Key Non-Profit Terms
Initial Contract Exceptions
Fixed compensation set out in a qualifying initial contract falls outside of the purview of the Intermediate Sanctions, no matter how unreasonable the fixed payment may be. A qualified initial contract is defined as “a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately prior to entering into the contract.”1 However, it should be noted, that due to the timing for determining the reasonableness of compensation, this exception only shelters fixed payment compensation (salaries, pre-determined nondiscretionary bonuses or performance-based bonus formulas) and will not shelter variable payment compensation (discretionary bonuses or performance-based bonus formulas which allow any discretion in the amount paid). In addition, as soon as this “initial contract” is renewed, amended, modified or terminated, the Intermediate Sanctions are generally applicable to any payments that were provided for under the contract if not yet paid.
Generally, a disqualified person is a person (or even an entity) in a position to exercise “substantial influence” over the affairs of the non-profit at any time during the 5-year period before the date of the excess benefit transaction.2 “Substantial influence” generally exists if such person’s compensation is primarily based on revenues derived from activities of the organization that the person controls.3 Such influential persons include those holding the power of presidents, chief executive officers, chief operating officers, treasurers, chief financial officers and/or voting members of a governing body. Depending on all the relevant facts and circumstances, certain other persons, including family members of a disqualified person, may also be deemed disqualified persons.
On the other hand, under the rules, individuals such as independent contractors providing advice to the organization, including compensation consultants, attorneys, accountants, or investment managers are likely not disqualified persons. However, the introduction to the intermediate sanctions suggests that “being in this category of persons is merely a factor tending to show no substantial influence…” but that it is not determinative.4 Below is a more detailed list of the statutory categories of disqualified and non-disqualified persons as well as the facts and circumstances tending to suggest one or the other.
Statutory Categories of Disqualified Persons:
- Family members of a disqualified person (spouse, sibling, ancestors, children, (great) grandchildren, or spouse of any of foregoing);
- 35% controlled entities of a disqualified person (considering, among other things, consider combined voting power, constructive ownership rules and profits or beneficial interest);
- In addition to president, chief executive officer and chief operating officer, any person who, regardless of title, has ultimate responsibility for implementing the decisions of the governing body or for supervising the management, administration or operation of the organization (even if such responsibilities reside with two or more individuals).
- In addition to treasurer and chief financial officer, any person who has ultimate responsibility for managing the finances of the organization; and
- Persons with material financial interest in a provider-sponsored organization.
Facts and Circumstances Tending to Show Substantial Influence5:
- Founder of the organization;
- Substantial financial contributor to the organization within the past 5 years;
- Manager of a segment or activity of the organization that represents a substantial portion of the activities, assets, income or expenses of the organization;
- Owner of a controlling interest (either vote or value) in a corporation, partnership or trust that is a disqualified person; and
- A non-stock organization controlled directly or indirectly by one or more disqualified persons.
Statutory Categories of Persons Not Disqualified Persons6:
- Tax-exempt entities organized under I.R.C. § 501(c)(3);
- Certain tax-exempt entities organized under I.R.C. § 501(c)(4) with respect to transactions engaged in with other 501(c)(4) organizations; and
- Employees who (1) receive economic benefits less than $110,000 in 2011 (limit established under I.R.C. § 414(q)(1)(B)(i)); (2) do not otherwise fall within the statutory category of disqualified individual or have substantial influence over the tax-exempt entity and (3) have not been substantial contributors.
Facts and Circumstances Tending to Show No Substantial Influence7:
- Independent consultant providing advice without decision making authority;
- Person who has taken a vow of poverty;
- Contributor receiving preferential treatment based on size of donation provided such preferential treatment is given to all contributors making similar size donations; and
- Person who does not participate in management decisions affecting (i) the organization as a whole or (ii) a segment or activity of the organization that represents a substantial portion of the activities, assets, income or expenses of the organization.
An organizational manager is generally any officer, director or trustee of an organization or any individual having powers or responsibilities similar to such positions regardless of title, or any individual who is part of the authorized body of the organization.8
1. See Treas. Reg. § 53. 4958-4T(a)(3)
2. See I.R.C. § 4958(f)(1); Treas. Reg. § 53.4958-3.
3. See Treas. Reg. § 53.4958-3(c).
4. See Introduction to Treas. Reg. § 53. 4958– Background – Definition of Disqualified Person.
5. See Treas. Reg. § 53.4958-3(e)(2).
6. See Treas. Reg. § 53.4958-3(d).
7. See Treas. Reg. § 53.4958-3(e)(3).
8. 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 (or as a designee of the governing body described in Treas. Reg. § 53.4958-6(c)(1) that is attempting to invoke the rebuttable presumption of reasonableness described in Treas. Reg. § 53.4958-6 based on the committee’s (or designee’s) actions, is an organization manager for purposed of the tax imposed under I.R.C. § 4958(a)(2).