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Avoid Excess Benefit Transactions & Keep Your Exempt Status

One of the worst things that can happen to a non-profit organization is to have its tax-exempt status revoked. Among other consequences, the non-profit may lose credibility with supporters and the public, and donors will no longer be able to make tax-exempt contributions.

Although loss of exempt status is not common, certain activities can increase your risk significantly. These include ignoring the IRS’ private benefit and private inurement provisions. Here is what you need to know to avoid reaping an excess benefit from your organization’s transactions.

Understand private inurement

A private benefit is any payment or transfer of assets made, directly or indirectly, by your non-profit that is:

  1. Beyond reasonable compensation for the services provided or the goods sold to your organization
  2. For services or products that do not further your tax-exempt purpose.

If any of your non-profit’s net earnings inure to the benefit of an individual, the IRS will not view your non-profit as operating primarily to further its tax-exempt purpose.

The private inurementrules extend the private benefit prohibition to your organization’s ‘insiders.’ The term ‘insider’ or ‘disqualified person’ generally refers to any officer, director, individual, or organization (as well as their family members and organizations they control) who is in a position to exert significant influence over your non-profit’s activities and finances. A violation occurs when a transaction that ultimately benefits the insider is approved.

Make reasonable payments

Of course, the rules do not prohibit all payments, such as salaries and wages, to an insider. You simply need to make sure that any payment is reasonable relative to the services or goods provided. In other words, the payment must be made with your non-profit’s tax-exempt purpose in mind.

To ensure you can later prove that any transaction was reasonable and made for a valid exempt purpose, formally document all payments made to insiders. Also ensure that board members understand their duty of care. This refers to a board member’s responsibility to act in good faith, in your organization’s best interest, and with such care that proper inquiry, skill, and diligence has been exercised in the performance of duties.

Avoid negative consequences

To make sure your non-profit does not participate in an excess benefit transaction, educate staffers and board members about the types of activities and transactions they must avoid. Stress that individuals involved could face significant excise tax penalties. For more information, please contact us.

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