subject to new tax laws
By Anna Marie Kukec
Bar foundations and other non-profits are subject to new Internal Revenue Service laws that penalize an individual instead of the organization regarding excessive benefit transactions.Intermediate Sanctions (Internal Revenue Code 4958) were enacted in 1996, and proposed regulations that offer guidance on these laws were released last summer. Reaction and changes to those proposed regulations were offered during a public hearing in Washington, D.C., on March 16-17. The final regulations may be issued later this year or next year.
Intermediate Sanctions have become a hot issue creating some confusion among non-profit leaders, according to Bruce Hopkins of Kansas City, Mo., who spoke at the National Conference of Bar Foundations’ midyear meeting.
"We’re in this bizarre period where the law is in effect, and insiders are subject to it. But guidance from the IRS hasn’t taken effect yet," Hopkins says.
Intermediate Sanctions primarily involve individuals employed with 501c3s, such as a bar foundation, and 501c4s, such as an issue-oriented organization like American Association of Retired Persons. While 501c6s, which comprise bar associations, are not directly included in these laws, they should be concerned if they hold certain financial and administrative relationships with a foundation. Instead of revoking the tax-exempt status of the organization, Intermediate Sanctions can penalize the individual, or "disqualified person," who inappropriately gains from a financial transaction because of their position or relationship with the non-profit. A disqualified person (or insider) can be an employee, board member or someone who has influence within the organization.
The American Society of Association Executives did not oppose Intermediate Sanctions, but did not lobby for it either, according to staff counsel George Constantine of Washington, D.C. ASAE is an individual membership organization of about 25,000 people representing 11,000 associations, including some 501c3s and 501c4s affected by Intermediate Sanctions.
"We’re more concerned with the regulations where all the nuts and bolts are discussed. We still believe that anyone who abuses their role as an insider should be punished," says Constantine. ASAE also testified on the proposed regulations at the March public hearings. "Since 1996, we have been working to make sure the regulations are reasonable and not unduly burdensome," adds Constantine.
Guiding the non-profits
While the regulations are pending, many lawyers are attempting to guide their non-profit clients when dealing with transactions that involve the sale, rental or lease of the organization’s property or assets; the use of outside fund-raisers for the organization’s events, and compensation for executives. The confusion concerns the term, "excessive." Apparently, the proposed regulations don’t provide amounts or define what is considered an excessive benefit, says Hopkins, who adds that this omission should be addressed in the final regulations.
"What is considered an inappropriate amount is the argument. The amount paid over or considered excessive isn’t determined. There’s no formal threshold," notes Hopkins. The amount considered over paid must be returned to the organization with interest. In addition, the individual would be taxed or penalized for accepting that overpayment, he adds.
For example, if a disqualified person purchases, rents or leases foundation property at what the IRS deems as being under value, then he must return to the foundation the difference between the fair value and the transaction’s value. In addition, that person will be penalized on the difference that should have been paid.
Organizations are encouraged to obtain fair market appraisals on the property before a transaction is completed. This ensures that the person doesn’t get the better part of the deal simply because of their position with the foundation.
Also, contracts with outside companies or individuals that organize events to raise funds for non-profits can be scrutinized. The fund-raiser may be considered someone who can exercise control over the organization because of his contract with the non-profit. Those fund-raisers may obtain a percentage of the proceeds or have another arrangement that can be scrutinized and possibly deemed excessive. In addition, Intermediate Sanctions can target excessive compensation to executives. While the laws do not specify amounts, the IRS can look at salaries of top employees to determine if the amounts are fair. A salary of $80,000 or more may raise a red flag, depending on the organization’s size and financial status, says Hopkins.
If the IRS determines that the executive is accepting an excessive salary, the difference between a fair salary and the overpaid amount must be returned to the organization with interest. In addition, the individual will be penalized.
Also, transactions between the bar association and its bar foundation can be examined. If the association has control over the foundation, it can be considered a disqualified person if a transaction between the two organizations is deemed inappropriate. For example, if the foundation over pays in a rental agreement with its bar association, then the bar association can be considered a disqualified person and subject to the Intermediate Sanctions. Already, Hopkins has a half dozen cases involving Intermediate Sanctions, despite the lack of final regulations to oversee the new laws. To support his clients’ claims, Hopkins may rely on specialists or consultants who can supply reports and surveys that show the transactions or salaries are reasonable.
"It’s almost like the appraisal of a house. You need to come up with figures based on comparables," Hopkins says.
The author is the reporter for Bar Leader.
