New IRS Guidance Offers
Exemption "Tipping Points"
Malcolm Gladwell's 2002 best seller, The Tipping Point: How Little Things Can Make a Big Difference, defined a "tipping point" as a critical mass or threshold that, when reached, creates dramatic transformation. On September 8th, the Internal Revenue Service (IRS) proposed regulations to illustrate the points at which certain private benefit activities may cause an organization to be deemed as one operating for private benefit rather than one serving public interests. When such a "tipping point" is reached, an organization will lose its status as tax-exempt under Section 501(c)(3) of the Internal Revenue Code (the "Code").
Key Points
These proposed regulations seek to clarify the relationship between the requirements for tax exemption under Code Section 501(c)(3) and the imposition of excise taxes upon individuals engaging in prohibited "excess benefit transactions" under Code Section 4958. The proposed regulations make clear the following points:
- Prohibited private benefit under Code Section 501(c)(3) can occur when an organization provides either economic or non-economic benefits to private interests.
- Prohibited private benefit under Code Section 501(c)(3) can occur regardless of whether payments to the private interests are reasonable in nature under an excess benefit transaction analysis.
- Engaging in excess benefit transactions, even if the organization has engaged in regular and ongoing activities that further exempt purposes both before and after the excess benefit transactions occurred, may result in loss of tax-exempt status.
- Identifying an excess benefit transaction on the organization's application for tax-exempt status could result in a denial of tax-exempt status to the organization.
What Steps Should Be
Taken by Your Organization?
These proposed regulations provide detailed examples to organizations of when prohibited private benefit may arise. The regulations clarify that a prohibited private benefit may arise even if the organization has not engaged in an excess benefit transaction. Further, the examples illustrate that when determining whether to revoke the exempt status of an organization engaged in an excess benefit transaction, the IRS will look favorably upon strong, swift and remedial action undertaken by a board.
These regulations highlight the importance of not only adopting and abiding by conflicts of interest policies and excess benefit transactions policies, but undergoing periodic evaluations of the operations of the organization, including assessments of all payments to private interests. Imposition of a Code Section 4958 excise tax may not constitute a "tipping point" that will cause the loss of exempt status in all situations, but these proposed regulations indicate that an organization must be proactive in correcting the violations (preferably before discovery of the excess benefit transaction by the IRS)[1] and taking steps to prevent further violations from occurring.
When reviewing current policies and evaluating payments to private interests, a governing board of an exempt organization will need to have access to knowledgeable legal counsel and a means of consistently analyzing and addressing the corrective or preventative action highlighted in the proposed regulations. If you have any questions regarding this topic, please feel free to contact Gina Giacone or Marilee Springer.
©2005 Ice Miller