Failure by Certain Charitable Organizations To Meet Certain Qualification Requirements; Taxes on Excess Benefit Transactions

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 53 and 301

[REG-246256-96]

RIN 1545-AV60

Failure by Certain Charitable Organizations To Meet Certain

Qualification Requirements; Taxes on Excess Benefit Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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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.ustreas.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; 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.

[[Page 41487]]

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

disqualified 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

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.

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, 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

[[Page 41488]]

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., Sec. 53.4941 and Sec. 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;

considering 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 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 tax-exempt 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

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

[[Page 41489]]

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 Sec. 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 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 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. 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 (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 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

[[Page 41490]]

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 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, including 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-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, acting in that

capacity, unless the person is acting in

[[Page 41491]]

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.

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 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 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.

[[Page 41492]]

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

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.

Transaction in Which Amount of Economic Benefit Determined in Whole or

in Part by the Revenues of One or More Activities of the Organization

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 tax-exempt 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 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 revenue-sharing transactions that do and do not constitute

excess benefit transactions.

Rebuttable Presumption That Transaction Is Not an Excess Benefit

Transaction

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.

To the extent permitted under local law, the governing body of an

applicable tax-exempt 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

[[Page 41493]]

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 economically 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 tax-exempt, 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.

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 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

[[Page 41494]]

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 proceedings 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 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 tax-exempt 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 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 considered 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

[[Page 41495]]

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.

List of Subjects

26 CFR Part 53

Excise taxes, Foundations, Investments, Lobbying, Reporting and

recordkeeping requirements, Trusts and trustees.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

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:

Sec. 53.4958-0 Table of contents.

This section lists the captions contained in Secs. 53.4958-1

through 53.4958-7.

Sec. 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 person.

(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.

Sec. 53.4958-2--Definition of applicable tax-exempt organization.

(a) In general.

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

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

Sec. 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.

(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.

Sec. 53.4958-4 Excess benefit transaction.

(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 cause.

(3) Effect of failing to establish intent.

(4) Examples.

Sec. 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.

Sec. 53.4958-6 Rebuttable presumption that transaction is not an

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.

[[Page 41496]]

Sec. 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.

Sec. 53.4958-1 Taxes on excess benefit transactions.

(a) In general. Section 4958 imposes excise taxes on each excess

benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4

and Sec. 53.4958-5) between an applicable tax-exempt organization (as

defined in section 4958(e) and Sec. 53.4958-2) and a disqualified

person (as defined in section 4958(f)(1) and Sec. 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 Sec. 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) imposes 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--

(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

Sec. 53.4958-6 based on the committee's actions, is an organization

manager for purposes of the 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

[[Page 41497]]

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 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 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 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 (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.

Sec. 53.4958-2 Definition of applicable tax-exempt organization.

(a) In general--(1) An applicable tax-exempt 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 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

[[Page 41498]]

not an applicable tax-exempt organization for section 4958 purposes.

Sec. 53.4958-3 Definition of disqualified person.

(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

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, direct 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 assets 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 Sec. 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).

[[Page 41499]]

(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

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;

(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-to-day 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 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

[[Page 41500]]

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 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 provider-sponsored

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 three-year

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 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.

Sec. 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

Sec. 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

[[Page 41501]]

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 receives

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 Sec. 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 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 tax-exempt

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;

(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

[[Page 41502]]

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. 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 Sec. 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 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 benefit

as income on the person's Form 1040 for the year in which the benefit

is received.

(iii) Failure to report due to reasonable cause. To show that its

failure to report an economic benefit that should have been reported on

an information return was due to reasonable cause, an applicable tax-

exempt organization must establish that there were significant

mitigating factors with respect to its failure to report (as described

in Sec. 301.6724-1(b) of this chapter), or the failure arose from

events beyond the organization's control (as described in

Sec. 301.6724-1(c) of this chapter), and that the organization acted in

a responsible manner both before and after the failure occurred (as

described in Sec. 301.6724-1(d) of this chapter).

(3) Effect of failing to establish intent. 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.

(4) Examples. The following examples illustrate the rules for an

organization to establish its intent to treat an economic benefit as

consideration for the performance of services as defined in this

paragraph (c):

Example 1. G is an applicable tax-exempt organization for

purposes of section 4958. G hires an individual contractor, P, to

design a computer program for it, executes a contract for that

purpose, and pays P $1,000 in a timely manner pursuant to the

contract. Before January 31 of the next year, G reports the full

amount paid to P under the contract on a Form 1099 filed with the

Internal Revenue Service. G has provided clear and convincing

evidence of its intent to provide the $1,000 paid to P as

compensation for the services P performed under the contract.

Example 2. The facts are the same as in Example 1, except that

the services are provided by Corporation V. The contract executed by

Corporation V and G and placed in G's files indicates that the

payment made to Corporation V is in return for computer programming

services provided by employees of Corporation V. G does not issue an

information return to Corporation V because Corporation V is not an

individual taxpayer. The contract constitutes clear and convincing

evidence of G's intent to provide the payment as compensation for

Corporation V's services.

Example 3. G is an applicable tax-exempt organization for

purposes of section 4958. D is the chief operating officer of G, and

a disqualified person with respect to any transaction involving G

that provides economic benefits to D directly or indirectly. D

receives a bonus at the end of the year. A copy of the letter from G

to D describing the amount and the basis for D's bonus is placed in

D's personnel file. Information provided to all employees in the

personnel handbook clearly states that bonuses are treated as

taxable income, and included in the total wages figure reported on

each employee's Form W-2. G's accounting department determines that

the bonus is to be reported on D's Form W-2. Due to a computer

malfunction after data was entered incorrectly by personnel of G's

accounting department, the bonus is not reflected on D's Form W-2.

As a result, D fails to report the bonus on his individual income

tax return. G acts to amend Forms W-2 affected as soon as G becomes

aware of the data entry error and consequent computer malfunction.

G's failure to report the bonus on an information return issued to D

arose from events beyond G's control, and G acted in a responsible

manner both before and after the failure occurred. Thus, because G

had reasonable cause for failing to report D's bonus, G will be

treated as having clear and convincing evidence of its intent to

provide the bonus as compensation for services when paid.

[[Page 41503]]

Sec. 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. 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 tax-

exempt organization (revenue-sharing transaction) results in inurement

and therefore constitutes an excess benefit transaction, depends upon

all relevant facts and circumstances. 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 as the ability of the party receiving the

compensation to control the activities generating the revenues on which

the compensation is based.

(b) Special rule for allocation or return of net margins or capital

to members of certain cooperatives. The allocation or return of net

margins or capital to the members of certain cooperatives in accordance

with their incorporating statute and bylaws does not result in

inurement of the net earnings to the benefit of any private shareholder

or individual, and therefore does not constitute an excess benefit

transaction for section 4958 purposes. The preceding sentence applies

to cooperatives that were determined by the Secretary of the Treasury

or his delegate to be described in section 501(c)(4) and exempt from

tax under section 501(a) before July 30, 1996, and have substantially

the same incorporating statute and bylaws as existed on July 30, 1996.

(c) Rules effective prospectively. The rules in this section apply

to any revenue-sharing transaction described in this section that

occurs on or after the date of publication of final regulations. The

excess benefit shall consist of the entire economic benefit provided in

any transaction described in this section. 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.

(d) Examples. The following examples illustrate the principles used

in determining whether a revenue-sharing transaction constitutes an

excess benefit transaction under the rules of this section:

Example 1. A is the manager of the investment portfolio of M, an

applicable tax-exempt organization for purposes of section 4958. A

and several other professional investment managers work exclusively

for M in an office in M's building. A's compensation consists of a

flat base annual salary, health insurance, eligibility to

participate in a retirement plan, and a bonus that is equal to a

percentage of any increase in the value of M's portfolio over the

year (net of expenses for investment management other than the in-

house managers' compensation). The revenue-based portion of A's

compensation gives A an incentive to provide the highest quality

service in order to maximize benefits and minimize expenses to M. A

has a measure of control over the activities generating the revenues

on which his bonus is based, but A can increase his own compensation

only if M also receives a proportional benefit. Under these facts

and circumstances, the payment to A of the bonus described above

does not constitute an excess benefit transaction under the rules of

this section.

Example 2. L, an applicable tax-exempt organization for purposes

of section 4958, enters into a contract with H, a company who

manages charitable gaming activities for public charities. As a

result of the contractual relationship, H becomes a disqualified

person with respect to any transaction involving L that provides

economic benefits to H directly or indirectly. Under the contract, H

agrees to provide all of the staff and equipment necessary to carry

out charitable gaming operations on behalf of L, and to pay L z

percent of the net profits, which are calculated as the gross

revenue less rental for the equipment, wages for the staff, prizes

for the winners, and other specified operating expenses. H retains

the balance of the proceeds after expenses and after paying L its z

percent of the net profits. As manager, H controls the activities

generating the revenue on which its compensation is based. In

addition, because H owns the equipment and employs the staff needed

to operate the charitable gaming activities, H controls what L is

charged, including the profit H makes above the cost of these items.

Therefore, H can also control the net revenues relative to the gross

revenues from the gaming activity. The structure of the compensation

H receives for its services does not provide H with an appropriate

incentive to maximize benefits and minimize costs to L. H benefits

whether expenses are high and net revenues are low or expenses are

low and net revenues are high. By contrast, L suffers if expenses

for the charitable gaming operation are high and net revenues are

low. All of the gross revenues generated by the charitable gaming

operation belong to L. The arrangement between H and L allows a

portion of those revenues to inure to H. Therefore, this arrangement

results in the inurement of L's net earnings to the benefit of H,

and the entire amount paid to H under this arrangement constitutes

an excess benefit under the rules of this section.

Example 3. R, a professor and faculty member at S, a university

that is an applicable tax-exempt organization for purposes of

section 4958, is the principal investigator in charge of certain

scientific research at S. The research produces an invention. In

accordance with S's agreement with its faculty, S owns the

invention. R assists S in preparing a patent application. S receives

a patent for R's invention, which S owns. Also in accordance with

S's agreement with its faculty, S grants R the right to receive v

percent of S's royalties on the patent, payable semi-annually. R

also receives an annual compensation package of salary and benefits.

The availability of revenue-based compensation under these

circumstances does not give R any incentive or opportunity to act

contrary to S's interests in accomplishing its exempt purpose. R

receives the revenue-based compensation, i.e., the percentage of

royalties, as an incentive and a reward for producing work of

especially high quality. In addition, any time R benefits by

receiving royalties, S benefits as well and to a proportionate

degree. Finally, because the patent belongs to S, R has no control

over how the patent is used nor the stream of revenue it generates.

Under these facts and circumstances, S's payment of revenue-based

compensation to R does not constitute an excess benefit transaction

under the rules of this section.

Sec. 53.4958-6 Rebuttable presumption that transaction is not an

excess benefit transaction.

(a) In general. Payments under a compensation arrangement between

an applicable tax-exempt organization and a disqualified person shall

be presumed to be reasonable, and a transfer of property, right to use

property, or any other benefit or privilege between an applicable tax-

exempt organization and a disqualified person shall be presumed to be

at fair market value, if the following conditions are satisfied--

(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

[[Page 41504]]

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.

(b) Delegation pursuant to procedures. To the extent permitted

under local law, the governing body of an applicable tax-exempt

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.

(c) Rebutting the presumption. The presumption established by

satisfying the three requirements of paragraph (a) of this section may

be rebutted by additional information showing that the compensation was

not reasonable or that the transfer was not at fair market value.

(d) Requirements for invoking rebuttable presumption--(1)

Disinterested governing body or committee--(i) In general. 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, if the rebuttable presumption arises as the result of actions

taken by a committee, 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), subject to the

rules of Sec. 53.4958-1(d).

(ii) Persons not included on governing body or committee. For

purposes of determining whether the requirements of paragraph (a) of

this section have been met with respect to a specific transaction or

compensation arrangement, a person is not included on the governing

body or committee when it is reviewing a transaction if that person

meets with 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.

(iii) Absence of conflict of interest. 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--

(A) Is not the disqualified person and is not related to any

disqualified person participating in or economically benefiting from

the compensation arrangement or transaction by a relationship described

in section 4958(f)(4) or Sec. 53.4958-3(b)(1);

(B) Is not in an employment relationship subject to the direction

or control of any disqualified person participating in or economically

benefiting from the compensation arrangement or transaction;

(C) Is not receiving compensation or other payments subject to

approval by any disqualified person participating in or economically

benefiting from the compensation arrangement or transaction;

(D) Has no material financial interest affected by the compensation

arrangement or transaction; and

(E) 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.

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

(2) Appropriate data as to comparability--(i) In general. A

governing body or committee has appropriate data as to comparability

if, given the knowledge and expertise of its members, it has

information sufficient to determine whether, under the standards set

forth in Sec. 53.4958-4(b), a compensation arrangement will result in

the payment of reasonable compensation or a transaction will be for

fair market value. Relevant information would include, but not be

limited to, compensation levels paid by similarly situated

organizations, both taxable and tax-exempt, 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 organization intends to purchase from, or sell or provide

to, the disqualified person.

(ii) Special rule for compensation paid by small organizations. For

organizations with annual gross receipts of less than $1 million

reviewing compensation arrangements, the governing body or committee

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 requirement with respect to the collection of

appropriate data.

(iii) Additional rules for special rule for small organizations.

For purposes of determining applicability of the special rule for small

organizations described in paragraph (d)(2)(ii) of this section, a

rolling average based on the three prior taxable years may be used to

calculate annual gross receipts of an organization. If any applicable

tax-exempt organization is affiliated with another entity by common

control or governing documents, the annual gross receipts of all such

related organizations must be aggregated to determine applicability of

the special rule stated in paragraph (d)(2)(ii) of this section.

(iv) Examples. The following examples illustrate the rules for

appropriate data as to comparability for purposes of invoking the

rebuttable presumption of reasonableness described in this section:

Example 1. Z is a large university that is an applicable tax-

exempt organization for purposes of section 4958. Z has had gross

receipts of $200 million for the preceding three taxable years. Z is

negotiating a new contract with its president because the old

contract will expire at the end of the year. In determining the

compensation for its president, the executive committee of the Board

of Trustees relies on a national survey of compensation for

university presidents; this survey does not divide its data by any

measure of university size or any other criteria. None of the

members of the executive committee has any particular expertise in

higher education compensation matters, although many members have

significant business experience. Given the lack of specificity in

the data collected and the lack of relevant expertise and experience

of the executive committee members, the data relied on by the

executive committee does not constitute appropriate data as to

comparability.

Example 2. X, a tax-exempt hospital that is an applicable tax-

exempt organization for purposes of section 4958, has average annual

gross receipts of $250 million. Before renewing the contracts of X's

chief executive officer and chief financial officer, X's governing

board commissioned a customized

[[Page 41505]]

compensation survey from an independent firm that specializes in

consulting on issues related to executive placement and

compensation. The survey covered executives with comparable

responsibilities at a significant number of hospitals. The survey

data are sorted by a number of different variables, including the

size of the hospitals and the nature of the services they provide,

the level of experience and specific responsibilities of the

executives, and the composition of the compensation packages. The

board members were provided with the survey results, a detailed

written analysis comparing the hospital's executives to those

covered by the survey and an opportunity to ask questions of a

member of the firm that prepared the survey. The survey, as prepared

and presented to X's board, constitutes appropriate data as to

comparability.

Example 3. W is a local repertory theater and an applicable tax-

exempt organization for purposes of section 4958. W has had annual

gross receipts ranging from $400,000 to $800,000 over its past three

taxable years. In determining the next year's compensation for W's

artistic director, the board relies on data compiled from a

telephone survey of six other unrelated repertory theaters of

similar size in various communities throughout the same geographic

region. A member of the board drafts a brief written summary of the

salary information obtained from this informal survey. This

information is later included in a written report that also includes

information about the membership of the board of directors, and an

evaluation of the artistic director's prior salary and performance

that is discussed and voted on by the board. The salary information

obtained in the telephone survey is appropriate data as to

comparability.

(3) Documentation--(i) For a decision to be documented adequately,

the written or electronic records of the governing body or committee

must note--

(A) The terms of the transaction that was approved and the date it

was approved;

(B) 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;

(C) The comparability data obtained and relied upon by the

committee and how the data was obtained; and

(D) 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.

(ii) 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.

(e) No presumption until circumstances exist to determine

reasonableness of compensation. 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 of this

section cannot arise until circumstances exist so that reasonableness

of compensation can be determined, and the three requirements for the

presumption under paragraph (d) of this section subsequently are

satisfied. See Sec. 53.4958-4(b)(3)(i).

(f) No inference from absence of presumption. 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 the

operation or administration of any applicable tax-exempt organization.

(g) Period of reliance on rebuttable presumption. 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.

Sec. 53.4958-7 Special rules.

(a) Substantive requirements for exemption still apply. 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.

(b) Interaction between section 4958 and section 7611 rules for

church tax inquiries and examinations. 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. See Sec. 301.7611-1 Q&A 19 of this chapter.

Sec. 53.4963-1 [Amended]

Par. 3. In Sec. 53.4963-1, paragraphs (a), (b), and (c) are amended

by adding the reference ``4958,'' immediately after the reference

``4955,'' in each place it appears.

PART 301--PROCEDURE AND ADMINISTRATION

Par. 4. The authority citation for part 301 continues to read in

part as follows:

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

Sec. 301.6213-1 [Amended]

Par. 5. Section 301.6213-1, paragraph (e) is amended by adding the

reference ``4958,'' immediately after the reference ``4955,'' in the

first sentence.

Sec. 301.6501(e)-1 [Amended]

Par. 6. Section 301.6501(e)-1 is amended as follows:

1. Paragraph (c)(3)(ii), first and second sentences are amended by

removing the language ``or trust'' and adding ``trust, or other

organization'' in its place.

2. Paragraph (c)(3)(ii), the first sentence is amended by removing

the language ``and 4953'' and adding ``4953, and 4958'' in its place.

Sec. 301.6501(n)-1 [Amended]

Par. 7. Section 301.6501(n)-1 is amended as follows:

1. The paragraph heading for paragraph (a) is amended by removing

the language ``or trust'' and adding ``trust, or other organization''

in its place.

2. Paragraph (a)(1), the first sentence is amended by removing the

language ``or trust'' and adding ``trust, or other organization'' in

its place.

3. Paragraph (b), the heading and the first sentence are amended by

removing the language ``or trust'' and adding ``trust, or other

organization'' in its place.

Sec. 301.7422-1 [Amended]

Par. 8. In section 301.7422-1, paragraphs (a) introductory text,

(c) introductory text and (d) are amended by adding the reference

``4958,'' immediately after the reference ``4955,''.

Sec. 301.7611-1 [Amended]

Par. 9. In Sec. 301.7611-1, the Table of Contents is amended by

adding

[[Page 41506]]

``Application to Section 4958......19'' immediately after ``Effective

Date......18''.

Par. 10. In Sec. 301.7611-1, an undesignated centerheading and Q-19

and A-19 are added to read as follows:

Sec. 301.7611-1 Questions and answers relating to church tax inquiries

and examinations.

* * * * *

Application to Section 4958

Q-19: When do the church tax inquiry and examination procedures

described in section 7611 apply to a determination of whether there was

an excess benefit transaction described in section 4958?

A-19: See Sec. 53.4958-7(b) of this chapter for rules governing the

interaction between section 4958 excise taxes on excess benefit

transactions and section 7611 church tax inquiry and examination

procedures.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 98-20419 Filed 7-30-98; 8:45 am]

BILLING CODE 4830-01-U