the applicable tax-exempt organization

1998–34 I.R.B.

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Page 13

without the disqualified person’s consent

is treated as a new contract as of the date

that any such termination or cancellation,

if made, would be effective. If a binding

written contract is materially modified

(including situations in which the contract

is amended to extend its term or to increase the amount of compensation

payable to the disqualified person), it is

treated as a new contract entered into as

of the date of the material modification.

Definition of applicable tax-exempt

organization

The proposed regulations generally define an applicable tax-exempt organization as any organization that, without regard to any excess benefit, is or would

have been described in sections 501(c)(3)

or (4) and exempt from tax under section

501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the lookback period). In

the specific case of any transaction occurring before September 14, 2000, the lookback period begins on September 14,

1995, and ends on the date of the transaction.

To be described in section 501(c)(3) for

purposes of section 4958, an organization

must meet the requirements of section

508 (subject to any applicable exceptions

provided by that section). A private

foundation as defined in section 509(a) is

not an applicable tax-exempt organization

for section 4958 purposes. An organization that has applied for and received

recognition of exemption as an organization described in section 501(c)(4) is an

applicable tax-exempt organization for

section 4958 purposes. In addition, an organization that has sought to take advantage of section 501(c)(4) status by filing

an application for recognition of exemption under section 501(c)(4) with the IRS,

filing an information return as a section

501(c)(4) organization under the Code or

regulations promulgated thereunder, or

otherwise holding itself out as being described in section 501(c)(4), is an applicable tax-exempt organization for section

4958 purposes.

A foreign organization that receives

substantially all of its support from

sources outside of the United States is not

an applicable tax-exempt organization for

section 4958 purposes. Section 4948(b)

generally states that chapter 42 taxes, in-

1998–34 I.R.B.

cluding section 4958 taxes on excess benefit transactions, do not apply to any foreign organization that has received substantially all of its support from sources

outside the United States.

Definition of disqualified person

The proposed regulations define a disqualified person as a person who, with respect to any transaction with an applicable tax-exempt organization, at any time

during a five-year period beginning after

September 13, 1995, and ending on the

date of such transaction, was in a position

to exercise substantial influence over the

affairs of the organization. Certain persons are statutorily defined to be disqualified persons under section 4958(f), including certain family members of

disqualified persons (spouse, brothers or

sisters (by whole or half blood), spouses

of brothers or sisters (by whole or half

blood), ancestors, children, grandchildren, great grandchildren, and spouses of

children, grandchildren, and great grandchildren), and 35 percent controlled entities (a corporation in which a disqualified

person owns more than 35 percent of the

combined voting power; a partnership in

which a disqualified person owns more

than 35 percent of the profits interest; or a

trust or estate in which a disqualified person owns more than 35 percent of the

beneficial interest).

The proposed regulations specifically

identify certain persons as having substantial influence over the affairs of an applicable tax-exempt organization. These

specified persons include any individual

who serves as a voting member on the

governing body of the organization; any

individual or individuals who have the

power or responsibilities of the president,

chief executive officer or chief operating

officer of an organization; any individual

or individuals who have the power or responsibilities of treasurer or chief financial officer of an organization; and any

person who has a material financial interest in certain provider-sponsored organizations in which a hospital that is an applicable tax-exempt organization

participates.

The proposed regulations deem two

categories of persons not to have substantial influence over the affairs of an applicable tax-exempt organization. The first

category comprises other applicable tax-

13

exempt organizations described in section

501(c)(3). The second category comprises any employee who, for the taxable

year in which the benefits are provided,

receives economic benefits, directly or indirectly from the organization, of less

than the amount of compensation referenced for a highly compensated employee

in section 414(q)(1)(B)(i), who is not a

statutorily-defined disqualified person

and not specifically identified by the regulations as having substantial influence,

and is not a substantial contributor to the

organization within the meaning of section 507(d)(2).

The proposed regulations provide that

except as specified in the categories set

forth in the statute or the preceding parts

of the regulation, the determination of

whether a person has substantial influence

over the affairs of an organization is

based on all relevant facts and circumstances. A person who has managerial

control over a discrete segment of an organization may nonetheless be in a position to exercise substantial influence over

the affairs of the entire organization.

Facts and circumstances tending to show

that a person has substantial influence

over the affairs of an organization include, but are not limited to, the following: that the person founded the organization; that the person is a substantial

contributor (within the meaning of section

507(d)(2)) to the organization; that the

person’s compensation is based on revenues derived from activities of the organization that the person controls; that the

person has authority to control or determine a significant portion of the organization’s capital expenditures, operating budget, or compensation for employees; that

the person has managerial authority or

serves as a key advisor to a person with

managerial authority; or that the person

owns a controlling interest in a corporation, partnership, or trust that is a disqualified person.

Facts and circumstances tending to

show that a person does not have substantial influence over the affairs of an organization include but are not limited to, the

following: that the person has taken a

bona fide vow of poverty as an employee,

agent, or on behalf of a religious organization; that the person is an independent

contractor, such as an attorney, accountant, or investment manager or advisor,

August 24, 1998

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acting in that capacity, unless the person

is acting in that capacity with respect to a

transaction from which the person might

economically benefit either directly or indirectly (aside from fees received for the

professional services rendered); and that

any preferential treatment a person receives based on the size of that person’s

donation is also offered to any other

donor making a comparable contribution

as part of a solicitation intended to attract

a substantial number of contributions.

In the case of multiple organizations affiliated by common control or governing

documents, the determination of whether

a person does or does not have substantial

influence will be made separately for each

applicable tax-exempt organization.

Excess benefit transaction

The proposed regulations state that an

excess benefit transaction is any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to, or for the

use of, any disqualified person if the

value of the economic benefit provided

exceeds the value of the consideration (including the performance of services) received for providing such benefit. An excess benefit transaction also includes

certain revenue-sharing transactions (described later in this section). A benefit

can be provided indirectly if it is provided

through one or more entities controlled by

or affiliated with the applicable tax-exempt organization.

Certain economic benefits provided by

an applicable tax-exempt organization to

a disqualified person are disregarded for

purposes of section 4958. These include

paying reasonable expenses for members

of the governing body of an applicable

tax-exempt organization to attend meetings of the governing body of the organization, not including expenses for luxury

travel or spousal travel; an economic benefit provided to a disqualified person that

the disqualified person receives solely as

a member of, or volunteer for, the organization, if the benefit is provided to members of the public in exchange for a membership fee of $75 or less per year; and an

economic benefit provided to a disqualified person that the disqualified person receives solely as a member of a charitable

class the applicable tax-exempt organization intends to benefit.

August 24, 1998

The proposed regulations provide that

the payment of a premium for an insurance policy providing liability insurance

to a disqualified person to cover any taxes

imposed under this section or indemnification of a disqualified person for such

taxes by an applicable tax-exempt organization is not an excess benefit transaction

if the premium or the indemnification is

treated as compensation to the disqualified person when paid, and the total compensation paid to the disqualified person

is reasonable.

The proposed regulations provide that

if the amount of the economic benefit provided by the applicable tax-exempt organization exceeds the fair market value of

the consideration, the excess is the excess

benefit on which tax is imposed by section 4958. Rules concerning the excess

benefit in certain revenue-sharing transactions are described later in this section.

The fair market value of property is the

price at which property or the right to use

property would change hands between a

willing buyer and a willing seller, neither

being under any compulsion to buy, sell,

or transfer property or the right to use

property, and both having reasonable

knowledge of relevant facts.

Compensation

Compensation for the performance of

services is reasonable only if it is an

amount that would ordinarily be paid for

like services by like enterprises under like

circumstances. Generally, the circumstances to be taken into consideration are

those existing at the date when the contract for services was made. However,

where reasonableness of compensation

cannot be determined based on circumstances existing at the date when the contract for services was made, then that determination is made based on all facts and

circumstances, up to and including circumstances as of the date of payment. In

no event shall circumstances existing at

the date when the contract is questioned

be considered in making a determination

of the reasonableness of compensation. A

written binding contract that is terminable

or subject to cancellation by the applicable tax-exempt organization without the

disqualified person’s consent is treated as

a new contract as of the date that any such

termination or cancellation, if made,

would be effective. If a binding written

14

contract is materially modified (which includes amending the contract to extend its

term or increase the amount of compensation payable to the disqualified person), it

is treated as a new contract entered into as

of the date of the material modification.

Examples illustrate whether the reasonableness of compensation can be determined based on circumstances existing at

the time a contract for the performance of

services was made. In accordance with

the legislative history, the fact that a State

or local legislative or agency body has authorized or approved a particular compensation package paid to a disqualified person is not determinative of the

reasonableness of compensation paid for

purposes of section 4958 excise taxes.

Under the proposed regulations, the fact

that a particular compensation package is

authorized or approved by a court also is

not determinative of the reasonableness of

compensation paid to a disqualified person.

Compensation for purposes of section

4958 includes all items of compensation

provided by an applicable tax-exempt organization in exchange for the performance of services by a disqualified person. These items of compensation

include, but are not limited to, all forms of

cash and noncash compensation, including salary, fees, bonuses, and severance

payments paid, and all forms of deferred

compensation that is earned and vested,

whether or not funded, and whether or not

paid under a deferred compensation plan

that is a qualified plan under section

401(a). If deferred compensation for services performed in multiple prior years

vests in a later year, then that compensation is attributed to the years in which the

services were performed. Compensation

also includes the amount of premiums

paid for liability or any other insurance

coverage, as well as any payment or reimbursement by the organization of charges,

expenses, fees, or taxes not covered ultimately by the insurance coverage; all

other benefits, whether or not included in

income for tax purposes, including payments to welfare benefit plans on behalf

of the disqualified persons, such as plans

providing medical, dental, life insurance,

severance pay, and disability benefits, and

both taxable and nontaxable fringe benefits (other than working condition fringe

benefits described in section 132(d) and

de minimis fringe benefits described in

1998–34 I.R.B.

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Page 15

section 132(e)), including expense allowances or reimbursements or foregone

interest on loans that the recipient must

report as income on his separate income

tax return; and any economic benefit provided by the applicable tax-exempt organization directly or indirectly through another entity, owned, controlled by or

affiliated with the applicable tax-exempt

organization, whether such other entity is

taxable or tax-exempt.

An economic benefit that an applicable

tax-exempt organization provides to, or

for the use, of a disqualified person is not

treated as consideration for the performance of services unless the organization

clearly indicates its intent to treat the benefit as compensation when the benefit is

paid. An applicable tax-exempt organization will be treated as having intended to

provide an economic benefit as compensation for services only if it provides clear

and convincing evidence of having that

intent when the benefit was paid. An applicable tax-exempt organization can provide clear and convincing evidence of

such intent by reporting the economic

benefit as compensation on original or

amended federal tax information returns

with respect to the payment (e.g., Form

W–2 or 1099) or with respect to the organization (e.g., Form 990), filed before the

commencement of an IRS examination in

which the reporting of the benefit is questioned. For purposes of section 4958 and

these proposed regulations, an IRS examination of an applicable tax-exempt organization has commenced if the organization has received written notification from

the Exempt Organizations Division of an

impending Exempt Organizations examination, or written notification of an impending referral for an Exempt Organizations examination, and also includes

having been under an Exempt Organizations examination that is now in Appeals

or in litigation for issues raised in an Exempt Organizations examination of the

period in which the excess benefit transaction occurred. Reporting of an economic benefit to provide clear and convincing evidence of intent is also

accomplished if the recipient disqualified

person reports the benefit as income on

the person’s Form 1040 for the year in

which the benefit is received. If the

amount of an economic benefit paid to a

disqualified person is not reported and

1998–34 I.R.B.

should have been reported on any information return issued by the applicable

tax-exempt organization, and the failure

to report was due to reasonable cause as

defined under section 6724 regulations,

then the organization is deemed to satisfy

the clear and convincing evidence requirement. To show that its failure to report an economic benefit that should have

been reported on an information return

was due to reasonable cause, the applicable tax-exempt organization must establish that there are significant mitigating

factors with respect to its failure to report,

or the failure arose from events beyond

the organization’s control, and the organization acted in a responsible manner both

before and after the failure occurred. If

an organization fails to provide clear and

convincing evidence that it intended to

provide an economic benefit as compensation for services when paid, any services provided by the disqualified person

will not be treated as provided in consideration for the economic benefit.

as the ability of the party receiving the

compensation to control the activities

generating the revenues on which the

compensation is based.

The type of revenue-sharing transaction described in the proposed regulations

constitutes an excess benefit transaction if

it occurs on or after the date of publication of final regulations. The excess benefit in such a transaction consists of the

entire economic benefit provided. Any

revenue-sharing transaction occurring

after September 13, 1995, may still constitute an excess benefit transaction if the

economic benefit provided to the disqualified person exceeds the fair market value

of the consideration provided in return.

Before the date of publication of final regulations, however, the excess benefit shall

consist only of that portion of the economic benefit that exceeds the fair market

value of the consideration provided in return. Examples are provided of revenuesharing transactions that do and do not

constitute excess benefit transactions.

Transaction in which amount of

economic benefit determined in whole or

in part by the revenues of one or more

activities of the organization

Rebuttable presumption that transaction

is not an excess benefit transaction

The proposed regulations apply a facts

and circumstances test to assess whether a

transaction in which the amount of an

economic benefit provided by an applicable tax-exempt organization to or for the

use of a disqualified person is determined

in whole or in part by the revenues of one

or more activities of the applicable taxexempt organization (revenue-sharing

transaction) results in inurement, and

therefore constitutes an excess benefit

transaction. A revenue-sharing transaction may constitute an excess benefit

transaction regardless of whether the economic benefit provided to the disqualified

person exceeds the fair market value of

the consideration provided in return if, at

any point, it permits a disqualified person

to receive additional compensation without providing proportional benefits that

contribute to the organization’s accomplishment of its exempt purpose. If the

economic benefit is provided as compensation for services, relevant facts and circumstances include, but are not limited to,

the relationship between the size of the

benefit provided and the quality and

quantity of the services provided, as well

15

The proposed regulations provide that a

compensation arrangement between an

applicable tax-exempt organization and a

disqualified person is presumed to be reasonable, and a transfer of property, a right

to use property, or any other benefit or

privilege between an applicable tax-exempt organization and a disqualified person is presumed to be at fair market value,

if three conditions are satisfied. The three

conditions are as follows: (1) the compensation arrangement or terms of transfer

are approved by the organization’s governing body or a committee of the governing body composed entirely of individuals

who do not have a conflict of interest with

respect to the arrangement or transaction;

(2) the governing body, or committee

thereof, obtained and relied upon appropriate data as to comparability prior to

making its determination; and (3) the governing body or committee adequately

documented the basis for its determination concurrently with making that determination. The presumption established

by satisfying these three requirements

may be rebutted by additional information

showing that the compensation was not

reasonable or that the transfer was not at

fair market value.

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Page 16

To the extent permitted under local law,

the governing body of an applicable taxexempt organization may authorize other

parties to act on its behalf by following

specified procedures that satisfy the three

requirements for invoking the rebuttable

presumption of reasonableness. An

arrangement or transaction that is subsequently approved by the board’s designee

or designees in accordance with those

procedures shall be subject to the rebuttable presumption even though the governing body does not vote separately on

the specific arrangement or transaction.

With respect to the first requirement,

the proposed regulations provide that the

governing body is the board of directors,

board of trustees, or equivalent controlling body of the applicable tax-exempt organization. A committee of the governing

body may be composed of any individuals

permitted under state law to serve on such

a committee, and may act on behalf of the

governing body to the extent permitted by

state law. However, any members of such

a committee who are not members of the

governing body are deemed to be organization managers for purposes of the tax

imposed by section 4958(a)(2) if the organization is invoking the rebuttable presumption based on the actions of the committee. A person is not included on an

organization’s governing body or committee thereof when the governing body

or committee is reviewing a transaction if

that person meets with the other members

only to answer questions, and otherwise

recuses himself from the meeting and is

not present during debate and voting on

the transaction or compensation arrangement.

The proposed regulations provide that a

member of the governing body, or committee thereof, does not have a conflict of

interest with respect to a compensation

arrangement or transaction if the member

is not the disqualified person and is not

related to any disqualified person participating in or economically benefitting

from the compensation arrangement or

transaction; is not in an employment relationship subject to the direction or control

of any disqualified person participating in

or economically benefitting from the

compensation arrangement or transaction;

is not receiving compensation or other

payments subject to approval by any disqualified person participating in or eco-

August 24, 1998

nomically benefitting from the compensation arrangement or transaction; has no

material financial interest affected by the

compensation arrangement or transaction; and, as prescribed in the legislative

history, does not approve a transaction

providing economic benefits to any disqualified person participating in the compensation arrangement or transaction,

who in turn has approved or will approve

a transaction providing economic benefits

to the member. An arrangement or transaction has not been approved by a committee of a governing body if, under the

governing documents of the organization

or state law, the committee’s decision

must be ratified by the full governing

body in order to become effective.

With respect to the second requirement

for the rebuttable presumption of reasonableness, the proposed regulations provide that a governing body or committee

has appropriate data on comparability if,

given the knowledge and expertise of its

members, it has information sufficient to

determine whether a compensation

arrangement will result in the payment of

reasonable compensation or a transaction

will be for fair market value. Relevant information includes, but is not limited to,

compensation levels paid by similarly situated organizations, both taxable and taxexempt, for functionally comparable positions; the availability of similar services

in the geographic area of the applicable

tax-exempt organization; independent

compensation surveys compiled by independent firms; actual written offers from

similar institutions competing for the services of the disqualified person; and independent appraisals of the value of property that the applicable tax-exempt

organization intends to purchase from, or

sell or provide to the disqualified person.

A special rule is provided for organizations with annual gross receipts of less

than $1 million. Under this rule, when the

governing body reviews compensation

arrangements, it will be considered to

have appropriate data as to comparability

if it has data on compensation paid by five

comparable organizations in the same or

similar communities for similar services.

No inference is intended with respect to

whether circumstances falling outside this

safe harbor will meet the requirements

with respect to the collection of appropriate data.

16

For purposes of the third requirement

of the rebuttable presumption of reasonableness under the proposed regulations,

to be documented adequately, the written

or electronic records of the governing

body or committee must note the terms of

the transaction that was approved and the

date it was approved; the members of the

governing body or committee who were

present during debate on the transaction

or arrangement that was approved and

those who voted on it; the comparability

data obtained and relied upon by the committee and how the data was obtained;

and the actions taken with respect to consideration of the transaction by anyone

who is otherwise a member of the governing body or committee but who had a conflict of interest with respect to the transaction or arrangement. If the governing

body or committee determines that reasonable compensation for a specific

arrangement or fair market value in a specific transaction is higher or lower than

the range of comparable data obtained,

the governing body or committee must

record the basis for its determination. For

a decision to be documented concurrently,

records must be prepared by the next

meeting of the governing body or committee occurring after the final action or

actions of the governing body or committee are taken. Records must be reviewed

and approved by the governing body or

committee as reasonable, accurate and

complete within a reasonable time period

thereafter.

If reasonableness of the compensation

cannot be determined based on circumstances existing at the date when a contract for services was made, then the rebuttable presumption cannot arise until

circumstances exist so that reasonableness of compensation can be determined,

and the three requirements for the presumption subsequently are satisfied .

The fact that a transaction between an

applicable tax-exempt organization and a

disqualified person is not subject to the

presumption described in this section

shall not create any inference that the

transaction is an excess benefit transaction. Neither shall the fact that a transaction qualifies for the presumption exempt

or relieve any person from compliance

with any federal or state law imposing

any obligation, duty, responsibility, or

other standard of conduct with respect to

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Page 17

the operation or administration of any applicable tax-exempt organization. The rebuttable presumption applies to all payments made or transactions completed in

accordance with a contract provided that

the three requirements of the rebuttable

presumption were met at the time the contract was agreed upon.

Special rules

The proposed regulations provide that

the excise taxes imposed by section 4958

do not affect the substantive statutory

standards for tax exemption under sections 501(c)(3) or (4). Organizations are

described in those sections only if no part

of their net earnings inure to the benefit of

any private shareholder or individual.

The proposed regulations provide that

the procedures of section 7611 will be

used in initiating and conducting any inquiry or examination into whether an excess benefit transaction has occurred between a church and a disqualified person.

For purposes of this rule, the reasonable

belief required to initiate a church tax inquiry is satisfied if there is a reasonable

belief that a section 4958 tax is due from a

disqualified person with respect to a

transaction involving a church. Any additional procedures that apply when determining whether disqualified persons are

liable for taxes as a result of transactions

with organizations other than churches

will apply when determining whether disqualified persons are liable for taxes as a

result of transactions with churches.

II. Amendment of regulations under

various procedural and administrative

provisions

The proposed regulations amend the

section 4963 regulations to include section 4958 taxes in the list of taxes subject

to abatement under sections 4961 and

4962; amend the section 6213 regulations

to suspend the time period for filing a Tax

Court petition for the time allowed by the

Commissioner to correct a section 4958

transaction; amend the section 6501 regulations to allow the filing of an information return by an applicable tax-exempt

organization to begin the three-year limitation on assessment and collection for

section 4958 taxes (or six years if an organization failed to disclose an item);

amend the section 7422 regulations to

apply existing rules for refund proceed-

1998–34 I.R.B.

ings to section 4958 taxes; and amend

section 7611 regulations to cross-reference the rules governing the interaction

between section 4958 and section 7611 in

these proposed regulations.

Except as otherwise specified in the

text of the final regulations, these regulations will be effective upon publication of

the final regulations in the Federal Register. Taxpayers may rely on these proposed regulations for guidance pending

the issuance of final regulations. If, and

to the extent, future guidance is more restrictive than the guidance in these proposed regulations, the future guidance

will be applied without retroactive effect.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required.

An initial regulatory flexibility analysis

has been prepared as required for the collection of information in this notice of

proposed rulemaking under 5 U.S.C. 603.

The analysis follows:

Initial Regulatory Flexibility Analysis

These proposed regulations clarifying

section 4958 of the Code (Taxes on excess benefit transactions) may have an

impact on small organizations if those organizations avail themselves of the rebuttable presumption of reasonableness described in the regulations (26 C.F.R.

§§ 53.4958–6(a)(2), 53.4958–6(a)(3),

53.4958–6(d)(2), and 53.4958–6(d)(3)).

The rebuttable presumption is being considered because the legislative history of

section 4958 (H. REP. 104–506 at 56–7,

March 28, 1996) stated that parties to a

transaction should be entitled to rely on

such a rebuttable presumption that a

compensation arrangement or a property

transaction between certain organizations

and disqualified persons of the organizations is reasonable or at fair market value.

The legislative history further instructed

the Secretary of the Treasury and the IRS

to issue guidance in connection with the

standard for establishing reasonable compensation or fair market value that incorporates this presumption.

The objective for the rebuttable presumption is to allow organizations that

satisfy the three requirements to presume

17

that compensation arrangements and

property transactions entered into with

disqualified persons pursuant to satisfaction of those requirements are reasonable

or at fair market value. In such cases, the

section 4958 excise taxes can be imposed

only if the IRS develops sufficient contrary evidence to rebut the probative value

of the evidence put forth by the parties to

the transaction. The legal basis for the

proposed rule is Code sections 4958 and

7805.

The proposed rule affects organizations

described in sections 501(c)(3) and (4)

(applicable tax-exempt organizations).

Some applicable tax-exempt organizations may be small organizations, defined

in 5 U.S.C. 601(4) as any not-for-profit

enterprise which is independently owned

and operated and is not dominant in its

field.

The proposed recordkeeping burden

entails obtaining and relying on appropriate comparability data and documenting

the basis of an organization’s determination that compensation is reasonable, or a

property transfer (or transfer of the right

to use property) is at fair market value.

These actions are necessary to meet two

of the requirements specified in the legislative history for obtaining the rebuttable presumption of reasonableness. The

skills necessary for these actions are of

the type required for obtaining and considering comparability data, and for documenting the membership and actions of

the governing board or relevant committee of the organization. Applicable taxexempt organizations that are small entities of the class that files Form 990–EZ

(i.e., those with gross receipts of less than

$100,000 and assets of less than

$250,000) are unlikely to undertake fulfilling the requirements of the rebuttable

presumption of reasonableness, and therefore will not be affected by the recordkeeping burden. All other classes of applicable tax-exempt organizations that file

Form 990, up to organizations with assets

of $50 million, are likely to be small organizations that avail themselves of the rebuttable presumption of reasonableness.

These classes range from organizations

with assets of $100,000 to $50 million.

The proposed rule currently contains a

less burdensome safe harbor for one of

the requirements (obtaining comparability

data on compensation) for organizations

August 24, 1998

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Page 18

with annual gross receipts of less than $1

million. The IRS is not aware of any

other relevant federal rules which may

duplicate, overlap, or conflict with the

proposed rule. A less burdensome alternative for small organizations would be to

exempt those entities from the requirements for establishing the rebuttable presumption of reasonableness. However, it

is not consistent with the statute to allow

organizations to rely on this presumption

without satisfying some conditions. Satisfaction of the requirements as outlined

in the legislative history leads to a benefit,

but failure to satisfy them does not necessarily lead to a penalty. A more burdensome alternative would be to require all

applicable tax- exempt organizations

under Code section 4958 to satisfy the

three requirements of the rebuttable presumption of reasonableness under all circumstances.

Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment on

its impact on business.

Comments and Requests for a Public

Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8)

copies) that are submitted timely to the

IRS. All comments will be available for

public inspection and copying. A teleconference public hearing may be scheduled

if requested in writing by a person wishing to testify outside the Washington, DC

area who timely submits written comments. A request for a hearing by video

conference was made on April 7, 1998, by

the Taxation Section of the Los Angeles

County Bar Association. If a teleconference public hearing is scheduled, notice

of the date, time, place, and remote teleconference sites for the hearing will be

published in the Federal Register.

In addition to several areas mentioned

earlier in this preamble, specific comments are requested with respect to certain issues raised by these proposed regulations. Concerning the relationship

between revocation of tax-exempt status

and the taxes imposed under section

4958, comments are invited to be consid-

August 24, 1998

ered in preparing guidance outlining the

factors the IRS will consider in exercising

its administrative discretion in accordance

with the legislative history. Comments

are also requested with regard to the rule

under which an economic benefit provided to, or for the use of, a disqualified

person will not be treated as consideration

for the performance of services absent the

clear indication of the organization’s intent to treat the benefit as compensation

when the benefit is paid. Specifically,

comments are requested on appropriate

ways of applying this rule that will not

create an unnecessary burden on affected

organizations. Additionally, comments

are requested with respect to the effect of

the proposed regulations on different

compensation arrangements, including

revenue-based compensation, deferred

compensation, and the use of options as

compensation.

Drafting Information

The principal author of these regulations

is Phyllis D. Haney, Office of Associate

Chief Counsel (Employee Benefits and

Exempt Organizations). However, other

personnel from the IRS and Treasury Department participated in their development.

* * * * *

Proposed Amendments to the

Regulations

Accordingly, 26 CFR Parts 53 and 301

are proposed to be amended as follows:

PART 53—FOUNDATION AND

SIMILAR EXCISE TAXES

Paragraph 1. The authority citation for

part 53 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 2. Sections 53.4958–0 through

53.4958–7 are added to read as follows:

§53.4958–0 Table of contents.

This section lists the captions contained in

§§53.4958–1 through 53.4958–7.

§53.4958–1 Taxes on excess benefit

transactions.

(a) In general.

(b) Excess benefit defined.

(c) Taxes paid by disqualified person.

(1) Initial tax.

(2) Additional tax on disqualified per-

18

son.

(i) In general.

(ii) Correction.

(iii) Taxable period.

(iv) Abatement if correction during the

correction period.

(d) Tax paid by organization managers.

(1) In general.

(2) Organization manager defined.

(i) In general.

(ii) Special rule for certain committee

members.

(3) Participation.

(4) Knowing.

(i) In general.

(ii) Special rule.

(5) Willful.

(6) Due to reasonable cause.

(7) Advice of counsel.

(8) Limits on liability for management.

(9) Joint and several liability.

(e) Date of occurrence.

(f) Statute of limitations.

(g) Effective date for imposition of

taxes.

(1) In general.

(2) Existing binding contracts.

§53.4958–2 Definition of applicable taxexempt organization.

(a) In general.

(b) Section 501(c)(3) organizations.

(c) Section 501(c)(4) organizations.

§53.4958–3 Definition of disqualified

person.

(a) In general.

(b) Statutory categories of disqualified

persons.

(1) Family members.

(2) Thirty-five percent controlled entities.

(i) In general.

(ii) Combined voting power.

(iii) Constructive ownership rules.

(A) Stockholdings.

(B) Profits or beneficial interest.

(c) Persons having substantial influence.

(1) Individuals serving on the governing body who are entitled to vote.

(2) Presidents, chief executive officers,

or chief operating officers.

(3) Treasurers and chief financial officers.

(4) Persons with a material financial interest in a provider-sponsored organization.

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(d) Persons deemed not to have substantial influence.

(1) Applicable tax-exempt organizations described in section 501(c)(3).

(2) Employees receiving economic

benefits of less than specified amount in a

taxable year.

(i) In general.

(ii) Examples.

(e) Facts and circumstances govern in

all other cases.

(1) In general.

(2) Facts and circumstances tending to

show substantial influence.

(3) Facts and circumstances tending to

show no substantial influence.

(f) Examples.

(g) Affiliated organizations.

cause.

(3) Effect of failing to establish intent.

(4) Examples.

§53.4958–4 Excess benefit transaction.

(a) In general.

(b) Delegation pursuant to procedures.

(c) Rebutting the presumption.

(d) Requirements for invoking rebuttable presumption.

(1) Disinterested governing body or

committee.

(i) In general.

(ii) Persons not included on governing

body or committee.

(iii) Absence of conflict of interest.

(iv) Rule where ratification of full governing body required.

(2) Appropriate data as to comparability.

(i) In general.

(ii) Special rule for compensation paid

by small organizations.

(iii) Additional rules for special rule for

small organizations.

(iv) Examples.

(3) Documentation.

(e) No presumption until circumstances

exist to determine reasonableness of compensation.

(f) No inference from absence of presumption.

(g) Period of reliance on rebuttable presumption.

(a) Definition of excess benefit transaction.

(1) In general.

(2) Economic benefit provided directly

or indirectly.

(3) Certain economic benefits disregarded for purposes of section 4958.

(i) Reimbursements for reasonable expenses of attending meetings of governing body.

(ii) Economic benefits provided to a

disqualified person solely as a member of,

or volunteer for, the organization.

(iii) Economic benefits provided to a

disqualified person solely as a member of

a charitable class.

(4) Insurance or indemnification of excise taxes.

(b) Standards for identifying excess

benefits.

(1) In general.

(2) Fair market value for transfer of

property.

(3) Reasonable compensation.

(i) In general.

(ii) Items included in determining the

value of compensation for purposes of

section 4958.

(iii) Examples.

(c) Establishing intent to treat economic benefit as consideration for the

performance of services.

(1) In general.

(2) Clear and convincing evidence of

intent.

(i) In general.

(ii) Reporting of benefit.

(iii) Failure to report due to reasonable

1998–34 I.R.B.

§53.4958–5 Transaction in which amount

of economic benefit determined in whole

or in part by the revenues of one or more

activities of the organization.

(a) In general.

(b) Special rule for allocation or return

of net margins or capital to members of

certain cooperatives.

(c) Rules effective prospectively.

(d) Examples.

§53.4958–6 Rebuttable presumption that

transaction is not an excess benefit

transaction.

§53.4958–7 Special rules.

(a) Substantive requirements for exemption still apply.

(b) Interaction between section 4958

and section 7611 rules for church tax inquiries and examinations.

§53.4958–1 Taxes on excess benefit

transactions.

19

(a) In general. Section 4958 imposes

excise taxes on each excess benefit transaction (as defined in section 4958(c) and

§53.4958–4 and §53.4958–5) between an

applicable tax-exempt organization (as

defined in section 4958(e) and

§53.4958–2) and a disqualified person (as

defined in section 4958(f)(1) and

§53.4958–3). A disqualified person who

receives an excess benefit from an excess

benefit transaction is liable for payment

of a section 4958(a)(1) excise tax equal to

25 percent of the excess benefit. If an initial tax is imposed by section 4958(a)(1)

on an excess benefit transaction and the

transaction is not corrected within the taxable period, then any disqualified person

who received an excess benefit from the

excess benefit transaction on which the

initial tax was imposed is liable for an additional tax of 200 percent of the excess

benefit. An organization manager (as defined in section 4958(f)(2) and paragraph

(d) of this section) who participates in an

excess benefit transaction, knowing that it

was such a transaction, is liable for payment of a section 4958(a)(2) excise tax

equal to 10 percent of the excess benefit,

unless the participation was not willful

and was due to reasonable cause. If an organization manager also receives an excess benefit from an excess benefit transaction, the manager may be liable for both

taxes imposed by section 4958(a).

(b) Excess benefit defined. Except as

provided in §53.4958–5 with respect to

certain revenue-sharing transactions, an

excess benefit is the value of the economic benefit provided by an applicable

tax-exempt organization directly or indirectly to or for the use of any disqualified

person that exceeds the value of the consideration (including the performance of

services) received by the organization for

providing such benefit.

(c) Taxes paid by disqualified person—

(1) Initial tax. Section 4958(a)(1) imposes

a tax equal to 25 percent of the excess benefit on each excess benefit transaction. The

section 4958(a)(1) tax shall be paid by any

disqualified person who received an excess

benefit from that excess benefit transaction.

With respect to any excess benefit transaction, if more than one disqualified person is

liable for the tax imposed by section

4958(a)(1), all such persons are jointly and

severally liable for that tax.

(2) Additional tax on disqualified person—(i) In general. Section 4958(b) im-

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poses a tax equal to 200 percent of the excess benefit in any case in which a section

4958(a)(1) tax is imposed on an excess

benefit transaction and the transaction is

not corrected (as defined in section

4958(f)(6) and paragraph (c)(2)(ii) of this

section) within the taxable period (as defined in section 4958(f)(5) and paragraph

(c)(2)(iii) of this section). The tax imposed by section 4958(b) is payable by

any disqualified person who received an

excess benefit from the excess benefit

transaction on which the initial tax was

imposed by section 4958(a)(1). With respect to any excess benefit transaction, if

more than one disqualified person is liable for the tax imposed by section

4958(b), all such persons are jointly and

severally liable for that tax.

(ii) Correction. Correction means,

with respect to any excess benefit transaction, undoing the excess benefit to the extent possible, and taking any additional

measures necessary to place the organization in a financial position not worse than

that in which it would be if the disqualified person had been dealing under the

highest fiduciary standards. Correction of

the excess benefit occurs if the disqualified person repays the applicable tax-exempt organization an amount of money

equal to the excess benefit, plus any additional amount needed to compensate the

organization for the loss of the use of the

money or other property during the period

commencing on the date of the excess

benefit transaction and ending on the date

the excess benefit is corrected. Correction may also be accomplished, in certain

circumstances, by returning property to

the organization and taking any additional

steps necessary to make the organization

whole. If the excess benefit transaction

consists of the payment of compensation

for services under a contract that has not

been completed, termination of the employment or independent contractor relationship between the organization and the

disqualified person is not required in

order to correct. However, the terms of

any ongoing compensation arrangement

may need to be modified to avoid future

excess benefit transactions.

(iii) Taxable period. Taxable period

means, with respect to any excess benefit

transaction, the period beginning with the

date on which the transaction occurs and

ending on the earlier of–

August 24, 1998

(A) The date of mailing a notice of deficiency under section 6212 with respect

to the section 4958(a)(1) tax; or

(B) The date on which the tax imposed

by section 4958(a)(1) is assessed.

(iv) Abatement if correction during the

correction period. For rules relating to

abatement of taxes on excess benefit

transactions that are corrected within the

correction period, as defined in section

4963(e), see sections 4961(a), 4962(a),

and the regulations thereunder.

(d) Tax paid by organization

managers—(1) In general. In any case in

which section 4958(a)(1) imposes a tax,

section 4958(a)(2) imposes a tax equal to

10 percent of the excess benefit on the

participation of any organization manager

who knowingly participated in the excess

benefit transaction, unless such participation was not willful and was due to reasonable cause. The tax is to be paid by

any organization manager who so participated.

(2) Organization manager defined—(i)

In general. An organization manager is,

with respect to any applicable tax-exempt

organization, any officer, director, or

trustee of such organization, or any individual having powers or responsibilities

similar to those of officers, directors, or

trustees of the organization, regardless of

title. A person shall be considered an officer of an organization if–

(A) That person is specifically so designated under the certificate of incorporation, by-laws, or other constitutive documents of the organization; or

(B) That person regularly exercises

general authority to make administrative

or policy decisions on behalf of the organization. Independent contractors, acting

in a capacity as attorneys, accountants,

and investment managers and advisors,

are not officers. Any person who has authority merely to recommend particular

administrative or policy decisions, but not

to implement them without approval of a

superior, is not an officer.

(ii) Special rule for certain committee

members. An individual who is not an officer, director, or trustee, yet serves on a

committee of the governing body of an

applicable tax-exempt organization that is

invoking the rebuttable presumption of

reasonableness described in §53.4958–6

based on the committee’s actions, is an

organization manager for purposes of the

20

tax imposed by section 4958(a)(2).

(3) Participation. For purposes of section 4958(a)(2) and this paragraph (d),

participation includes silence or inaction

on the part of an organization manager

where the manager is under a duty to

speak or act, as well as any affirmative action by such manager. However, an organization manager will not be considered

to have participated in an excess benefit

transaction where the manager has opposed such transaction in a manner consistent with the fulfillment of the manager’s responsibilities to the applicable

tax-exempt organization.

(4) Knowing—(i) In general. For purposes of section 4958(a)(2) and this paragraph (d), a person participates in a transaction knowing that it is an excess benefit

transaction only if the person—

(A) Has actual knowledge of sufficient

facts so that, based solely upon such facts,

such transaction would be an excess benefit transaction;

(B) Is aware that such an act under

these circumstances may violate the provisions of federal tax law governing excess benefit transactions; and

(C) Negligently fails to make reasonable attempts to ascertain whether the

transaction is an excess benefit transaction, or the person is in fact aware that it

is such a transaction.

(ii) Special rule. Knowing does not

mean having reason to know. However,

evidence tending to show that a person

has reason to know of a particular fact or

particular rule is relevant in determining

whether the person had actual knowledge

of such a fact or rule. Thus, for example,

evidence tending to show that a person

has reason to know of sufficient facts so

that, based solely upon such facts, a transaction would be an excess benefit transaction is relevant in determining whether

the person has actual knowledge of such

facts.

(5) Willful. For purposes of section

4958(a)(2) and this paragraph (d), participation by an organization manager is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions

of the law or the incurrence of any tax is

necessary to make the participation willful. However, participation by an organization manager is not willful if the manager does not know that the transaction in

which the manager is participating is an

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excess benefit transaction.

(6) Due to reasonable cause. An organization manager’s participation is due to

reasonable cause if the manager has exercised his responsibility on behalf of the

organization with ordinary business care

and prudence.

(7) Advice of counsel. If a person, after

full disclosure of the factual situation to

legal counsel (including in-house counsel) relies on the advice of such counsel

expressed in a reasoned written legal

opinion that a transaction is not an excess

benefit transaction, the person’s participation in such transaction will ordinarily not

be considered knowing or willful and will

ordinarily be considered due to reasonable cause within the meaning of section

4958(a)(2), even if such transaction is

subsequently held to be an excess benefit

transaction. For purposes of satisfying

the requirements of section 4958(a)(2), a

written legal opinion is reasoned so long

as the opinion addresses itself to the facts

and applicable law. However, a written

legal opinion is not reasoned if it does

nothing more than recite the facts and express a conclusion. The absence of advice

of counsel with respect to an act shall not,

by itself, however, give rise to any inference that a person participated in such act

knowingly, willfully, or without reasonable cause.

(8) Limits on liability for management.

The maximum aggregate amount of tax

collectible under section 4958(a)(2) and

this paragraph (d) from organization managers with respect to any one excess benefit transaction is $10,000.

(9) Joint and several liability. In any

case where more than one person is liable

for a tax imposed by section 4958(a)(2),

all such persons shall be jointly and severally liable for the taxes imposed under

section 4958(a)(2) with respect to that excess benefit transaction.

(e) Date of occurrence. Except as otherwise provided, an excess benefit transaction occurs on the date on which the

disqualified person receives the economic

benefit from the applicable tax-exempt

organization for federal income tax purposes. In the case of a transaction consisting of payment of deferred compensation, the transaction occurs on the date the

deferred compensation is earned and

vested.

(f) Statute of limitations. See sections

1998–34 I.R.B.

6501(e)(3) and 6501(l) and the regulations thereunder, as amended, for statute

of limitations rules as they apply to section 4958 excise taxes.

(g) Effective date for imposition of

taxes—(1) In general. The section 4958

taxes imposed on excess benefit transactions or on participation in excess benefit

transactions apply to transactions occurring on or after September 14, 1995.

(2) Existing binding contracts. The

section 4958 taxes do not apply to any

transaction occurring pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter

before the transaction occurs. A written

binding contract that is terminable or subject to cancellation by the applicable taxexempt organization without the disqualified person’s consent is treated as a new

contract as of the date that any such termination or cancellation, if made, would be

effective. If a binding written contract is

materially modified (a material modification includes amending the contract to extend its term or to increase the amount of

compensation payable to the disqualified

person), it is treated as a new contract entered into as of the date of the material

modification.

United States is not subject to the requirements of section 508 and is not an organization described in section 501(c)(3) for

purposes of section 4958. A private foundation as defined in section 509(a) is not

an applicable tax-exempt organization for

section 4958 purposes.

(c) Section 501(c)(4) organizations.

An organization that has applied for and

received recognition of exemption as an

organization described in section

501(c)(4) is an applicable tax-exempt organization for section 4958 purposes. In

addition, an organization that has sought

to take advantage of section 501(c)(4) status by filing an application for recognition

of exemption under section 501(c)(4)

with the Internal Revenue Service, filing

an information return as a section

501(c)(4) organization under the Internal

Revenue Code or regulations promulgated thereunder, or otherwise holding itself out as being described in section

501(c)(4), is an applicable tax-exempt organization for section 4958 purposes. A

foreign organization that receives substantially all of its support from sources

outside of the United States is not an applicable tax-exempt organization for section 4958 purposes.

§53.4958–2 Definition of applicable taxexempt organization.

§53.4958–3 Definition of disqualified

person.

(a) In general—(1) An applicable taxexempt organization is any organization

that, without regard to any excess benefit,

would be described in section 501(c)(3)

or (4) and exempt from tax under section

501(a). An applicable tax-exempt organization also includes any organization that

was described in section 501(c)(3) or (4)

and was exempt from tax under section

501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the lookback period).

(2) In the case of any transaction occurring before September 14, 2000, the lookback period begins on September 14,

1995, and ends on the date of the transaction.

(b) Section 501(c)(3) organizations. To

be described in section 501(c)(3) for purposes of section 4958, an organization

must meet the requirements of section

508 (subject to any applicable exceptions

provided by that section). A foreign organization that receives substantially all of

its support from sources outside of the

(a) In general. Section 4958(f)(1) defines disqualified person, with respect to

any transaction, as any person who was in

a position to exercise substantial influence over the affairs of the organization at

any time during the five-year period ending on the date of the transaction. If the

five-year period ending on the date of the

transaction would have begun on or before September 13, 1995, then the preceding sentence shall be applied to the period

beginning September 14, 1995, and ending on the date of the transaction. Paragraph (b) of this section further describes

other persons who are defined to be disqualified persons under the statute, including certain family members of an individual in a position to exercise

substantial influence, and certain 35 percent controlled entities. Paragraph (c) of

this section describes persons in a position to exercise substantial influence over

the affairs of an applicable tax-exempt organization by virtue of their powers and

responsibilities or certain interests they

21

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hold. Paragraph (d) of this section describes persons deemed not to be in a position to exercise substantial influence.

Whether any person not described in

paragraph (b), (c) or (d) of this section is a

disqualified person with respect to the

transaction for purposes of section 4958 is

based on all relevant facts and circumstances, as described in paragraph (e) of

this section. Examples in paragraphs

(d)(2)(ii) and (f) of this section illustrate

these categories of persons.

(b) Statutory categories of disqualified

persons—(1) Family members. A person

is a disqualified person with respect to

any transaction with an applicable tax-exempt organization if the person is a member of the family of another disqualified

person described in paragraph (a) of this

section with respect to any transaction

with the same organization. A person’s

family includes–

(i) Spouse;

(ii) Brothers or sisters (by whole or half

blood);

(iii) Spouses of brothers or sisters (by

whole or half blood);

(iv) Ancestors;

(v) Children;

(vi) Grandchildren;

(vii) Great grandchildren; and

(viii) Spouses of children, grandchildren, and great grandchildren.

(2) Thirty-five percent controlled entities—(i) In general. A person is a disqualified person with respect to any transaction with an applicable tax-exempt

organization if the person is a 35 percent

controlled entity. A 35 percent controlled

entity is–

(A) A corporation in which persons described in this section (except in this paragraph (b)(2) and paragraph (d) of this section) own more than 35 percent of the

combined voting power;

(B) A partnership in which persons described in this section (except in this paragraph (b)(2) and paragraph (d) of this section) own more than 35 percent of the

profits interest; or

(C) A trust or estate in which persons

described in this section (except in this

paragraph (b)(2) and paragraph (d) of this

section) own more than 35 percent of the

beneficial interest.

(ii) Combined voting power. For purposes of this paragraph (b)(2), combined

voting power includes voting power represented by holdings of voting stock, di-

August 24, 1998

rect or indirect, but does not include voting rights held only as a director or

trustee.

(iii) Constructive ownership rules—(A)

Stockholdings. For purposes of section

4958(f)(3) and this paragraph (b)(2), indirect stockholdings are taken into account

as under section 267(c), except that in applying section 267(c)(4), the family of an

individual shall include the members of

the family specified in section 4958(f)(4)

and paragraph (b)(1) of this section.

(B) Profits or beneficial interest. For

purposes of section 4958(f)(3) and this

paragraph (b)(2), the ownership of profits

or beneficial interests shall be determined

in accordance with the rules for constructive ownership of stock provided in section 267(c) (other than section 267(c)(3)),

except that in applying section 267(c)(4),

the family of an individual shall include

the members of the family specified in

section 4958(f)(4) and paragraph (b)(1) of

this section.

(c) Persons having substantial influence. A person is in a position to exercise

substantial influence over the affairs of an

applicable tax-exempt organization if that

person has the powers or responsibilities,

or holds the type of interests, described in

one of the following categories:

(1) Individuals serving on the governing body who are entitled to vote. This

category includes any individual serving

on the governing body of the organization

who is entitled to vote on matters over

which the governing body has authority.

(2) Presidents, chief executive officers,

or chief operating officers. This category

includes any individual who, individually

or with others, serves as the president,

chief executive officer, or chief operating

officer of the organization. An individual

serves as a president, chief executive officer, or chief operating officer, regardless

of title, if that individual has or shares ultimate responsibility for implementing the

decisions of the governing body or supervising the management, administration, or

operation of the applicable organization.

(3) Treasurers and chief financial officers. This category includes any individual who, independently or with others,

serves as treasurer or chief financial officer of the organization. An individual

serves as a treasurer or chief financial officer, regardless of title, if that individual

has or shares ultimate responsibility for

managing the organization’s financial as-

22

sets and has or shares authority to sign

drafts or direct the signing of drafts, or

authorize electronic transfer of funds,

from organization bank accounts.

(4) Persons with a material financial

interest in a provider-sponsored organization. Pursuant to section 501(o), this category includes any person with a material

financial interest in a provider-sponsored

organization (as defined in section

1853(e) of the Social Security Act (42

U.S.C. 1395w–23)) if a hospital that participates in the provider-sponsored organization is an applicable tax-exempt organization.

(d) Persons deemed not to have substantial influence. A person is deemed not

to be in a position to exercise substantial

influence over the affairs of an applicable

tax-exempt organization if that person is

described in one of the following categories:

(1) Applicable tax-exempt organizations described in section 501(c)(3). This

category includes any other applicable

tax-exempt organization described in section 501(c)(3).

(2) Employees receiving economic benefits of less than specified amount in a

taxable year—(i) In general. This category includes, for the taxable year in

which benefits are provided, any employee of the applicable tax-exempt organization who–

(A) Receives economic benefits, directly or indirectly from the organization,

of less than the amount of compensation

referenced for a highly compensated employee in section 414(q)(1)(B)(i);

(B) Is not described in § 53.4958–3(b)

or (c) with respect to the organization;

and

(C) Is not a substantial contributor to

the organization within the meaning of

section 507(d)(2).

(ii) Examples. The following examples

illustrate the category of persons described in this paragraph (d)(2):

Example 1. N, an artist by profession, works

part-time at R, a local museum. In the first taxable

year in which R employs N, R pays N a modest

salary and provides no additional benefits to N except for free admission to the museum, a benefit R

provides to all of its employees and volunteers. The

total economic benefits N receives from R during

the taxable year are less than the amount of compensation referenced for a highly compensated employee in section 414(q)(1)(B)(i). The part-time job

constitutes N’s only relationship with R. N is not related to any other disqualified person with respect to

R. N is deemed not to be in a position to exercise

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substantial influence over the affairs of R. Therefore N is not a disqualified person with respect to

any transaction involving N and R in that year.

Example 2. The facts are the same as in Example

1, except that in addition to the modest salary that R

pays N in exchange for N’s provision of services to

R during the taxable year, R also purchases one of

N’s paintings for $90,000. The total economic benefits provided by R to N in that year exceed the

amount of compensation referenced for highly compensated employees in section 414(q)(1)(B)(i).

Consequently, whether N is in a position to exercise

substantial influence over the affairs of R for that

taxable year depends upon all relevant facts and circumstances.

(e) Facts and circumstances govern in

all other cases—(1) In general. Whether

a person who is not described in paragraph (b), (c) or (d) of this section is a disqualified person depends upon all relevant facts and circumstances. A person

who has managerial control over a discrete segment of an organization may

nonetheless be in a position to exercise

substantial influence over the affairs of

the entire organization.

(2) Facts and circumstances tending to

show substantial influence. Facts and circumstances tending to show that a person

has substantial influence over the affairs

of an organization include, but are not

limited to, the following—

(i) The person founded the organization;

(ii) The person is a substantial contributor (within the meaning of section

507(d)(2)) to the organization;

(iii) The person’s compensation is

based on revenues derived from activities

of the organization that the person controls;

(iv) The person has authority to control

or determine a significant portion of the

organization’s capital expenditures, operating budget, or compensation for employees;

(v) The person has managerial authority or serves as a key advisor to a person

with managerial authority; or

(vi) The person owns a controlling interest in a corporation, partnership, or

trust that is a disqualified person.

(3) Facts and circumstances tending to

show no substantial influence. Facts and

circumstances tending to show that a person does not have substantial influence

over the affairs of an organization include, but are not limited to–

(i) The person has taken a bona fide

vow of poverty as an employee, agent, or

on behalf of a religious organization;

1998–34 I.R.B.

(ii) The person is an independent contractor, such as an attorney, accountant, or

investment manager or advisor, acting in

that capacity, unless the person is acting

in that capacity with respect to a transaction from which the person might economically benefit either directly or indirectly (aside from fees received for the

professional services rendered); and

(iii) Any preferential treatment a person

receives based on the size of that person’s

donation is also offered to any other

donor making a comparable contribution

as part of a solicitation intended to attract

a substantial number of contributions.

(f) Examples. The following examples

illustrate the principles of this section.

Finding a person to be a disqualified person in the following examples does not

indicate that an excess benefit transaction

has occurred, but only that any transaction with the applicable tax-exempt organization that provides benefits to the disqualified person directly or indirectly may

be scrutinized to determine whether it is

an excess benefit transaction:

Example 1. E is the headmaster of Z, a school

that is an applicable tax-exempt organization for

purposes of section 4958. E reports to Z’s board of

trustees and is the principal employee responsible

for implementing the board’s decisions. E also has

ultimate responsibility for supervising Z’s day-today operations. For example, E can hire faculty

members and staff, make changes to the school’s

curriculum and discipline students without specific

board approval. Because E serves as the chief executive officer of Z, E is in a position to exercise substantial influence over the affairs of Z. Therefore E

is a disqualified person with respect to any transaction involving Z that provides economic benefits to

E directly or indirectly.

Example 2. G is a program officer at community

organization C, an applicable tax-exempt organization for purposes of section 4958. G’s total compensation for the taxable year, including benefits, is less

than the amount of compensation referenced for a

highly compensated employee in section

414(q)(1)(B)(i). G is not related to any other disqualified person with respect to C. G does not serve

on C’s governing body and or as an officer of C. G

makes a modest annual contribution to C, but is not

a substantial contributor to C (within the meaning of

section 507(d)(2)). G is deemed not to be in a position to exercise substantial influence over the affairs

of C for this year because G is an employee who receives economic benefits for the year of less than the

amount of compensation referenced for a highly

compensated employee in section 414(q)(1)(B)(i).

Therefore, for this year, G is not a disqualified person with respect to any transaction involving C that

provides economic benefits to G directly or indirectly.

Example 3. Y, an applicable tax-exempt organization for purposes of section 4958, enters into a

contract with B, a company that manages bingo

23

games. Under the contract, B agrees to provide all

of the staff and equipment necessary to carry out a

bingo operation one night per week, and to pay Y q

percent of the revenue from this activity. B retains

the balance of the proceeds. Y provides no goods or

services in connection with the bingo operation

other than the use of its hall for the bingo game. The

annual gross revenue earned from the bingo game

represents more than half of Y’s total annual revenue. B’s status as a disqualified person is determined by all relevant facts and circumstances. B’s

compensation is based on revenues from an activity

B controls. B also has full managerial authority over

Y’s principal source of income. Under these facts

and circumstances, B is in a position to exercise substantial influence over the affairs of Y. Therefore B

is a disqualified person with respect to any transaction involving Y that provides economic benefits to

B directly or indirectly.

Example 4. The facts are the same as in Example

3, with the additional fact that the stock of B is 100

percent owned by P, an individual who is actively involved in managing B. Because P owns a controlling interest (measured by either vote or value) in

and actively manages B, the facts and circumstances

establish that P is also in a position to exercise substantial influence over the affairs of Y. Therefore P

is a disqualified person with respect to any transaction involving Y that provides economic benefits to

P directly or indirectly.

Example 5. A, an applicable tax-exempt organization for purposes of section 4958, owns and operates one acute care hospital. B is a for-profit corporation that owns and operates a number of hospitals.

A and B form C, a limited liability company. In exchange for proportional ownership interests, A contributes its hospital, and B contributes other financial assets, to C. All of A’s assets then consist of its

membership interest in C. A continues to be operated for exempt purposes based almost exclusively

on the activities it conducts through C. C enters into

a management agreement with a management company, M, to provide day-to-day management services to C. M is generally subject to supervision by

C’s board, but M is given broad discretion to manage C’s day-to-day operation. Under these facts and

circumstances, M is in a position to exercise substantial influence over the affairs of A because it has

day to day control over the hospital operated by C,

A’s ownership interest in C is its primary asset, and

C’s activities form the basis for A’s continued exemption as an organization described in section

501(c)(3). Therefore, M is a disqualified person

with respect to any transaction involving A, including any transaction that A conducts through C, that

provides economic benefits to M directly or indirectly.

Example 6. T is a large university and an applicable tax-exempt organization for purposes of section

4958. L is the dean of the College of Law of T, a

major source of revenue for T. The College of Law

is important to T’s reputation for excellent teaching

and high quality faculty scholarship. T relies on this

reputation to attract students and contributions from

alumni and foundations. L plays a key role in faculty hiring and has authority to control or determine

a significant portion of T’s capital expenditures and

operating budget because of L’s position in the College of Law. L’s compensation is greater than the

amount of compensation referenced for a highly

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compensated employee in section 414(q)(1)(B)(i) in

the year benefits are provided. Because of the importance of the College of Law to T and L’s managerial control over that segment of T, L is in a position

to exercise substantial influence over the affairs of T.

Therefore L is a disqualified person with respect to

any transaction involving T that provides economic

benefits to L directly or indirectly.

Example 7. X is a radiologist employed by U, a

large acute-care hospital that is an applicable tax-exempt organization for purposes of section 4958. X

has no managerial authority over any part of U or its

operations. X gives instructions to staff with respect

to the radiology work X conducts, but X does not

serve as supervisor to other U employees. X’s total

compensation package includes nontaxable retirement and welfare benefits and a specified amount of

salary. X’s compensation is greater than the amount

of compensation referenced for a highly compensated employee in section 414(q)(1)(B)(i) in the year

benefits are provided. X is not related to any other

disqualified person of U. X does not serve on U’s

governing body or as an officer of U. Although U

participates in a provider-sponsored organization (as

defined in section 1853(e) of the Social Security

Act), X does not have a material financial interest in

that organization. Whether X is a disqualified person is determined by all relevant facts and circumstances. X did not found U, and although X makes a

modest annual financial contribution to U, the

amount of the contribution does not make X a substantial contributor within the meaning of section

507(d)(2). X does not receive compensation based

on revenues derived from activities of U that X controls, and has no authority to control or determine a

significant portion of U’s capital expenditures, operating budget, or compensation for employees.

Under these facts and circumstances, X does not

have substantial influence over the affairs of U, and

therefore X is not a disqualified person with respect

to any transaction involving U that provides economic benefits to X directly or indirectly.

Example 8. W is a cardiologist and head of the

cardiology department of the same hospital U described in Example 7. W does not serve on U’s

board and does not serve as an officer of U. W does

not have a material financial interest in the providersponsored organization (as defined in section

1853(e) of the Social Security Act) in which U participates. W is compensated personally with a salary

and retirement and welfare benefits fixed by a threeyear renewable employment contract with U. W’s

annual amount of compensation exceeds the amount

referenced for a highly compensated employee in

section 414(q)(1)(B)(i). Whether W is a disqualified

person is determined by all relevant facts and circumstances. W has managerial authority for the cardiology department. The cardiology department is a

principal source of patients admitted to U and consequently a major source of revenue for U. W also has

authority to allocate the budget for that department,

which includes authority to distribute incentive

bonuses among cardiologists according to criteria

that he has authority to set. The pool for the bonuses

is funded by a portion of U’s revenues attributable to

the cardiology department. Because of the importance of the cardiology department to U and W’s

managerial control over that segment of U, W is in a

position to exercise substantial influence over the affairs of U. Therefore W is a disqualified person with

August 24, 1998

respect to any transaction involving U that provides

economic benefits to W directly or indirectly.

Example 9. D is an accountant who periodically

provides accounting and tax advisory services as an

independent contractor in return for a fee to M, a

museum that is an applicable tax-exempt organization for purposes of section 4958. For several years,

D has advised M’s officers and members of M’s

governing body with respect to accounting and tax

matters. D’s firm also prepares tax returns on behalf

of M. D has no relationship with M other than as a

professional accounting and tax advisor. D is not related to any other disqualified person of M. D’s firm

has a policy prohibiting employees from providing

professional advice with respect to a transaction

from which they might economically benefit either

directly or indirectly (aside from fees received for

the professional services rendered). D abides by the

firm’s policy in all activities, including the work for

M. Whether D is a disqualified person is determined

by all relevant facts and circumstances. Because D

acts only in D’s capacity as an independent contractor providing occasional professional services to M

and abides by the firm’s conflict of interest policy,

under these facts and circumstances, D is not a disqualified person with respect to any transaction with

M.

Example 10. F, a repertory theater company that

is an applicable tax-exempt organization for purposes of section 4958, holds a fund-raising campaign to pay for the construction of a new theater. J

is a regular subscriber to F’s productions who has

made modest gifts to F in the past. J has no relationship to F other than as a subscriber and contributor.

F solicits contributions as part of a broad public

campaign intended to attract a large number of

donors, including a substantial number of donors

making large gifts. In its solicitations for contributions, F promises to invite all contributors giving $z

or more to a special opening production and party

held at the new theater. These contributors are also

given a special number to call in F’s office to reserve

tickets for performances, make ticket exchanges,

and make other special arrangements for their convenience. J makes a contribution of $z to F, which

makes J a substantial contributor within the meaning

of section 507(d)(2). F provides J with the preferential treatment described in its solicitation. Whether J

is a disqualified person is determined by all relevant

facts and circumstances. Under these facts and circumstances, any influence that may arise from the

size of J’s donation is limited by F’s commitment to

provide similar treatment to any other member of

the public making a similar contribution and by the

nature of the benefits being offered. Accordingly,

the preferential treatment that J receives does not indicate that J is in a position to exercise substantial

influence over the affairs of the organization. Therefore, barring a change in J’s relationship with F, J is

not a disqualified person with respect to any transaction involving F that provides economical benefits

to J directly or indirectly.

(g) Affiliated organizations. In the case

of multiple organizations affiliated by

common control or governing documents,

the determination of whether a person

does or does not have substantial influence shall be made separately for each applicable tax-exempt organization.

24

§53.4958–4 Excess benefit transaction.

(a) Definition of excess benefit transaction—(1) In general. An excess benefit

transaction means any transaction in

which an economic benefit is provided by

an applicable tax-exempt organization directly or indirectly, to or for the use of,

any disqualified person, and the value of

the economic benefit provided exceeds

the value of the consideration (including

the performance of services) received by

the organization for providing such benefit. An excess benefit transaction also includes certain revenue-sharing transactions described in §53.4958–5. An

economic benefit shall not be treated as

consideration for the performance of services unless the organization providing

the benefit clearly indicates its intent to

treat the benefit as compensation when

the benefit is paid.

(2) Economic benefit provided directly

or indirectly. An excess benefit transaction occurs when an applicable tax-exempt organization provides an excess

benefit directly or indirectly to a disqualified person. A benefit may be provided

indirectly through the use of one or more

entities controlled by or affiliated with the

applicable tax-exempt organization. For

example, if an applicable tax-exempt organization causes its taxable subsidiary to

pay excessive compensation to, or engage

in a transaction at other than fair market

value with, a disqualified person of the

parent organization, the payment of the

compensation or the transfer of property

is an excess benefit transaction.

(3) Certain economic benefits disregarded for purposes of section 4958. The

following economic benefits are disregarded for purposes of section 4958:

(i) Reimbursements for reasonable expenses of attending meetings of governing

body. Paying reasonable expenses for

members of the governing body of an applicable tax-exempt organization to attend

meetings of the governing body of the organization will be disregarded for purposes of section 4958. For purposes of

the preceding sentence, reasonable expenses do not include luxury travel or

spousal travel.

(ii) Economic benefits provided to a

disqualified person solely as a member of,

or volunteer for, the organization. An

economic benefit provided to a disqualified person that the disqualified person re-

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ceives solely as a member of, or volunteer

for, the organization is disregarded for

purposes of section 4958 if the benefit is

provided to members of the public in exchange for a membership fee of $75 or

less per year. Thus, for example, if a disqualified person is also a member of the

organization and receives membership

benefits such as advance ticket purchases

and a discount at the organization’s gift

shop that would normally be provided in

exchange for a membership fee of $75 or

less per year, then the membership benefit

is disregarded for purposes of section

4958.

(iii) Economic benefits provided to a

disqualified person solely as a member of

a charitable class. An economic benefit

provided to a disqualified person that the

disqualified person receives solely as a

member of a charitable class that the applicable tax-exempt organization intends

to benefit as part of the accomplishment

of the organization’s exempt purpose is

generally disregarded for purposes of section 4958.

(4) Insurance or indemnification of excise taxes. The payment of a premium for

an insurance policy providing liability insurance to a disqualified person for the

taxes imposed under this section or indemnification of a disqualified person for

such taxes by an applicable tax-exempt

organization will not constitute an excess

benefit transaction for purposes of section

4958 if the premium or the indemnification is treated as compensation to the disqualified person when paid, and the total

compensation paid to the disqualified person is reasonable.

(b) Standards for identifying excess

benefits—(1) In general. If an economic

benefit provided by the applicable tax-exempt organization to or for the use of any

disqualified person exceeds the fair market value of the consideration, the excess

is the excess benefit on which tax is imposed by section 4958.

See

§53.4958–5(c) for rules concerning the

excess benefit in certain revenue-sharing

transactions.

(2) Fair market value for transfer of

property. The fair market value of property, including the right to use property, is

the price at which property or the right to

use property would change hands between a willing buyer and a willing seller,

neither being under any compulsion to

1998–34 I.R.B.

buy, sell or transfer property or the right

to use property, and both having reasonable knowledge of relevant facts.

(3) Reasonable compensation—(i) In

general. Compensation paid may not exceed what is reasonable under all the circumstances. Compensation for the performance of services is reasonable if it is

only such amount as would ordinarily be

paid for like services by like enterprises

under like circumstances. Generally, the

circumstances to be taken into consideration are those existing at the date when

the contract for services was made. However, where reasonableness of compensation cannot be determined based on circumstances existing at the date when the

contract for services was made, then that

determination is made based on all facts

and circumstances, up to and including

circumstances as of the date of payment.

In no event shall circumstances existing at

the date when the contract is questioned

be considered in making a determination

of the reasonableness of compensation. A

written binding contract that is terminable

or subject to cancellation by the applicable tax-exempt organization without the

disqualified person’s consent is treated as

a new contract as of the date that any such

termination or cancellation, if made,

would be effective. If a binding written

contract is materially modified, it is

treated as a new contract entered into as

of the date of the material modification.

A material modification includes, but is

not limited to, amending the contract to

extend its term or to increase the amount

of compensation payable to the disqualified person. The fact that a State or local

legislative or agency body or court has

authorized or approved a particular compensation package paid to a disqualified

person is not determinative of the reasonableness of compensation paid for purposes of section 4958 excise taxes.

(ii) Items included in determining the

value of compensation for purposes of

section 4958. Compensation for purposes

of section 4958 includes all items of compensation provided by an applicable taxexempt organization in exchange for the

performance of services. These items of

compensation include, but are not limited

to–

(A) All forms of cash and noncash

compensation, including salary, fees,

bonuses, and severance payments paid;

25

(B) All forms of deferred compensation

that is earned and vested, whether or not

funded, and whether or not paid under a

deferred compensation plan that is a qualified plan under section 401(a), but if deferred compensation for services performed in multiple prior years vests in a

later year, then that compensation is attributed to the years in which the services

were performed;

(C) The amount of premiums paid for

liability or any other insurance coverage,

as well as any payment or reimbursement

by the organization of charges, expenses,

fees, or taxes not covered ultimately by

the insurance coverage;

(D) All other benefits, whether or not

included in income for tax purposes, including payments to welfare benefit plans

on behalf of the persons being compensated, such as plans providing medical,

dental, life insurance, severance pay, and

disability benefits, and both taxable and

nontaxable fringe benefits (other than

working condition fringe benefits described in section 132(d) and de minimis

fringe benefits described in section

132(e)), including expense allowances or

reimbursements or foregone interest on

loans that the recipient must report as income on his separate income tax return;

and

(E) Any economic benefit provided by

an applicable tax-exempt organization,

whether provided directly or through another entity owned, controlled by or affiliated with the applicable tax-exempt organization, whether such other entity is

taxable or tax-exempt.

(iii) Examples. The following examples illustrate whether the reasonableness

of compensation can be determined based

on circumstances existing at the time a

contract for the performance of services

was made under the rules of this paragraph (b)(3):

Example 1. G is an applicable tax-exempt organization for purposes of section 4958. H is an employee of G and a disqualified person with respect to

any transaction involving G that provides economic

benefits to H directly or indirectly. H’s multi-year

employment contract provides for payment of a

salary and provision of specific amounts of health

and retirement benefits. The contract provides for

an annual increase in H’s salary equal to the percentage increase, if any, over the preceding year in the

Consumer Price Index (CPI). The CPI for a year is

determined using an average of the monthly CPI as

determined for each month in that calendar year.

The health benefits consist of insurance coverage

under a plan that is available to all of G’s employees.

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The retirement benefits are equal to the maximum

amount G is permitted to contribute under the rules

applicable to qualified retirement plans. Under

these facts, the reasonableness of H’s compensation

can be determined based on the circumstances existing at the time G and H enter into the employment

contract.

Example 2. N is an applicable tax-exempt organization for purposes of section 4958. N uses the

cash method of accounting and a calendar year as its

taxable year. On January 2, N’s governing body enters into a one-year employment contract for K, its

new executive director, who is a disqualified person

with respect to any transaction involving N and K.

In addition to providing that K will receive a specified amount of salary, deferred compensation, and

other health and retirement benefits from N in return

for K’s services, the terms of the contract permit N’s

governing body to declare a bonus to be paid to K at

any time during the year covered by the contract.

Declaration and payment of any bonus is within the

governing body’s discretion, with no specified limitations or guidelines. The reasonableness of K’s

compensation cannot be determined based on the

circumstances existing as of the date the contract

was made because there were no guidelines in the

contract for the bonus that N may potentially pay.

Therefore, the determination of whether N’s compensation is reasonable must be made based on all

circumstances, up to and including circumstances as

of the date of payment of any bonus actually paid

under the contract. If N pays K a bonus on December 31, the reasonableness of K’s compensation

must be based on all circumstances from January 2

through December 31.

(c) Establishing intent to treat economic benefit as consideration for the

performance of services—(1) In general.

An applicable tax-exempt organization

will be treated as having intended to provide an economic benefit as compensation for services only if the organization

provides clear and convincing evidence

that it intended to so treat the economic

benefit when the benefit was paid.

(2) Clear and convincing evidence of

intent—(i) In general. If an applicable

tax- exempt organization or a disqualified

person reports an economic benefit as described in paragraph (c)(2)(ii) of this section then the organization will have provided clear and convincing evidence that

it intended to provide an economic benefit

as compensation for services when the

benefit was paid. If an applicable tax-exempt organization’s failure to report an

economic benefit as required under the

Internal Revenue Code is due to reasonable cause (within the meaning

§301.6724–1 of this chapter and paragraph (c)(2)(iii) of this section), then the

organization will be treated as having provided clear and convincing evidence of

the requisite intent. An organization may

August 24, 1998

use methods other than those described in

paragraphs (c)(2)(ii) and (iii) of this section to provide clear and convincing evidence of its intent.

(ii) Reporting of benefit. The organization reports the economic benefit as compensation on original or amended federal

tax information returns with respect to the

payment (e.g., Form W–2 or 1099) or

with respect to the organization (e.g.,

Form 990), filed before the commencement of an Internal Revenue Service examination in which the reporting of the

benefit is questioned. For purposes of

section 4958 and this section, an Internal

Revenue Service examination of an applicable tax-exempt organization has

commenced if the organization has

received written notification from the Exempt Organizations Division of an impending Exempt Organizations examination, or written notification of an

impending referral for an Exempt Organizations examination, and also includes

having been under an Exempt Organizations examination that is now in Appeals

or in litigation for issues raised in an Exempt Organizations examination of the

period in which the excess benefit transaction occurred. Reporting of an economic benefit to provide clear and convincing evidence of intent is also

accomplished if the recipient disqualified

person reports the bene

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