Intermediate sanctions loom on the horizon for some tax-exempts.

• Author: Kalick, Laura

Many legislative proposals in recent years have included provisions that call for the imposition of "intermediate sanctions" on some exempt entities that engage in prohibited transactions. The only sanction currently available to the IRS when an exempt organization engages in transactions that give rise to private inurement is the revocation of the organization's exempt status. The Service is reluctant to use this measure because it does not necessarily punish the person who profits from the prohibited transaction, and often harms the community served by the exempt organization.

At this writing, pending legislation with support from both Congress and the Administration provides for intermediate sanctions. These proposals would apply to organizations exempt under Sec. 501 (c) (3) or (c) (4) (other than private foundations).

The pending legislation calls for a first-tier excise tax of 25% of the excess benefit amount to be imposed on a "disqualified person" who is enriched by an "excess benefit transaction" and a first-tier excise tax of 10% (up to a maximum of $10,000) on an "organization manager" who knowingly participates in such a transaction. If the transaction is not corrected, a second-tier tax of 200% may be imposed on the disqualified person. "Correction" means the undoing of the excess benefit, where possible. Where fully undoing is not possible, taking additional corrective action as prescribed by Treasury regulations would be required.

An "excess benefit transaction" is defined as any transaction in which an economic benefit is provided to or for the use of any disqualified person if the value of the economic benefit provided directly by the organization (or indirectly through a controlled entity) to such person exceeds the value of the consideration (including the performance of services) received by the organization providing such benefit. An excess benefit transaction would include any transaction in which the amount of any economic benefit provided to any disqualified person is determined by the revenues of the organization, provided that the transaction constitutes prohibited inurement under present law.

A "disqualified person" is any person in position to exercise substantial control or authority over an organization whether by being an organization manager or otherwise. It also includes certain family members and 35%-owned entities of a disqualified person as well as anyone who was a disqualified person at any time during...