[Federal Register Volume 63, Number 149 (Tuesday, August 4, 1998)]
[Proposed Rules]
[Pages 41486-41506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20419]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 53 and 301

[REG-246256-96]
RIN 1545-AV60


Failure by Certain Charitable Organizations To Meet Certain 
Qualification Requirements; Taxes on Excess Benefit Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
excise taxes on excess benefit transactions under section 4958 of the 
Internal Revenue Code (Code), as well as certain amendments and 
additions to existing Income Tax Regulations affected by section 4958. 
Section 4958 was enacted in section 1311 of the Taxpayer Bill of Rights 
2. Section 4958 generally is effective for transactions occurring on or 
after September 14, 1995. Section 4958 imposes excise taxes on 
transactions that provide excess economic benefits to disqualified 
persons of public charities and social welfare organizations. The 
proposed regulations clarify certain definitions and rules contained in 
section 4958.

DATES: Written comments and requests for a teleconference must be 
received by November 2, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-246256-96), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (REG-246256-96), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at <a href="http://www.irs.ustreas.gov/prod/tax__regs/
comments.html">http://www.irs.ustreas.gov/prod/tax__regs/
comments.html</a>.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Phyllis D. 
Haney of the Office of Associate Chief Counsel (Employee Benefits and 
Exempt Organizations), (202) 622-4290; concerning submissions, LaNita 
VanDyke, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224. 
Comments on the collection of information should be received by October 
5, 1998. Comments are specifically requested concerning:

    Whether the proposed collections of information are necessary 
for the proper performance of the functions of the Internal Revenue 
Service, including whether the information will have practical 
utility;
    The accuracy of the estimated burden associated with the 
proposed collections of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.

[[Page 41487]]

The collections of information in this proposed regulation are in 26 
CFR 53.4958-6(a)(2), 53.4958-6(a)(3), 53.4958-6(d)(2), and 53.4958-
6(d)(3). This information is required for an applicable tax-exempt 
organization to avail itself of a rebuttable presumption that payments 
under a compensation arrangement between the organization and a 
disqualified person are reasonable, or a transfer of property, right to 
use property, or any other benefit or privilege between the 
organization and a disqualified person is at fair market value. This 
information will be used by the organization's governing body, or 
committee thereof, to document the basis for its determination that 
compensation was reasonable or any other benefit was at fair market 
value. The collections of information are required to obtain the 
benefit of this rebuttable presumption of reasonableness. The likely 
recordkeepers are nonprofit institutions.
    Estimated total annual recordkeeping burden: 910,083 hours.
    The estimated annual burden per recordkeeper varies from 3 hours to 
308 hours, depending on individual circumstances, with an estimated 
weighted average of 6 hours, 3 minutes.
    Estimated number of recordkeepers: 150,427.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document provides rules regarding section 4958 excise taxes on 
excess benefit transactions. Section 4958 was added to the Code by the 
Taxpayer Bill of Rights 2, Public Law 104-168 (110 Stat. 1452), enacted 
July 30, 1996. The section 4958 excise taxes generally apply to excess 
benefit transactions occurring on or after September 14, 1995. They do 
not apply, however, to any benefit arising from a transaction pursuant 
to any written contract that was binding on September 13, 1995, and 
continued in force through the time of the transaction.
    An excess benefit transaction subject to tax under section 4958 is 
any transaction in which an economic benefit provided by an applicable 
tax-exempt organization to, or for the use of, any disqualified person 
exceeds the value of consideration received by the organization in 
exchange for the benefit. An excess benefit transaction also includes 
certain revenue-sharing transactions. An applicable tax-exempt 
organization is any organization described in section 501(c)(3) (except 
private foundations) or section 501(c)(4) at the time of the excess 
benefit transaction or at any time during the five-year period ending 
on the date of the transaction. The excess benefit is generally the 
excess of the value of the benefit provided to a disqualified person 
over the value of the consideration received by the organization.
    A disqualified person is any person who was, at any time during the 
5-year period ending on the date of the excess benefit transaction, in 
a position to exercise substantial influence over the affairs of the 
organization. A disqualified person also includes any family member of 
a person described in the preceding sentence or any entity in which at 
least 35 percent of the control or beneficial interest is held by such 
a person.
    There are three taxes under section 4958. Disqualified persons are 
liable for the first two taxes, which are imposed as follows: Pursuant 
to section 4958(a)(1), a tax of 25 percent of the excess benefit must 
be paid by any disqualified person who benefits from an excess benefit 
transaction with an applicable tax-exempt organization. Pursuant to 
section 4958(b), a tax of 200 percent of the excess benefit must be 
paid by any disqualified person who benefits from an excess benefit 
transaction if that transaction is not corrected before the earlier of 
either the date a deficiency notice is mailed with respect to the 25 
percent tax or the date the 25 percent tax is assessed.
    Certain organization managers are liable for the third tax, which 
is imposed as follows: Pursuant to section 4958(a)(2), a tax of 10 
percent of the excess benefit must be paid by any organization manager 
who participates in an excess benefit transaction knowingly, willfully, 
and without reasonable cause. An organization manager is an officer, 
director, or trustee of the organization, or any individual having 
powers or responsibilities similar to those of an officer, director, or 
trustee. The tax that must be paid by participating organization 
managers for any one excess benefit transaction cannot exceed $10,000.
    The IRS notified the general public of the new section 4958 excise 
taxes in Notice 96-46 (1996-2 C.B. 112). Notice 96-46 also solicited 
comments to be used in drafting these proposed regulations.

Comments Received Pursuant to Notice 96-46

    In response to its request for comments in Notice 96-46, the IRS 
received 28 comment letters addressing a variety of topics pertaining 
to section 4958. Some general comments requested that in applying the 
section 4958 excise taxes the IRS avoid creating administrative burdens 
on the vast majority of charities and only scrutinize a narrowly 
targeted group of charities prone to abuse the inurement prohibition. 
Most comments, however, focused on specific definitions or other 
statutory language in section 4958. A brief summary of the most 
frequently made suggestions follows. All of the comments were given 
consideration in preparing these proposed regulations.
    Commentators made suggestions regarding the definition of 
disqualified person, including applying a facts and circumstances test 
that annunciates only general principles; using a test that does not 
treat all of an organization's officers as necessarily being 
disqualified persons; deferring to an organization's own internal good-
faith identification of disqualified persons; treating certain donors 
as disqualified persons under standards similar to those for private 
foundation substantial contributors; clarifying that a donor is not in 
a position to exercise substantial influence over the affairs of an 
organization solely by reason of having made a large donation; 
including as disqualified persons those persons who provide advice and 
consultation to organizations regarding potential excess benefit 
transactions; providing that a person does not become a disqualified 
person with respect to a transaction as a result of the transaction 
(thus a person who negotiated a compensation arrangement in good faith 
before entering into an employment relationship would not become a 
disqualified person by virtue of the negotiation); and excluding 
certain independent contractors from disqualified person status.
    Commentators on the tax to be paid by organization managers who 
participate in an excess benefit transaction knowingly, willfully, and 
without reasonable cause suggested the following: defining organization 
manager narrowly; using the principles of the regulations under 
sections 4946 and 4955 in defining organization

[[Page 41488]]

manager; excluding in-house counsel and independent contractors 
(attorneys, accountants, etc.) from the definition; using an 
organization's bylaws as the source of determining whether an 
individual is an officer, director, or trustee; excluding managers who 
voted against an excess benefit transaction from joint and several 
liability for any 10% tax associated with the transaction; using the 
definitions in current section 4946 private foundation regulations for 
knowing, willful, and reasonable cause; allowing managers to rely on 
advice of legal counsel to prove their participation in a transaction 
was due to reasonable cause, and expanding the category of persons 
qualified to render opinions with this effect. Although the proposed 
regulations provide that only advice of counsel in a reasoned written 
legal opinion protects organization managers in this regard, the IRS 
invites further comments on this topic. The IRS also requests that such 
comments address whether, to be consistent on this point, other 
regulations (e.g., Sec. 53.4941 and Sec. 53.4945) should be amended as 
well.
    Numerous comments were received on determining reasonable 
compensation for services and fair market value in sale or exchange 
transactions. Commentators asked the IRS to use existing law standards 
under section 162 for determining reasonable compensation and to 
provide special standards for new organizations in the start-up phase 
of operations. With respect to compensation, some commentators also 
requested objective standards or charts of reasonable compensation 
amounts; others requested that the regulations not impose strict dollar 
limitations on what would constitute reasonable compensation.
    Several commentators made suggestions regarding the requirement 
that an organization must demonstrate its intent to treat economic 
benefits as compensation in order to treat the benefit as being 
provided in exchange for services. These suggestions included using a 
facts and circumstances test to determine whether an organization 
clearly indicated its intent to treat a benefit as compensation; 
considering certain small amounts inadvertently not included in a 
disqualified person's reported compensation as de minimis and not 
triggering section 4958 taxes; and allowing a reasonable cause 
exception under which items that were not reported as compensation 
could still be treated as provided in exchange for services.
    A number of commentators requested that the definition of an excess 
benefit transaction exclude the provision of certain types of benefits 
to a disqualified person. These benefits included economic benefits 
made available to the general public on at least as favorable a basis; 
economic benefits that are de minimis fringe benefits under section 
132; reimbursements for expenses of administration of an organization; 
and incidental benefits.
    Commentators provided a wide range of suggestions on the subject of 
which revenue-sharing arrangements should constitute excess benefit 
transactions. Suggestions included incorporating existing IRS 
unpublished guidance in a safe harbor rule; using the principles of 
Rev. Rul. 69-383 (1969-2 C.B. 113), to determine whether a particular 
plan of compensation results in prohibited inurement or private 
benefit; limiting the category of revenue-sharing arrangements that 
constitute excess benefit transactions to arrangements based on the 
organization's revenues only; and applying regulations on revenue-
sharing arrangements prospectively, with transition rules for existing 
arrangements.
    Many comments were received on the rebuttable presumption of 
reasonableness that is described in the legislative history as arising 
when a board of directors approves certain compensation arrangements or 
other transactions. The following suggestions were submitted in 
multiple comments: that the presumption apply when an applicable 
organization's board approves general guidelines for entering into 
transactions with disqualified persons rather than voting on each 
individual transaction; that the regulations require a determination of 
reasonableness at the time the organization makes a payment to a 
disqualified person; that the presumption apply when approval is given 
by a compensation committee that is not composed exclusively of 
directors or trustees; that the board or committee be considered 
independent if members recuse themselves when they have conflicts of 
interest; that the regulations clarify whether a joint compensation 
committee composed of representatives from several affiliated 
organizations would be a committee of each of the respective boards; 
that the regulations allow an organization's board to delegate the 
responsibility for setting compensation to an independent committee; 
that the regulations use examples to define what is an independent firm 
that can produce salary surveys that will serve as appropriate data on 
comparability; that the regulations clarify that the rebuttable 
presumption is a safe harbor and no negative inference should be drawn 
if an organization does not avail itself of that safe harbor; and that 
the regulations clarify that compensation outside the range of 
comparables is not per se unreasonable. Some church representatives 
submitted comments noting that the religious beliefs of some churches 
and some state laws regarding churches prevent churches from 
benefitting from the rebuttable presumption of reasonableness because 
of the identity of the parties required to approve compensation 
arrangements or other transactions. While these proposed regulations do 
not provide a special exception for churches from the requirements that 
must be met to give rise to the rebuttable presumption, they do provide 
churches with a special rule stating that the procedures of section 
7611 will be used in initiating and conducting any inquiry or 
examination into whether an excess benefit transaction has occurred 
between a church and a disqualified person. For purposes of this rule, 
the reasonable belief required to initiate a church tax inquiry is 
satisfied if there is a reasonable belief that a section 4958 tax is 
due from a disqualified person with respect to a transaction involving 
a church.
    Several comments were received on the relationship between 
revocation of tax-exempt status and the taxes imposed under section 
4958, recommending that the regulations follow the legislative history 
on this question. The IRS intends to exercise its administrative 
discretion in enforcing the requirements of sections 4958, 501(c)(3) 
and 501(c)(4) in accordance with the direction given in the legislative 
history. The legislative history specifically provides that the IRS may 
still revoke the tax-exempt status of an organization for violating the 
inurement proscription, with or without imposition of section 4958 
excise taxes. It further provides that, in practice, the excise taxes 
imposed by section 4958 will be the sole sanction imposed in those 
cases in which the excess benefit does not rise to a level where it 
calls into question whether, on the whole, the organization functions 
as a charitable or other tax-exempt organization. In determining 
whether an excess benefit transaction rises to such a level, factors 
relating to the organization's general pattern of compliance with the 
requirements of section 501(c)(3) or (4) and other applicable Federal 
and State laws will be taken into account. These factors would include 
whether the organization has been involved in repeated excess benefit 
transactions; the size and scope

[[Page 41489]]

of the excess benefit transaction; whether, after concluding that it 
has been party to an excess benefit transaction, the organization has 
implemented safeguards to prevent future recurrences; and whether there 
was compliance with other applicable laws. The IRS intends to publish 
the factors that it will consider in exercising its administrative 
discretion in guidance issued in conjunction with the issuance of final 
regulations under section 4958.

Explanation of Provisions

Overview

    This document contains proposed regulations that add new 
regulations under section 4958, and that amend and add to existing 
Income Tax and Excise Tax Regulations under sections 4963, 6213, 6501, 
7422, and 7611. The explanation of these proposed regulations is 
grouped into two parts: the substantive section 4958 regulations, and 
regulations under the provisions amended to reflect various effects of 
the enactment of section 4958 on abatement, Tax Court petitions, 
statute of limitations, refund actions, and church tax inquiries and 
examinations. The proposed Sec. 53.4958 regulations are described in 
more detail in this preamble under Section I, Taxes on excess benefit 
transactions, immediately below. The proposed amendments and additions 
to regulations under various procedural and administrative provisions 
affected by the enactment of section 4958 are described in Section II, 
Amendment of regulations under various procedural and administrative 
provisions, below.

I. Taxes on Excess Benefit Transactions

    The proposed regulations describe the three taxes imposed under 
section 4958 on excess benefit transactions between an applicable tax-
exempt organization and a disqualified person. Two of the taxes are 
paid by certain disqualified persons who benefit economically from a 
transaction, and the other tax is paid by certain organization managers 
who participate in the transaction knowingly, willfully, and without 
reasonable cause.
    A disqualified person who receives an excess benefit from a 
transaction is liable for a tax equal to 25 percent of the excess 
benefit. If the excess benefit is not corrected within the taxable 
period, that disqualified person is then liable for a tax of 200 
percent of the excess benefit. Taxable period is defined as the period 
beginning on the date the transaction occurs and ending on the earlier 
of the date of mailing a notice of deficiency for the 25 percent tax or 
the date on which the 25 percent tax is assessed.
    Correction is defined in the proposed regulations as undoing the 
excess benefit to the extent possible, and taking any additional 
measures necessary to place the organization in a financial position 
not worse than that in which it would be if the disqualified person had 
been dealing under the highest fiduciary standards. Correction of the 
excess benefit occurs if the disqualified person repays the applicable 
tax-exempt organization an amount of money equal to the excess benefit, 
plus any additional amount needed to compensate the organization for 
the loss of the use of the money or other property during the period 
commencing on the date the excess benefit transaction occurs and ending 
on the date the excess benefit is corrected. Correction may also be 
accomplished, in certain circumstances, by returning property to the 
organization and taking any additional steps necessary to make the 
organization whole. If the excess benefit transaction consists of the 
payment of compensation for services under a contract that has not been 
completed, termination of the employment or independent contractor 
relationship between the organization and the disqualified person is 
not required in order to correct. However, the terms of any ongoing 
compensation arrangement may need to be modified to avoid future excess 
benefit transactions. If the excess benefit is corrected within the 
correction period, then under the rules of section 4961 the 200 percent 
tax under section 4958(b) is not assessed. If the excess benefit is 
corrected within the correction period and it is established to the 
satisfaction of the Secretary that the excess benefit transaction was 
due to reasonable cause and not to willful neglect, then under the 
rules of section 4962 the 25 percent tax under section 4958(a)(1) will 
be abated.
    Each organization manager who participated in the excess benefit 
transaction, knowing that it was such a transaction, unless such 
participation was not willful and was due to reasonable cause, is 
liable for a tax equal to 10 percent of the excess benefit, not to 
exceed an aggregate amount of $10,000 with respect to any one excess 
benefit transaction. An organization manager is, with respect to any 
applicable tax-exempt organization, any officer, director, or trustee 
of such organization, or any individual having powers or 
responsibilities similar to those of officers, directors, or trustees 
of the organization. Independent contractors, acting in a capacity as 
attorneys, accountants, and investment managers and advisors, are not 
officers. Any person who has authority merely to recommend particular 
administrative or policy decisions, but not to implement them without 
approval of a superior, is not an officer. 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 that is 
invoking the rebuttable presumption of reasonableness (described later 
in this section) based on the committee's action, however, is an 
organization manager for purposes of the 10 percent tax.
    The definitions provided in the proposed regulations for the terms 
participation, knowing, willful, and due to reasonable cause with 
respect to organization managers for section 4958 purposes parallel the 
definitions of those terms used with respect to foundation managers in 
the section 4941 regulations. If an organization manager, after full 
disclosure of the factual situation to legal counsel (including in-
house counsel) relies on the advice of such counsel expressed in a 
reasoned written legal opinion that a transaction is not an excess 
benefit transaction under section 4958, that manager's participation in 
such transaction will ordinarily not be considered knowing or willful, 
and will ordinarily be considered due to reasonable cause, even if the 
transaction is subsequently held to be an excess benefit transaction.
    With respect to any specific excess benefit transaction, if more 
than one person is liable for any of the taxes imposed by section 4958, 
all persons with respect to whom a particular tax is imposed are 
jointly and severally liable for that tax. For instance, if more than 
one disqualified person benefits from the same transaction, all the 
benefitting disqualified persons are jointly and severally liable for 
the respective section 4958(a)(1) or (b) taxes on that transaction. 
Where an organization manager also receives an excess benefit from an 
excess benefit transaction, the manager may be liable for both taxes 
imposed by section 4958(a).
    Except as otherwise provided in the proposed regulations, a 
transaction occurs on the date on which a disqualified person receives 
an economic benefit from the applicable tax-exempt organization for 
federal income tax purposes. In the case of payment of deferred 
compensation, the transaction occurs on the date the deferred 
compensation is earned and vested.
    The proposed regulations cross-reference sections 6501(e)(3) and 
6501(l) and the regulations thereunder, as

[[Page 41490]]

amended, for statute of limitations rules for section 4958 excise 
taxes. Thus, the statute of limitations for imposition of tax under 
section 4958 generally begins to run as of the date the applicable tax-
exempt organization files its return (Form 990) for the year in which 
the excess benefit transaction occurred.
    The proposed regulations provide that the taxes imposed on excess 
benefit transactions apply to transactions occurring on or after 
September 14, 1995. However, these taxes do not apply to a transaction 
pursuant to a written contract that was binding on September 13, 1995, 
and at all times thereafter before the transaction occurred. A written 
binding contract that is terminable or subject to cancellation by the 
applicable tax-exempt organization without the disqualified person's 
consent is treated as a new contract as of the date that any such 
termination or cancellation, if made, would be effective. If a binding 
written contract is materially modified (including situations in which 
the contract is amended to extend its term or to increase the amount of 
compensation payable to the disqualified person), it is treated as a 
new contract entered into as of the date of the material modification.
Definition of Applicable Tax-Exempt Organization
    The proposed regulations generally define an applicable tax-exempt 
organization as any organization that, without regard to any excess 
benefit, is or would have been described in sections 501(c)(3) or (4) 
and exempt from tax under section 501(a) at any time during a five-year 
period ending on the date of an excess benefit transaction (the 
lookback period). In the specific case of any transaction occurring 
before September 14, 2000, the lookback period begins on September 14, 
1995, and ends on the date of the transaction.
    To be described in section 501(c)(3) for purposes of section 4958, 
an organization must meet the requirements of section 508 (subject to 
any applicable exceptions provided by that section). A private 
foundation as defined in section 509(a) is not an applicable tax-exempt 
organization for section 4958 purposes. An organization that has 
applied for and received recognition of exemption as an organization 
described in section 501(c)(4) is an applicable tax-exempt organization 
for section 4958 purposes. In addition, an organization that has sought 
to take advantage of section 501(c)(4) status by filing an application 
for recognition of exemption under section 501(c)(4) with the IRS, 
filing an information return as a section 501(c)(4) organization under 
the Code or regulations promulgated thereunder, or otherwise holding 
itself out as being described in section 501(c)(4), is an applicable 
tax-exempt organization for section 4958 purposes.
    A foreign organization that receives substantially all of its 
support from sources outside of the United States is not an applicable 
tax-exempt organization for section 4958 purposes. Section 4948(b) 
generally states that chapter 42 taxes, including section 4958 taxes on 
excess benefit transactions, do not apply to any foreign organization 
that has received substantially all of its support from sources outside 
the United States.
Definition of Disqualified Person
    The proposed regulations define a disqualified person as a person 
who, with respect to any transaction with an applicable tax-exempt 
organization, at any time during a five-year period beginning after 
September 13, 1995, and ending on the date of such transaction, was in 
a position to exercise substantial influence over the affairs of the 
organization. Certain persons are statutorily defined to be 
disqualified persons under section 4958(f), including certain family 
members of disqualified persons (spouse, brothers or sisters (by whole 
or half blood), spouses of brothers or sisters (by whole or half 
blood), ancestors, children, grandchildren, great grandchildren, and 
spouses of children, grandchildren, and great grandchildren), and 35 
percent controlled entities (a corporation in which a disqualified 
person owns more than 35 percent of the combined voting power; a 
partnership in which a disqualified person owns more than 35 percent of 
the profits interest; or a trust or estate in which a disqualified 
person owns more than 35 percent of the beneficial interest).
    The proposed regulations specifically identify certain persons as 
having substantial influence over the affairs of an applicable tax-
exempt organization. These specified persons include any individual who 
serves as a voting member on the governing body of the organization; 
any individual or individuals who have the power or responsibilities of 
the president, chief executive officer or chief operating officer of an 
organization; any individual or individuals who have the power or 
responsibilities of treasurer or chief financial officer of an 
organization; and any person who has a material financial interest in 
certain provider-sponsored organizations in which a hospital that is an 
applicable tax-exempt organization participates.
    The proposed regulations deem two categories of persons not to have 
substantial influence over the affairs of an applicable tax-exempt 
organization. The first category comprises other applicable tax-exempt 
organizations described in section 501(c)(3). The second category 
comprises any employee who, for the taxable year in which the benefits 
are provided, receives economic benefits, directly or indirectly from 
the organization, of less than the amount of compensation referenced 
for a highly compensated employee in section 414(q)(1)(B)(i), who is 
not a statutorily-defined disqualified person and not specifically 
identified by the regulations as having substantial influence, and is 
not a substantial contributor to the organization within the meaning of 
section 507(d)(2).
    The proposed regulations provide that except as specified in the 
categories set forth in the statute or the preceding parts of the 
regulation, the determination of whether a person has substantial 
influence over the affairs of an organization is based on all relevant 
facts and circumstances. A person who has managerial control over a 
discrete segment of an organization may nonetheless be in a position to 
exercise substantial influence over the affairs of the entire 
organization. Facts and circumstances tending to show that a person has 
substantial influence over the affairs of an organization include, but 
are not limited to, the following: that the person founded the 
organization; that the person is a substantial contributor (within the 
meaning of section 507(d)(2)) to the organization; that the person's 
compensation is based on revenues derived from activities of the 
organization that the person controls; that the person has authority to 
control or determine a significant portion of the organization's 
capital expenditures, operating budget, or compensation for employees; 
that the person has managerial authority or serves as a key advisor to 
a person with managerial authority; or that the person owns a 
controlling interest in a corporation, partnership, or trust that is a 
disqualified person.
    Facts and circumstances tending to show that a person does not have 
substantial influence over the affairs of an organization include but 
are not limited to, the following: that the person has taken a bona 
fide vow of poverty as an employee, agent, or on behalf of a religious 
organization; that the person is an independent contractor, such as an 
attorney, accountant, or investment manager or advisor, acting in that 
capacity, unless the person is acting in

[[Page 41491]]

that capacity with respect to a transaction from which the person might 
economically benefit either directly or indirectly (aside from fees 
received for the professional services rendered); and that any 
preferential treatment a person receives based on the size of that 
person's donation is also offered to any other donor making a 
comparable contribution as part of a solicitation intended to attract a 
substantial number of contributions.
    In the case of multiple organizations affiliated by common control 
or governing documents, the determination of whether a person does or 
does not have substantial influence will be made separately for each 
applicable tax-exempt organization.
Excess Benefit Transaction
    The proposed regulations state that an excess benefit transaction 
is any transaction in which an economic benefit is provided by an 
applicable tax-exempt organization directly or indirectly to, or for 
the use of, any disqualified person if the value of the economic 
benefit provided exceeds the value of the consideration (including the 
performance of services) received for providing such benefit. An excess 
benefit transaction also includes certain revenue-sharing transactions 
(described later in this section). A benefit can be provided indirectly 
if it is provided through one or more entities controlled by or 
affiliated with the applicable tax-exempt organization.
    Certain economic benefits provided by an applicable tax-exempt 
organization to a disqualified person are disregarded for purposes of 
section 4958. These include paying reasonable expenses for members of 
the governing body of an applicable tax-exempt organization to attend 
meetings of the governing body of the organization, not including 
expenses for luxury travel or spousal travel; an economic benefit 
provided to a disqualified person that the disqualified person receives 
solely as a member of, or volunteer for, the organization, if the 
benefit is provided to members of the public in exchange for a 
membership fee of $75 or less per year; and an economic benefit 
provided to a disqualified person that the disqualified person receives 
solely as a member of a charitable class the applicable tax-exempt 
organization intends to benefit.
    The proposed regulations provide that the payment of a premium for 
an insurance policy providing liability insurance to a disqualified 
person to cover any taxes imposed under this section or indemnification 
of a disqualified person for such taxes by an applicable tax-exempt 
organization is not an excess benefit transaction if the premium or the 
indemnification is treated as compensation to the disqualified person 
when paid, and the total compensation paid to the disqualified person 
is reasonable.
    The proposed regulations provide that if the amount of the economic 
benefit provided by the applicable tax-exempt organization exceeds the 
fair market value of the consideration, the excess is the excess 
benefit on which tax is imposed by section 4958. Rules concerning the 
excess benefit in certain revenue-sharing transactions are described 
later in this section. The fair market value of property is the price 
at which property or the right to use property would change hands 
between a willing buyer and a willing seller, neither being under any 
compulsion to buy, sell, or transfer property or the right to use 
property, and both having reasonable knowledge of relevant facts.
Compensation
    Compensation for the performance of services is reasonable only if 
it is an amount that would ordinarily be paid for like services by like 
enterprises under like circumstances. Generally, the circumstances to 
be taken into consideration are those existing at the date when the 
contract for services was made. However, where reasonableness of 
compensation cannot be determined based on circumstances existing at 
the date when the contract for services was made, then that 
determination is made based on all facts and circumstances, up to and 
including circumstances as of the date of payment. In no event shall 
circumstances existing at the date when the contract is questioned be 
considered in making a determination of the reasonableness of 
compensation. A written binding contract that is terminable or subject 
to cancellation by the applicable tax-exempt organization without the 
disqualified person's consent is treated as a new contract as of the 
date that any such termination or cancellation, if made, would be 
effective. If a binding written contract is materially modified (which 
includes amending the contract to extend its term or increase the 
amount of compensation payable to the disqualified person), it is 
treated as a new contract entered into as of the date of the material 
modification. Examples illustrate whether the reasonableness of 
compensation can be determined based on circumstances existing at the 
time a contract for the performance of services was made. In accordance 
with the legislative history, the fact that a State or local 
legislative or agency body has authorized or approved a particular 
compensation package paid to a disqualified person is not determinative 
of the reasonableness of compensation paid for purposes of section 4958 
excise taxes. Under the proposed regulations, the fact that a 
particular compensation package is authorized or approved by a court 
also is not determinative of the reasonableness of compensation paid to 
a disqualified person.
    Compensation for purposes of section 4958 includes all items of 
compensation provided by an applicable tax-exempt organization in 
exchange for the performance of services by a disqualified person. 
These items of compensation include, but are not limited to, all forms 
of cash and noncash compensation, including salary, fees, bonuses, and 
severance payments paid, and all forms of deferred compensation that is 
earned and vested, whether or not funded, and whether or not paid under 
a deferred compensation plan that is a qualified plan under section 
401(a). If deferred compensation for services performed in multiple 
prior years vests in a later year, then that compensation is attributed 
to the years in which the services were performed. Compensation also 
includes the amount of premiums paid for liability or any other 
insurance coverage, as well as any payment or reimbursement by the 
organization of charges, expenses, fees, or taxes not covered 
ultimately by the insurance coverage; all other benefits, whether or 
not included in income for tax purposes, including payments to welfare 
benefit plans on behalf of the disqualified persons, such as plans 
providing medical, dental, life insurance, severance pay, and 
disability benefits, and both taxable and nontaxable fringe benefits 
(other than working condition fringe benefits described in section 
132(d) and de minimis fringe benefits described in section 132(e)), 
including expense allowances or reimbursements or foregone interest on 
loans that the recipient must report as income on his separate income 
tax return; and any economic benefit provided by the applicable tax-
exempt organization directly or indirectly through another entity, 
owned, controlled by or affiliated with the applicable tax-exempt 
organization, whether such other entity is taxable or tax-exempt.
    An economic benefit that an applicable tax-exempt organization 
provides to, or for the use, of a disqualified person is not treated as 
consideration for the performance of services unless the organization 
clearly indicates its intent to treat the benefit as compensation when 
the benefit is paid.

[[Page 41492]]

An applicable tax-exempt organization will be treated as having 
intended to provide an economic benefit as compensation for services 
only if it provides clear and convincing evidence of having that intent 
when the benefit was paid. An applicable tax-exempt organization can 
provide clear and convincing evidence of such intent by reporting the 
economic benefit as compensation on original or amended federal tax 
information returns with respect to the payment (e.g., Form W-2 or 
1099) or with respect to the organization (e.g., Form 990), filed 
before the commencement of an IRS examination in which the reporting of 
the benefit is questioned. For purposes of section 4958 and these 
proposed regulations, an IRS examination of an applicable tax-exempt 
organization has commenced if the organization has received written 
notification from the Exempt Organizations Division of an impending 
Exempt Organizations examination, or written notification of an 
impending referral for an Exempt Organizations examination, and also 
includes having been under an Exempt Organizations examination that is 
now in Appeals or in litigation for issues raised in an Exempt 
Organizations examination of the period in which the excess benefit 
transaction occurred. Reporting of an economic benefit to provide clear 
and convincing evidence of intent is also accomplished if the recipient 
disqualified person reports the benefit as income on the person's Form 
1040 for the year in which the benefit is received. If the amount of an 
economic benefit paid to a disqualified person is not reported and 
should have been reported on any information return issued by the 
applicable tax-exempt organization, and the failure to report was due 
to reasonable cause as defined under section 6724 regulations, then the 
organization is deemed to satisfy the clear and convincing evidence 
requirement. To show that its failure to report an economic benefit 
that should have been reported on an information return was due to 
reasonable cause, the applicable tax-exempt organization must establish 
that there are significant mitigating factors with respect to its 
failure to report, or the failure arose from events beyond the 
organization's control, and the organization acted in a responsible 
manner both before and after the failure occurred. If an organization 
fails to provide clear and convincing evidence that it intended to 
provide an economic benefit as compensation for services when paid, any 
services provided by the disqualified person will not be treated as 
provided in consideration for the economic benefit.
Transaction in Which Amount of Economic Benefit Determined in Whole or 
in Part by the Revenues of One or More Activities of the Organization
    The proposed regulations apply a facts and circumstances test to 
assess whether a transaction in which the amount of an economic benefit 
provided by an applicable tax-exempt organization to or for the use of 
a disqualified person is determined in whole or in part by the revenues 
of one or more activities of the applicable tax-exempt organization 
(revenue-sharing transaction) results in inurement, and therefore 
constitutes an excess benefit transaction. A revenue-sharing 
transaction may constitute an excess benefit transaction regardless of 
whether the economic benefit provided to the disqualified person 
exceeds the fair market value of the consideration provided in return 
if, at any point, it permits a disqualified person to receive 
additional compensation without providing proportional benefits that 
contribute to the organization's accomplishment of its exempt purpose. 
If the economic benefit is provided as compensation for services, 
relevant facts and circumstances include, but are not limited to, the 
relationship between the size of the benefit provided and the quality 
and quantity of the services provided, as well as the ability of the 
party receiving the compensation to control the activities generating 
the revenues on which the compensation is based.
    The type of revenue-sharing transaction described in the proposed 
regulations constitutes an excess benefit transaction if it occurs on 
or after the date of publication of final regulations. The excess 
benefit in such a transaction consists of the entire economic benefit 
provided. Any revenue-sharing transaction occurring after September 13, 
1995, may still constitute an excess benefit transaction if the 
economic benefit provided to the disqualified person exceeds the fair 
market value of the consideration provided in return. Before the date 
of publication of final regulations, however, the excess benefit shall 
consist only of that portion of the economic benefit that exceeds the 
fair market value of the consideration provided in return. Examples are 
provided of revenue-sharing transactions that do and do not constitute 
excess benefit transactions.
Rebuttable Presumption That Transaction Is Not an Excess Benefit 
Transaction
    The proposed regulations provide that a compensation arrangement 
between an applicable tax-exempt organization and a disqualified person 
is presumed to be reasonable, and a transfer of property, a right to 
use property, or any other benefit or privilege between an applicable 
tax-exempt organization and a disqualified person is presumed to be at 
fair market value, if three conditions are satisfied. The three 
conditions are as follows: (1) the compensation arrangement or terms of 
transfer are approved by the organization's governing body or a 
committee of the governing body composed entirely of individuals who do 
not have a conflict of interest with respect to the arrangement or 
transaction; (2) the governing body, or committee thereof, obtained and 
relied upon appropriate data as to comparability prior to making its 
determination; and (3) the governing body or committee adequately 
documented the basis for its determination concurrently with making 
that determination. The presumption established by satisfying these 
three requirements may be rebutted by additional information showing 
that the compensation was not reasonable or that the transfer was not 
at fair market value.
    To the extent permitted under local law, the governing body of an 
applicable tax-exempt organization may authorize other parties to act 
on its behalf by following specified procedures that satisfy the three 
requirements for invoking the rebuttable presumption of reasonableness. 
An arrangement or transaction that is subsequently approved by the 
board's designee or designees in accordance with those procedures shall 
be subject to the rebuttable presumption even though the governing body 
does not vote separately on the specific arrangement or transaction.
    With respect to the first requirement, the proposed regulations 
provide that the governing body is the board of directors, board of 
trustees, or equivalent controlling body of the applicable tax-exempt 
organization. A committee of the governing body may be composed of any 
individuals permitted under state law to serve on such a committee, and 
may act on behalf of the governing body to the extent permitted by 
state law. However, any members of such a committee who are not members 
of the governing body are deemed to be organization managers for 
purposes of the tax imposed by section 4958(a)(2) if

[[Page 41493]]

the organization is invoking the rebuttable presumption based on the 
actions of the committee. A person is not included on an organization's 
governing body or committee thereof when the governing body or 
committee is reviewing a transaction if that person meets with the 
other members only to answer questions, and otherwise recuses himself 
from the meeting and is not present during debate and voting on the 
transaction or compensation arrangement.
    The proposed regulations provide that a member of the governing 
body, or committee thereof, does not have a conflict of interest with 
respect to a compensation arrangement or transaction if the member is 
not the disqualified person and is not related to any disqualified 
person participating in or economically benefitting from the 
compensation arrangement or transaction; is not in an employment 
relationship subject to the direction or control of any disqualified 
person participating in or economically benefitting from the 
compensation arrangement or transaction; is not receiving compensation 
or other payments subject to approval by any disqualified person 
participating in or economically benefitting from the compensation 
arrangement or transaction; has no material financial interest affected 
by the compensation arrangement or transaction; and, as prescribed in 
the legislative history, does not approve a transaction providing 
economic benefits to any disqualified person participating in the 
compensation arrangement or transaction, who in turn has approved or 
will approve a transaction providing economic benefits to the member. 
An arrangement or transaction has not been approved by a committee of a 
governing body if, under the governing documents of the organization or 
state law, the committee's decision must be ratified by the full 
governing body in order to become effective.
    With respect to the second requirement for the rebuttable 
presumption of reasonableness, the proposed regulations provide that a 
governing body or committee has appropriate data on comparability if, 
given the knowledge and expertise of its members, it has information 
sufficient to determine whether a compensation arrangement will result 
in the payment of reasonable compensation or a transaction will be for 
fair market value. Relevant information includes, but is not limited 
to, compensation levels paid by similarly situated organizations, both 
taxable and tax-exempt, for functionally comparable positions; the 
availability of similar services in the geographic area of the 
applicable tax-exempt organization; independent compensation surveys 
compiled by independent firms; actual written offers from similar 
institutions competing for the services of the disqualified person; and 
independent appraisals of the value of property that the applicable 
tax-exempt organization intends to purchase from, or sell or provide to 
the disqualified person.
    A special rule is provided for organizations with annual gross 
receipts of less than $1 million. Under this rule, when the governing 
body reviews compensation arrangements, it will be considered to have 
appropriate data as to comparability if it has data on compensation 
paid by five comparable organizations in the same or similar 
communities for similar services. No inference is intended with respect 
to whether circumstances falling outside this safe harbor will meet the 
requirements with respect to the collection of appropriate data.
    For purposes of the third requirement of the rebuttable presumption 
of reasonableness under the proposed regulations, to be documented 
adequately, the written or electronic records of the governing body or 
committee must note the terms of the transaction that was approved and 
the date it was approved; the members of the governing body or 
committee who were present during debate on the transaction or 
arrangement that was approved and those who voted on it; the 
comparability data obtained and relied upon by the committee and how 
the data was obtained; and the actions taken with respect to 
consideration of the transaction by anyone who is otherwise a member of 
the governing body or committee but who had a conflict of interest with 
respect to the transaction or arrangement. If the governing body or 
committee determines that reasonable compensation for a specific 
arrangement or fair market value in a specific transaction is higher or 
lower than the range of comparable data obtained, the governing body or 
committee must record the basis for its determination. For a decision 
to be documented concurrently, records must be prepared by the next 
meeting of the governing body or committee occurring after the final 
action or actions of the governing body or committee are taken. Records 
must be reviewed and approved by the governing body or committee as 
reasonable, accurate and complete within a reasonable time period 
thereafter.
    If reasonableness of the compensation cannot be determined based on 
circumstances existing at the date when a contract for services was 
made, then the rebuttable presumption cannot arise until circumstances 
exist so that reasonableness of compensation can be determined, and the 
three requirements for the presumption subsequently are satisfied.
    The fact that a transaction between an applicable tax-exempt 
organization and a disqualified person is not subject to the 
presumption described in this section shall not create any inference 
that the transaction is an excess benefit transaction. Neither shall 
the fact that a transaction qualifies for the presumption exempt or 
relieve any person from compliance with any federal or state law 
imposing any obligation, duty, responsibility, or other standard of 
conduct with respect to the operation or administration of any 
applicable tax-exempt organization. The rebuttable presumption applies 
to all payments made or transactions completed in accordance with a 
contract provided that the three requirements of the rebuttable 
presumption were met at the time the contract was agreed upon.
Special Rules
    The proposed regulations provide that the excise taxes imposed by 
section 4958 do not affect the substantive statutory standards for tax 
exemption under sections 501(c)(3) or (4). Organizations are described 
in those sections only if no part of their net earnings inure to the 
benefit of any private shareholder or individual.
    The proposed regulations provide that the procedures of section 
7611 will be used in initiating and conducting any inquiry or 
examination into whether an excess benefit transaction has occurred 
between a church and a disqualified person. For purposes of this rule, 
the reasonable belief required to initiate a church tax inquiry is 
satisfied if there is a reasonable belief that a section 4958 tax is 
due from a disqualified person with respect to a transaction involving 
a church. Any additional procedures that apply when determining whether 
disqualified persons are liable for taxes as a result of transactions 
with organizations other than churches will apply when determining 
whether disqualified persons are liable for taxes as a result of 
transactions with churches.

II. Amendment of Regulations Under Various Procedural and 
Administrative Provisions

    The proposed regulations amend the section 4963 regulations to 
include section 4958 taxes in the list of taxes subject to abatement 
under sections

[[Page 41494]]

4961 and 4962; amend the section 6213 regulations to suspend the time 
period for filing a Tax Court petition for the time allowed by the 
Commissioner to correct a section 4958 transaction; amend the section 
6501 regulations to allow the filing of an information return by an 
applicable tax-exempt organization to begin the three-year limitation 
on assessment and collection for section 4958 taxes (or six years if an 
organization failed to disclose an item); amend the section 7422 
regulations to apply existing rules for refund proceedings to section 
4958 taxes; and amend section 7611 regulations to cross-reference the 
rules governing the interaction between section 4958 and section 7611 
in these proposed regulations.
    Except as otherwise specified in the text of the final regulations, 
these regulations will be effective upon publication of the final 
regulations in the Federal Register. Taxpayers may rely on these 
proposed regulations for guidance pending the issuance of final 
regulations. If, and to the extent, future guidance is more restrictive 
than the guidance in these proposed regulations, the future guidance 
will be applied without retroactive effect.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required.
    An initial regulatory flexibility analysis has been prepared as 
required for the collection of information in this notice of proposed 
rulemaking under 5 U.S.C. 603. The analysis follows:

Initial Regulatory Flexibility Analysis

    These proposed regulations clarifying section 4958 of the Code 
(Taxes on excess benefit transactions) may have an impact on small 
organizations if those organizations avail themselves of the rebuttable 
presumption of reasonableness described in the regulations (26 C.F.R. 
53.4958-6(a)(2), 53.4958-6(a)(3), 53.4958-6(d)(2), and 53.4958-
6(d)(3)). The rebuttable presumption is being considered because the 
legislative history of section 4958 (H. REP. 104-506 at 56-7, March 28, 
1996) stated that parties to a transaction should be entitled to rely 
on such a rebuttable presumption that a compensation arrangement or a 
property transaction between certain organizations and disqualified 
persons of the organizations is reasonable or at fair market value. The 
legislative history further instructed the Secretary of the Treasury 
and the IRS to issue guidance in connection with the standard for 
establishing reasonable compensation or fair market value that 
incorporates this presumption.
    The objective for the rebuttable presumption is to allow 
organizations that satisfy the three requirements to presume that 
compensation arrangements and property transactions entered into with 
disqualified persons pursuant to satisfaction of those requirements are 
reasonable or at fair market value. In such cases, the section 4958 
excise taxes can be imposed only if the IRS develops sufficient 
contrary evidence to rebut the probative value of the evidence put 
forth by the parties to the transaction. The legal basis for the 
proposed rule is Code sections 4958 and 7805.
    The proposed rule affects organizations described in sections 
501(c)(3) and (4) (applicable tax-exempt organizations). Some 
applicable tax-exempt organizations may be small organizations, defined 
in 5 U.S.C. 601(4) as any not-for-profit enterprise which is 
independently owned and operated and is not dominant in its field.
    The proposed recordkeeping burden entails obtaining and relying on 
appropriate comparability data and documenting the basis of an 
organization's determination that compensation is reasonable, or a 
property transfer (or transfer of the right to use property) is at fair 
market value. These actions are necessary to meet two of the 
requirements specified in the legislative history for obtaining the 
rebuttable presumption of reasonableness. The skills necessary for 
these actions are of the type required for obtaining and considering 
comparability data, and for documenting the membership and actions of 
the governing board or relevant committee of the organization. 
Applicable tax-exempt organizations that are small entities of the 
class that files Form 990-EZ (i.e., those with gross receipts of less 
than $100,000 and assets of less than $250,000) are unlikely to 
undertake fulfilling the requirements of the rebuttable presumption of 
reasonableness, and therefore will not be affected by the recordkeeping 
burden. All other classes of applicable tax-exempt organizations that 
file Form 990, up to organizations with assets of $50 million, are 
likely to be small organizations that avail themselves of the 
rebuttable presumption of reasonableness. These classes range from 
organizations with assets of $100,000 to $50 million. The proposed rule 
currently contains a less burdensome safe harbor for one of the 
requirements (obtaining comparability data on compensation) for 
organizations with annual gross receipts of less than $1 million. The 
IRS is not aware of any other relevant federal rules which may 
duplicate, overlap, or conflict with the proposed rule. A less 
burdensome alternative for small organizations would be to exempt those 
entities from the requirements for establishing the rebuttable 
presumption of reasonableness. However, it is not consistent with the 
statute to allow organizations to rely on this presumption without 
satisfying some conditions. Satisfaction of the requirements as 
outlined in the legislative history leads to a benefit, but failure to 
satisfy them does not necessarily lead to a penalty. A more burdensome 
alternative would be to require all applicable tax-exempt organizations 
under Code section 4958 to satisfy the three requirements of the 
rebuttable presumption of reasonableness under all circumstances.
    Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying. A 
teleconference public hearing may be scheduled if requested in writing 
by a person wishing to testify outside the Washington, DC area who 
timely submits written comments. A request for a hearing by video 
conference was made on April 7, 1998, by the Taxation Section of the 
Los Angeles County Bar Association. If a teleconference public hearing 
is scheduled, notice of the date, time, place, and remote 
teleconference sites for the hearing will be published in the Federal 
Register.
    In addition to several areas mentioned earlier in this preamble, 
specific comments are requested with respect to certain issues raised 
by these proposed regulations. Concerning the relationship between 
revocation of tax-exempt status and the taxes imposed under section 
4958, comments are invited to be considered in preparing guidance 
outlining the factors the IRS will consider in exercising its 
administrative discretion in accordance with the legislative history. 
Comments are also requested with regard to the rule under

[[Page 41495]]

which an economic benefit provided to, or for the use of, a 
disqualified person will not be treated as consideration for the 
performance of services absent the clear indication of the 
organization's intent to treat the benefit as compensation when the 
benefit is paid. Specifically, comments are requested on appropriate 
ways of applying this rule that will not create an unnecessary burden 
on affected organizations. Additionally, comments are requested with 
respect to the effect of the proposed regulations on different 
compensation arrangements, including revenue-based compensation, 
deferred compensation, and the use of options as compensation.

Drafting Information

    The principal author of these regulations is Phyllis D. Haney, 
Office of Associate Chief Counsel (Employee Benefits and Exempt 
Organizations). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects

26 CFR Part 53

    Excise taxes, Foundations, Investments, Lobbying, Reporting and 
recordkeeping requirements, Trusts and trustees.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR Parts 53 and 301 are proposed to be amended as 
follows:

PART 53--FOUNDATION AND SIMILAR EXCISE TAXES

    Paragraph 1. The authority citation for part 53 continues to read 
as follows:

    Authority: 26 U.S.C. 7805.

    Par. 2. Sections 53.4958-0 through 53.4958-7 are added to read as 
follows:


Sec. 53.4958-0  Table of contents.

    This section lists the captions contained in Secs. 53.4958-1 
through 53.4958-7.

Sec. 53.4958-1  Taxes on excess benefit transactions.

    (a) In general.
    (b) Excess benefit defined.
    (c) Taxes paid by disqualified person.
    (1) Initial tax.
    (2) Additional tax on disqualified person.
    (i) In general.
    (ii) Correction.
    (iii) Taxable period.
    (iv) Abatement if correction during the correction period.
    (d) Tax paid by organization managers.
    (1) In general.
    (2) Organization manager defined.
    (i) In general.
    (ii) Special rule for certain committee members.
    (3) Participation.
    (4) Knowing.
    (i) In general.
    (ii) Special rule.
    (5) Willful.
    (6) Due to reasonable cause.
    (7) Advice of counsel.
    (8) Limits on liability for management.
    (9) Joint and several liability.
    (e) Date of occurrence.
    (f) Statute of limitations.
    (g) Effective date for imposition of taxes.
    (1) In general.
    (2) Existing binding contracts.

Sec. 53.4958-2--Definition of applicable tax-exempt organization.

    (a) In general.
    (b) Section 501(c)(3) organizations.
    (c) Section 501(c)(4) organizations.

Sec. 53.4958-3--Definition of disqualified person.

    (a) In general.
    (b) Statutory categories of disqualified persons.
    (1) Family members.
    (2) Thirty-five percent controlled entities.
    (i) In general.
    (ii) Combined voting power.
    (iii) Constructive ownership rules.
    (A) Stockholdings.
    (B) Profits or beneficial interest.
    (c) Persons having substantial influence.
    (1) Individuals serving on the governing body who are entitled 
to vote.
    (2) Presidents, chief executive officers, or chief operating 
officers.
    (3) Treasurers and chief financial officers.
    (4) Persons with a material financial interest in a provider-
sponsored organization.
    (d) Persons deemed not to have substantial influence.
    (1) Applicable tax-exempt organizations described in section 
501(c)(3).
    (2) Employees receiving economic benefits of less than specified 
amount in a taxable year.
    (i) In general.
    (ii) Examples.
    (e) Facts and circumstances govern in all other cases.
    (1) In general.
    (2) Facts and circumstances tending to show substantial 
influence.
    (3) Facts and circumstances tending to show no substantial 
influence.
    (f) Examples.
    (g) Affiliated organizations.

Sec. 53.4958-4  Excess benefit transaction.

    (a) Definition of excess benefit transaction.
    (1) In general.
    (2) Economic benefit provided directly or indirectly.
    (3) Certain economic benefits disregarded for purposes of 
section 4958.
    (i) Reimbursements for reasonable expenses of attending meetings 
of governing body.
    (ii) Economic benefits provided to a disqualified person solely 
as a member of, or volunteer for, the organization.
    (iii) Economic benefits provided to a disqualified person solely 
as a member of a charitable class.
    (4) Insurance or indemnification of excise taxes.
    (b) Standards for identifying excess benefits.
    (1) In general.
    (2) Fair market value for transfer of property.
    (3) Reasonable compensation.
    (i) In general.
    (ii) Items included in determining the value of compensation for 
purposes of section 4958.
    (iii) Examples.
    (c) Establishing intent to treat economic benefit as 
consideration for the performance of services.
    (1) In general.
    (2) Clear and convincing evidence of intent.
    (i) In general.
    (ii) Reporting of benefit.
    (iii) Failure to report due to reasonable cause.
    (3) Effect of failing to establish intent.
    (4) Examples.

Sec. 53.4958-5  Transaction in which amount of economic benefit 
determined in whole or in part by the revenues of one or more 
activities of the organization.

    (a) In general.
    (b) Special rule for allocation or return of net margins or 
capital to members of certain cooperatives.
    (c) Rules effective prospectively.
    (d) Examples.

Sec. 53.4958-6  Rebuttable presumption that transaction is not an 
excess benefit transaction.

    (a) In general.
    (b) Delegation pursuant to procedures.
    (c) Rebutting the presumption.
    (d) Requirements for invoking rebuttable presumption.
    (1) Disinterested governing body or committee.
    (i) In general.
    (ii) Persons not included on governing body or committee.
    (iii) Absence of conflict of interest.
    (iv) Rule where ratification of full governing body required.
    (2) Appropriate data as to comparability.
    (i) In general.
    (ii) Special rule for compensation paid by small organizations.
    (iii) Additional rules for special rule for small organizations.
    (iv) Examples.
    (3) Documentation.
    (e) No presumption until circumstances exist to determine 
reasonableness of compensation.
    (f) No inference from absence of presumption.
    (g) Period of reliance on rebuttable presumption.

[[Page 41496]]

Sec. 53.4958-7  Special rules.

    (a) Substantive requirements for exemption still apply.
    (b) Interaction between section 4958 and section 7611 rules for 
church tax inquiries and examinations.


Sec. 53.4958-1  Taxes on excess benefit transactions.

    (a) In general. Section 4958 imposes excise taxes on each excess 
benefit transaction (as defined in section 4958(c) and Sec. 53.4958-4 
and Sec. 53.4958-5) between an applicable tax-exempt organization (as 
defined in section 4958(e) and Sec. 53.4958-2) and a disqualified 
person (as defined in section 4958(f)(1) and Sec. 53.4958-3). A 
disqualified person who receives an excess benefit from an excess 
benefit transaction is liable for payment of a section 4958(a)(1) 
excise tax equal to 25 percent of the excess benefit. If an initial tax 
is imposed by section 4958(a)(1) on an excess benefit transaction and 
the transaction is not corrected within the taxable period, then any 
disqualified person who received an excess benefit from the excess 
benefit transaction on which the initial tax was imposed is liable for 
an additional tax of 200 percent of the excess benefit. An organization 
manager (as defined in section 4958(f)(2) and paragraph (d) of this 
section) who participates in an excess benefit transaction, knowing 
that it was such a transaction, is liable for payment of a section 
4958(a)(2) excise tax equal to 10 percent of the excess benefit, unless 
the participation was not willful and was due to reasonable cause. If 
an organization manager also receives an excess benefit from an excess 
benefit transaction, the manager may be liable for both taxes imposed 
by section 4958(a).
    (b) Excess benefit defined. Except as provided in Sec. 53.4958-5 
with respect to certain revenue-sharing transactions, an excess benefit 
is the value of the economic benefit provided by an applicable tax-
exempt organization directly or indirectly to or for the use of any 
disqualified person that exceeds the value of the consideration 
(including the performance of services) received by the organization 
for providing such benefit.
    (c) Taxes paid by disqualified person--(1) Initial tax. Section 
4958(a)(1) imposes a tax equal to 25 percent of the excess benefit on 
each excess benefit transaction. The section 4958(a)(1) tax shall be 
paid by any disqualified person who received an excess benefit from 
that excess benefit transaction. With respect to any excess benefit 
transaction, if more than one disqualified person is liable for the tax 
imposed by section 4958(a)(1), all such persons are jointly and 
severally liable for that tax.
    (2) Additional tax on disqualified person--(i) In general. Section 
4958(b) imposes a tax equal to 200 percent of the excess benefit in any 
case in which a section 4958(a)(1) tax is imposed on an excess benefit 
transaction and the transaction is not corrected (as defined in section 
4958(f)(6) and paragraph (c)(2)(ii) of this section) within the taxable 
period (as defined in section 4958(f)(5) and paragraph (c)(2)(iii) of 
this section). The tax imposed by section 4958(b) is payable by any 
disqualified person who received an excess benefit from the excess 
benefit transaction on which the initial tax was imposed by section 
4958(a)(1). With respect to any excess benefit transaction, if more 
than one disqualified person is liable for the tax imposed by section 
4958(b), all such persons are jointly and severally liable for that 
tax.
    (ii) Correction. Correction means, with respect to any excess 
benefit transaction, undoing the excess benefit to the extent possible, 
and taking any additional measures necessary to place the organization 
in a financial position not worse than that in which it would be if the 
disqualified person had been dealing under the highest fiduciary 
standards. Correction of the excess benefit occurs if the disqualified 
person repays the applicable tax-exempt organization an amount of money 
equal to the excess benefit, plus any additional amount needed to 
compensate the organization for the loss of the use of the money or 
other property during the period commencing on the date of the excess 
benefit transaction and ending on the date the excess benefit is 
corrected. Correction may also be accomplished, in certain 
circumstances, by returning property to the organization and taking any 
additional steps necessary to make the organization whole. If the 
excess benefit transaction consists of the payment of compensation for 
services under a contract that has not been completed, termination of 
the employment or independent contractor relationship between the 
organization and the disqualified person is not required in order to 
correct. However, the terms of any ongoing compensation arrangement may 
need to be modified to avoid future excess benefit transactions.
    (iii) Taxable period. Taxable period means, with respect to any 
excess benefit transaction, the period beginning with the date on which 
the transaction occurs and ending on the earlier of--
    (A) The date of mailing a notice of deficiency under section 6212 
with respect to the section 4958(a)(1) tax; or
    (B) The date on which the tax imposed by section 4958(a)(1) is 
assessed.
    (iv) Abatement if correction during the correction period. For 
rules relating to abatement of taxes on excess benefit transactions 
that are corrected within the correction period, as defined in section 
4963(e), see sections 4961(a), 4962(a), and the regulations thereunder.
    (d) Tax paid by organization managers--(1) In general. In any case 
in which section 4958(a)(1) imposes a tax, section 4958(a)(2) imposes a 
tax equal to 10 percent of the excess benefit on the participation of 
any organization manager who knowingly participated in the excess 
benefit transaction, unless such participation was not willful and was 
due to reasonable cause. The tax is to be paid by any organization 
manager who so participated.
    (2) Organization manager defined--(i) In general. An organization 
manager is, with respect to any applicable tax-exempt organization, any 
officer, director, or trustee of such organization, or any individual 
having powers or responsibilities similar to those of officers, 
directors, or trustees of the organization, regardless of title. A 
person shall be considered an officer of an organization if--
    (A) That person is specifically so designated under the certificate 
of incorporation, by-laws, or other constitutive documents of the 
organization; or
    (B) That person regularly exercises general authority to make 
administrative or policy decisions on behalf of the organization. 
Independent contractors, acting in a capacity as attorneys, 
accountants, and investment managers and advisors, are not officers. 
Any person who has authority merely to recommend particular 
administrative or policy decisions, but not to implement them without 
approval of a superior, is not an officer.
    (ii) Special rule for certain committee members. 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 that is 
invoking the rebuttable presumption of reasonableness described in 
Sec. 53.4958-6 based on the committee's actions, is an organization 
manager for purposes of the tax imposed by section 4958(a)(2).
    (3) Participation. For purposes of section 4958(a)(2) and this 
paragraph (d), participation includes silence or inaction on the part 
of an organization manager where the manager is under a

[[Page 41497]]

duty to speak or act, as well as any affirmative action by such 
manager. However, an organization manager will not be considered to 
have participated in an excess benefit transaction where the manager 
has opposed such transaction in a manner consistent with the 
fulfillment of the manager's responsibilities to the applicable tax-
exempt organization.
    (4) Knowing--(i) In general. For purposes of section 4958(a)(2) and 
this paragraph (d), a person participates in a transaction knowing that 
it is an excess benefit transaction only if the person--
    (A) Has actual knowledge of sufficient facts so that, based solely 
upon such facts, such transaction would be an excess benefit 
transaction;
    (B) Is aware that such an act under these circumstances may violate 
the provisions of federal tax law governing excess benefit 
transactions; and
    (C) Negligently fails to make reasonable attempts to ascertain 
whether the transaction is an excess benefit transaction, or the person 
is in fact aware that it is such a transaction.
    (ii) Special rule. Knowing does not mean having reason to know. 
However, evidence tending to show that a person has reason to know of a 
particular fact or particular rule is relevant in determining whether 
the person had actual knowledge of such a fact or rule. Thus, for 
example, evidence tending to show that a person has reason to know of 
sufficient facts so that, based solely upon such facts, a transaction 
would be an excess benefit transaction is relevant in determining 
whether the person has actual knowledge of such facts.
    (5) Willful. For purposes of section 4958(a)(2) and this paragraph 
(d), participation by an organization manager is willful if it is 
voluntary, conscious, and intentional. No motive to avoid the 
restrictions of the law or the incurrence of any tax is necessary to 
make the participation willful. However, participation by an 
organization manager is not willful if the manager does not know that 
the transaction in which the manager is participating is an excess 
benefit transaction.
    (6) Due to reasonable cause. An organization manager's 
participation is due to reasonable cause if the manager has exercised 
his responsibility on behalf of the organization with ordinary business 
care and prudence.
    (7) Advice of counsel. If a person, after full disclosure of the 
factual situation to legal counsel (including in-house counsel) relies 
on the advice of such counsel expressed in a reasoned written legal 
opinion that a transaction is not an excess benefit transaction, the 
person's participation in such transaction will ordinarily not be 
considered knowing or willful and will ordinarily be considered due to 
reasonable cause within the meaning of section 4958(a)(2), even if such 
transaction is subsequently held to be an excess benefit transaction. 
For purposes of satisfying the requirements of section 4958(a)(2), a 
written legal opinion is reasoned so long as the opinion addresses 
itself to the facts and applicable law. However, a written legal 
opinion is not reasoned if it does nothing more than recite the facts 
and express a conclusion. The absence of advice of counsel with respect 
to an act shall not, by itself, however, give rise to any inference 
that a person participated in such act knowingly, willfully, or without 
reasonable cause.
    (8) Limits on liability for management. The maximum aggregate 
amount of tax collectible under section 4958(a)(2) and this paragraph 
(d) from organization managers with respect to any one excess benefit 
transaction is $10,000.
    (9) Joint and several liability. In any case where more than one 
person is liable for a tax imposed by section 4958(a)(2), all such 
persons shall be jointly and severally liable for the taxes imposed 
under section 4958(a)(2) with respect to that excess benefit 
transaction.
    (e) Date of occurrence. Except as otherwise provided, an excess 
benefit transaction occurs on the date on which the disqualified person 
receives the economic benefit from the applicable tax-exempt 
organization for federal income tax purposes. In the case of a 
transaction consisting of payment of deferred compensation, the 
transaction occurs on the date the deferred compensation is earned and 
vested.
    (f) Statute of limitations. See sections 6501(e)(3) and 6501(l) and 
the regulations thereunder, as amended, for statute of limitations 
rules as they apply to section 4958 excise taxes.
    (g) Effective date for imposition of taxes--(1) In general. The 
section 4958 taxes imposed on excess benefit transactions or on 
participation in excess benefit transactions apply to transactions 
occurring on or after September 14, 1995.
    (2) Existing binding contracts. The section 4958 taxes do not apply 
to any transaction occurring pursuant to a written contract that was 
binding on September 13, 1995, and at all times thereafter before the 
transaction occurs. A written binding contract that is terminable or 
subject to cancellation by the applicable tax-exempt organization 
without the disqualified person's consent is treated as a new contract 
as of the date that any such termination or cancellation, if made, 
would be effective. If a binding written contract is materially 
modified (a material modification includes amending the contract to 
extend its term or to increase the amount of compensation payable to 
the disqualified person), it is treated as a new contract entered into 
as of the date of the material modification.


Sec. 53.4958-2  Definition of applicable tax-exempt organization.

    (a) In general--(1) An applicable tax-exempt organization is any 
organization that, without regard to any excess benefit, would be 
described in section 501(c)(3) or (4) and exempt from tax under section 
501(a). An applicable tax-exempt organization also includes any 
organization that was described in section 501(c)(3) or (4) and was 
exempt from tax under section 501(a) at any time during a five-year 
period ending on the date of an excess benefit transaction (the 
lookback period).
    (2) In the case of any transaction occurring before September 14, 
2000, the lookback period begins on September 14, 1995, and ends on the 
date of the transaction.
    (b) Section 501(c)(3) organizations. To be described in section 
501(c)(3) for purposes of section 4958, an organization must meet the 
requirements of section 508 (subject to any applicable exceptions 
provided by that section). A foreign organization that receives 
substantially all of its support from sources outside of the United 
States is not subject to the requirements of section 508 and is not an 
organization described in section 501(c)(3) for purposes of section 
4958. A private foundation as defined in section 509(a) is not an 
applicable tax-exempt organization for section 4958 purposes.
    (c) Section 501(c)(4) organizations. An organization that has 
applied for and received recognition of exemption as an organization 
described in section 501(c)(4) is an applicable tax-exempt organization 
for section 4958 purposes. In addition, an organization that has sought 
to take advantage of section 501(c)(4) status by filing an application 
for recognition of exemption under section 501(c)(4) with the Internal 
Revenue Service, filing an information return as a section 501(c)(4) 
organization under the Internal Revenue Code or regulations promulgated 
thereunder, or otherwise holding itself out as being described in 
section 501(c)(4), is an applicable tax-exempt organization for section 
4958 purposes. A foreign organization that receives substantially all 
of its support from sources outside of the United States is

[[Page 41498]]

not an applicable tax-exempt organization for section 4958 purposes.


Sec. 53.4958-3  Definition of disqualified person.

    (a) In general. Section 4958(f)(1) defines disqualified person, 
with respect to any transaction, as any person who was in a position to 
exercise substantial influence over the affairs of the organization at 
any time during the five-year period ending on the date of the 
transaction. If the five-year period ending on the date of the 
transaction would have begun on or before September 13, 1995, then the 
preceding sentence shall be applied to the period beginning September 
14, 1995, and ending on the date of the transaction. Paragraph (b) of 
this section further describes other persons who are defined to be 
disqualified persons under the statute, including certain family 
members of an individual in a position to exercise substantial 
influence, and certain 35 percent controlled entities. Paragraph (c) of 
this section describes persons in a position to exercise substantial 
influence over the affairs of an applicable tax-exempt organization by 
virtue of their powers and responsibilities or certain interests they 
hold. Paragraph (d) of this section describes persons deemed not to be 
in a position to exercise substantial influence. Whether any person not 
described in paragraph (b), (c) or (d) of this section is a 
disqualified person with respect to the transaction for purposes of 
section 4958 is based on all relevant facts and circumstances, as 
described in paragraph (e) of this section. Examples in paragraphs 
(d)(2)(ii) and (f) of this section illustrate these categories of 
persons.
    (b) Statutory categories of disqualified persons--(1) Family 
members. A person is a disqualified person with respect to any 
transaction with an applicable tax-exempt organization if the person is 
a member of the family of another disqualified person described in 
paragraph (a) of this section with respect to any transaction with the 
same organization. A person's family includes--
    (i) Spouse;
    (ii) Brothers or sisters (by whole or half blood);
    (iii) Spouses of brothers or sisters (by whole or half blood);
    (iv) Ancestors;
    (v) Children;
    (vi) Grandchildren;
    (vii) Great grandchildren; and
    (viii) Spouses of children, grandchildren, and great grandchildren.
    (2) Thirty-five percent controlled entities--(i) In general. A 
person is a disqualified person with respect to any transaction with an 
applicable tax-exempt organization if the person is a 35 percent 
controlled entity. A 35 percent controlled entity is--
    (A) A corporation in which persons described in this section 
(except in this paragraph (b)(2) and paragraph (d) of this section) own 
more than 35 percent of the combined voting power;
    (B) A partnership in which persons described in this section 
(except in this paragraph (b)(2) and paragraph (d) of this section) own 
more than 35 percent of the profits interest; or
    (C) A trust or estate in which persons described in this section 
(except in this paragraph (b)(2) and paragraph (d) of this section) own 
more than 35 percent of the beneficial interest.
    (ii) Combined voting power. For purposes of this paragraph (b)(2), 
combined voting power includes voting power represented by holdings of 
voting stock, direct or indirect, but does not include voting rights 
held only as a director or trustee.
    (iii) Constructive ownership rules--(A) Stockholdings. For purposes 
of section 4958(f)(3) and this paragraph (b)(2), indirect stockholdings 
are taken into account as under section 267(c), except that in applying 
section 267(c)(4), the family of an individual shall include the 
members of the family specified in section 4958(f)(4) and paragraph 
(b)(1) of this section.
    (B) Profits or beneficial interest. For purposes of section 
4958(f)(3) and this paragraph (b)(2), the ownership of profits or 
beneficial interests shall be determined in accordance with the rules 
for constructive ownership of stock provided in section 267(c) (other 
than section 267(c)(3)), except that in applying section 267(c)(4), the 
family of an individual shall include the members of the family 
specified in section 4958(f)(4) and paragraph (b)(1) of this section.
    (c) Persons having substantial influence. A person is in a position 
to exercise substantial influence over the affairs of an applicable 
tax-exempt organization if that person has the powers or 
responsibilities, or holds the type of interests, described in one of 
the following categories:
    (1) Individuals serving on the governing body who are entitled to 
vote. This category includes any individual serving on the governing 
body of the organization who is entitled to vote on matters over which 
the governing body has authority.
    (2) Presidents, chief executive officers, or chief operating 
officers. This category includes any individual who, individually or 
with others, serves as the president, chief executive officer, or chief 
operating officer of the organization. An individual serves as a 
president, chief executive officer, or chief operating officer, 
regardless of title, if that individual has or shares ultimate 
responsibility for implementing the decisions of the governing body or 
supervising the management, administration, or operation of the 
applicable organization.
    (3) Treasurers and chief financial officers. This category includes 
any individual who, independently or with others, serves as treasurer 
or chief financial officer of the organization. An individual serves as 
a treasurer or chief financial officer, regardless of title, if that 
individual has or shares ultimate responsibility for managing the 
organization's financial assets and has or shares authority to sign 
drafts or direct the signing of drafts, or authorize electronic 
transfer of funds, from organization bank accounts.
    (4) Persons with a material financial interest in a provider-
sponsored organization. Pursuant to section 501(o), this category 
includes any person with a material financial interest in a provider-
sponsored organization (as defined in section 1853(e) of the Social 
Security Act (42 U.S.C. 1395w-23)) if a hospital that participates in 
the provider-sponsored organization is an applicable tax-exempt 
organization.
    (d) Persons deemed not to have substantial influence. A person is 
deemed not to be in a position to exercise substantial influence over 
the affairs of an applicable tax-exempt organization if that person is 
described in one of the following categories:
    (1) Applicable tax-exempt organizations described in section 
501(c)(3). This category includes any other applicable tax-exempt 
organization described in section 501(c)(3).
    (2) Employees receiving economic benefits of less than specified 
amount in a taxable year--(i) In general. This category includes, for 
the taxable year in which benefits are provided, any employee of the 
applicable tax-exempt organization who--
    (A) Receives economic benefits, directly or indirectly from the 
organization, of less than the amount of compensation referenced for a 
highly compensated employee in section 414(q)(1)(B)(i);
    (B) Is not described in Sec. 53.4958-3(b) or (c) with respect to 
the organization; and
    (C) Is not a substantial contributor to the organization within the 
meaning of section 507(d)(2).

[[Page 41499]]

    (ii) Examples. The following examples illustrate the category of 
persons described in this paragraph (d)(2):

    Example 1. N, an artist by profession, works part-time at R, a 
local museum. In the first taxable year in which R employs N, R pays 
N a modest salary and provides no additional benefits to N except 
for free admission to the museum, a benefit R provides to all of its 
employees and volunteers. The total economic benefits N receives 
from R during the taxable year are less than the amount of 
compensation referenced for a highly compensated employee in section 
414(q)(1)(B)(i). The part-time job constitutes N's only relationship 
with R. N is not related to any other disqualified person with 
respect to R. N is deemed not to be in a position to exercise 
substantial influence over the affairs of R. Therefore N is not a 
disqualified person with respect to any transaction involving N and 
R in that year.
    Example 2. The facts are the same as in Example 1, except that 
in addition to the modest salary that R pays N in exchange for N's 
provision of services to R during the taxable year, R also purchases 
one of N's paintings for $90,000. The total economic benefits 
provided by R to N in that year exceed the amount of compensation 
referenced for highly compensated employees in section 
414(q)(1)(B)(i). Consequently, whether N is in a position to 
exercise substantial influence over the affairs of R for that 
taxable year depends upon all relevant facts and circumstances.

    (e) Facts and circumstances govern in all other cases--(1) In 
general. Whether a person who is not described in paragraph (b), (c) or 
(d) of this section is a disqualified person depends upon all relevant 
facts and circumstances. A person who has managerial control over a 
discrete segment of an organization may nonetheless be in a position to 
exercise substantial influence over the affairs of the entire 
organization.
    (2) Facts and circumstances tending to show substantial influence. 
Facts and circumstances tending to show that a person has substantial 
influence over the affairs of an organization include, but are not 
limited to, the following--
    (i) The person founded the organization;
    (ii) The person is a substantial contributor (within the meaning of 
section 507(d)(2)) to the organization;
    (iii) The person's compensation is based on revenues derived from 
activities of the organization that the person controls;
    (iv) The person has authority to control or determine a significant 
portion of the organization's capital expenditures, operating budget, 
or compensation for employees;
    (v) The person has managerial authority or serves as a key advisor 
to a person with managerial authority; or
    (vi) The person owns a controlling interest in a corporation, 
partnership, or trust that is a disqualified person.
    (3) Facts and circumstances tending to show no substantial 
influence. Facts and circumstances tending to show that a person does 
not have substantial influence over the affairs of an organization 
include, but are not limited to--
    (i) The person has taken a bona fide vow of poverty as an employee, 
agent, or on behalf of a religious organization;
    (ii) The person is an independent contractor, such as an attorney, 
accountant, or investment manager or advisor, acting in that capacity, 
unless the person is acting in that capacity with respect to a 
transaction from which the person might economically benefit either 
directly or indirectly (aside from fees received for the professional 
services rendered); and
    (iii) Any preferential treatment a person receives based on the 
size of that person's donation is also offered to any other donor 
making a comparable contribution as part of a solicitation intended to 
attract a substantial number of contributions.
    (f) Examples. The following examples illustrate the principles of 
this section. Finding a person to be a disqualified person in the 
following examples does not indicate that an excess benefit transaction 
has occurred, but only that any transaction with the applicable tax-
exempt organization that provides benefits to the disqualified person 
directly or indirectly may be scrutinized to determine whether it is an 
excess benefit transaction:

    Example 1. E is the headmaster of Z, a school that is an 
applicable tax-exempt organization for purposes of section 4958. E 
reports to Z's board of trustees and is the principal employee 
responsible for implementing the board's decisions. E also has 
ultimate responsibility for supervising Z's day-to-day operations. 
For example, E can hire faculty members and staff, make changes to 
the school's curriculum and discipline students without specific 
board approval. Because E serves as the chief executive officer of 
Z, E is in a position to exercise substantial influence over the 
affairs of Z. Therefore E is a disqualified person with respect to 
any transaction involving Z that provides economic benefits to E 
directly or indirectly.
    Example 2. G is a program officer at community organization C, 
an applicable tax-exempt organization for purposes of section 4958. 
G's total compensation for the taxable year, including benefits, is 
less than the amount of compensation referenced for a highly 
compensated employee in section 414(q)(1)(B)(i). G is not related to 
any other disqualified person with respect to C. G does not serve on 
C's governing body and or as an officer of C. G makes a modest 
annual contribution to C, but is not a substantial contributor to C 
(within the meaning of section 507(d)(2)). G is deemed not to be in 
a position to exercise substantial influence over the affairs of C 
for this year because G is an employee who receives economic 
benefits for the year of less than the amount of compensation 
referenced for a highly compensated employee in section 
414(q)(1)(B)(i). Therefore, for this year, G is not a disqualified 
person with respect to any transaction involving C that provides 
economic benefits to G directly or indirectly.
    Example 3. Y, an applicable tax-exempt organization for purposes 
of section 4958, enters into a contract with B, a company that 
manages bingo games. Under the contract, B agrees to provide all of 
the staff and equipment necessary to carry out a bingo operation one 
night per week, and to pay Y q percent of the revenue from this 
activity. B retains the balance of the proceeds. Y provides no goods 
or services in connection with the bingo operation other than the 
use of its hall for the bingo game. The annual gross revenue earned 
from the bingo game represents more than half of Y's total annual 
revenue. B's status as a disqualified person is determined by all 
relevant facts and circumstances. B's compensation is based on 
revenues from an activity B controls. B also has full managerial 
authority over Y's principal source of income. Under these facts and 
circumstances, B is in a position to exercise substantial influence 
over the affairs of Y. Therefore B is a disqualified person with 
respect to any transaction involving Y that provides economic 
benefits to B directly or indirectly.
    Example 4. The facts are the same as in Example 3, with the 
additional fact that the stock of B is 100 percent owned by P, an 
individual who is actively involved in managing B. Because P owns a 
controlling interest (measured by either vote or value) in and 
actively manages B, the facts and circumstances establish that P is 
also in a position to exercise substantial influence over the 
affairs of Y. Therefore P is a disqualified person with respect to 
any transaction involving Y that provides economic benefits to P 
directly or indirectly.
    Example 5. A, an applicable tax-exempt organization for purposes 
of section 4958, owns and operates one acute care hospital. B is a 
for-profit corporation that owns and operates a number of hospitals. 
A and B form C, a limited liability company. In exchange for 
proportional ownership interests, A contributes its hospital, and B 
contributes other financial assets, to C. All of A's assets then 
consist of its membership interest in C. A continues to be operated 
for exempt purposes based almost exclusively on the activities it 
conducts through C. C enters into a management agreement with a 
management company, M, to provide day-to-day management services to 
C. M is generally subject to supervision by C's board, but M is 
given broad discretion to manage C's day-to-day operation. Under 
these facts and circumstances, M is in a position to exercise 
substantial influence over the affairs of A because it has day to 
day control over the hospital operated by C, A's ownership interest 
in C is its primary asset, and C's

[[Page 41500]]

activities form the basis for A's continued exemption as an 
organization described in section 501(c)(3). Therefore, M is a 
disqualified person with respect to any transaction involving A, 
including any transaction that A conducts through C, that provides 
economic benefits to M directly or indirectly.
    Example 6. T is a large university and an applicable tax-exempt 
organization for purposes of section 4958. L is the dean of the 
College of Law of T, a major source of revenue for T. The College of 
Law is important to T's reputation for excellent teaching and high 
quality faculty scholarship. T relies on this reputation to attract 
students and contributions from alumni and foundations. L plays a 
key role in faculty hiring and has authority to control or determine 
a significant portion of T's capital expenditures and operating 
budget because of L's position in the College of Law. L's 
compensation is greater than the amount of compensation referenced 
for a highly compensated employee in section 414(q)(1)(B)(i) in the 
year benefits are provided. Because of the importance of the College 
of Law to T and L's managerial control over that segment of T, L is 
in a position to exercise substantial influence over the affairs of 
T. Therefore L is a disqualified person with respect to any 
transaction involving T that provides economic benefits to L 
directly or indirectly.
    Example 7. X is a radiologist employed by U, a large acute-care 
hospital that is an applicable tax-exempt organization for purposes 
of section 4958. X has no managerial authority over any part of U or 
its operations. X gives instructions to staff with respect to the 
radiology work X conducts, but X does not serve as supervisor to 
other U employees. X's total compensation package includes 
nontaxable retirement and welfare benefits and a specified amount of 
salary. X's compensation is greater than the amount of compensation 
referenced for a highly compensated employee in section 
414(q)(1)(B)(i) in the year benefits are provided. X is not related 
to any other disqualified person of U. X does not serve on U's 
governing body or as an officer of U. Although U participates in a 
provider-sponsored organization (as defined in section 1853(e) of 
the Social Security Act), X does not have a material financial 
interest in that organization. Whether X is a disqualified person is 
determined by all relevant facts and circumstances. X did not found 
U, and although X makes a modest annual financial contribution to U, 
the amount of the contribution does not make X a substantial 
contributor within the meaning of section 507(d)(2). X does not 
receive compensation based on revenues derived from activities of U 
that X controls, and has no authority to control or determine a 
significant portion of U's capital expenditures, operating budget, 
or compensation for employees. Under these facts and circumstances, 
X does not have substantial influence over the affairs of U, and 
therefore X is not a disqualified person with respect to any 
transaction involving U that provides economic benefits to X 
directly or indirectly.
    Example 8. W is a cardiologist and head of the cardiology 
department of the same hospital U described in Example 7. W does not 
serve on U's board and does not serve as an officer of U. W does not 
have a material financial interest in the provider-sponsored 
organization (as defined in section 1853(e) of the Social Security 
Act) in which U participates. W is compensated personally with a 
salary and retirement and welfare benefits fixed by a three-year 
renewable employment contract with U. W's annual amount of 
compensation exceeds the amount referenced for a highly compensated 
employee in section 414(q)(1)(B)(i). Whether W is a disqualified 
person is determined by all relevant facts and circumstances. W has 
managerial authority for the cardiology department. The cardiology 
department is a principal source of patients admitted to U and 
consequently a major source of revenue for U. W also has authority 
to allocate the budget for that department, which includes authority 
to distribute incentive bonuses among cardiologists according to 
criteria that he has authority to set. The pool for the bonuses is 
funded by a portion of U's revenues attributable to the cardiology 
department. Because of the importance of the cardiology department 
to U and W's managerial control over that segment of U, W is in a 
position to exercise substantial influence over the affairs of U. 
Therefore W is a disqualified person with respect to any transaction 
involving U that provides economic benefits to W directly or 
indirectly.
    Example 9. D is an accountant who periodically provides 
accounting and tax advisory services as an independent contractor in 
return for a fee to M, a museum that is an applicable tax-exempt 
organization for purposes of section 4958. For several years, D has 
advised M's officers and members of M's governing body with respect 
to accounting and tax matters. D's firm also prepares tax returns on 
behalf of M. D has no relationship with M other than as a 
professional accounting and tax advisor. D is not related to any 
other disqualified person of M. D's firm has a policy prohibiting 
employees from providing professional advice with respect to a 
transaction from which they might economically benefit either 
directly or indirectly (aside from fees received for the 
professional services rendered). D abides by the firm's policy in 
all activities, including the work for M. Whether D is a 
disqualified person is determined by all relevant facts and 
circumstances. Because D acts only in D's capacity as an independent 
contractor providing occasional professional services to M and 
abides by the firm's conflict of interest policy, under these facts 
and circumstances, D is not a disqualified person with respect to 
any transaction with M.
    Example 10. F, a repertory theater company that is an applicable 
tax-exempt organization for purposes of section 4958, holds a fund-
raising campaign to pay for the construction of a new theater. J is 
a regular subscriber to F's productions who has made modest gifts to 
F in the past. J has no relationship to F other than as a subscriber 
and contributor. F solicits contributions as part of a broad public 
campaign intended to attract a large number of donors, including a 
substantial number of donors making large gifts. In its 
solicitations for contributions, F promises to invite all 
contributors giving $z or more to a special opening production and 
party held at the new theater. These contributors are also given a 
special number to call in F's office to reserve tickets for 
performances, make ticket exchanges, and make other special 
arrangements for their convenience. J makes a contribution of $z to 
F, which makes J a substantial contributor within the meaning of 
section 507(d)(2). F provides J with the preferential treatment 
described in its solicitation. Whether J is a disqualified person is 
determined by all relevant facts and circumstances. Under these 
facts and circumstances, any influence that may arise from the size 
of J's donation is limited by F's commitment to provide similar 
treatment to any other member of the public making a similar 
contribution and by the nature of the benefits being offered. 
Accordingly, the preferential treatment that J receives does not 
indicate that J is in a position to exercise substantial influence 
over the affairs of the organization. Therefore, barring a change in 
J's relationship with F, J is not a disqualified person with respect 
to any transaction involving F that provides economical benefits to 
J directly or indirectly.

    (g) Affiliated organizations. In the case of multiple organizations 
affiliated by common control or governing documents, the determination 
of whether a person does or does not have substantial influence shall 
be made separately for each applicable tax-exempt organization.


Sec. 53.4958-4  Excess benefit transaction.

    (a) Definition of excess benefit transaction--(1) In general. An 
excess benefit transaction means any transaction in which an economic 
benefit is provided by an applicable tax-exempt organization directly 
or indirectly, to or for the use of, any disqualified person, and the 
value of the economic benefit provided exceeds the value of the 
consideration (including the performance of services) received by the 
organization for providing such benefit. An excess benefit transaction 
also includes certain revenue-sharing transactions described in 
Sec. 53.4958-5. An economic benefit shall not be treated as 
consideration for the performance of services unless the organization 
providing the benefit clearly indicates its intent to treat the benefit 
as compensation when the benefit is paid.
    (2) Economic benefit provided directly or indirectly. An excess 
benefit transaction occurs when an applicable tax-exempt organization 
provides an excess benefit directly or indirectly to a disqualified 
person. A benefit may be provided indirectly through the use of one or 
more entities controlled by or affiliated with the applicable tax-
exempt organization. For example, if an

[[Page 41501]]

applicable tax-exempt organization causes its taxable subsidiary to pay 
excessive compensation to, or engage in a transaction at other than 
fair market value with, a disqualified person of the parent 
organization, the payment of the compensation or the transfer of 
property is an excess benefit transaction.
    (3) Certain economic benefits disregarded for purposes of section 
4958. The following economic benefits are disregarded for purposes of 
section 4958:
    (i) Reimbursements for reasonable expenses of attending meetings of 
governing body. Paying reasonable expenses for members of the governing 
body of an applicable tax-exempt organization to attend meetings of the 
governing body of the organization will be disregarded for purposes of 
section 4958. For purposes of the preceding sentence, reasonable 
expenses do not include luxury travel or spousal travel.
    (ii) Economic benefits provided to a disqualified person solely as 
a member of, or volunteer for, the organization. An economic benefit 
provided to a disqualified person that the disqualified person receives 
solely as a member of, or volunteer for, the organization is 
disregarded for purposes of section 4958 if the benefit is provided to 
members of the public in exchange for a membership fee of $75 or less 
per year. Thus, for example, if a disqualified person is also a member 
of the organization and receives membership benefits such as advance 
ticket purchases and a discount at the organization's gift shop that 
would normally be provided in exchange for a membership fee of $75 or 
less per year, then the membership benefit is disregarded for purposes 
of section 4958.
    (iii) Economic benefits provided to a disqualified person solely as 
a member of a charitable class. An economic benefit provided to a 
disqualified person that the disqualified person receives solely as a 
member of a charitable class that the applicable tax-exempt 
organization intends to benefit as part of the accomplishment of the 
organization's exempt purpose is generally disregarded for purposes of 
section 4958.
    (4) Insurance or indemnification of excise taxes. The payment of a 
premium for an insurance policy providing liability insurance to a 
disqualified person for the taxes imposed under this section or 
indemnification of a disqualified person for such taxes by an 
applicable tax-exempt organization will not constitute an excess 
benefit transaction for purposes of section 4958 if the premium or the 
indemnification is treated as compensation to the disqualified person 
when paid, and the total compensation paid to the disqualified person 
is reasonable.
    (b) Standards for identifying excess benefits--(1) In general. If 
an economic benefit provided by the applicable tax-exempt organization 
to or for the use of any disqualified person exceeds the fair market 
value of the consideration, the excess is the excess benefit on which 
tax is imposed by section 4958. See Sec. 53.4958-5(c) for rules 
concerning the excess benefit in certain revenue-sharing transactions.
    (2) Fair market value for transfer of property. The fair market 
value of property, including the right to use property, is the price at 
which property or the right to use property would change hands between 
a willing buyer and a willing seller, neither being under any 
compulsion to buy, sell or transfer property or the right to use 
property, and both having reasonable knowledge of relevant facts.
    (3) Reasonable compensation--(i) In general. Compensation paid may 
not exceed what is reasonable under all the circumstances. Compensation 
for the performance of services is reasonable if it is only such amount 
as would ordinarily be paid for like services by like enterprises under 
like circumstances. Generally, the circumstances to be taken into 
consideration are those existing at the date when the contract for 
services was made. However, where reasonableness of compensation cannot 
be determined based on circumstances existing at the date when the 
contract for services was made, then that determination is made based 
on all facts and circumstances, up to and including circumstances as of 
the date of payment. In no event shall circumstances existing at the 
date when the contract is questioned be considered in making a 
determination of the reasonableness of compensation. A written binding 
contract that is terminable or subject to cancellation by the 
applicable tax-exempt organization without the disqualified person's 
consent is treated as a new contract as of the date that any such 
termination or cancellation, if made, would be effective. If a binding 
written contract is materially modified, it is treated as a new 
contract entered into as of the date of the material modification. A 
material modification includes, but is not limited to, amending the 
contract to extend its term or to increase the amount of compensation 
payable to the disqualified person. The fact that a State or local 
legislative or agency body or court has authorized or approved a 
particular compensation package paid to a disqualified person is not 
determinative of the reasonableness of compensation paid for purposes 
of section 4958 excise taxes.
    (ii) Items included in determining the value of compensation for 
purposes of section 4958. Compensation for purposes of section 4958 
includes all items of compensation provided by an applicable tax-exempt 
organization in exchange for the performance of services. These items 
of compensation include, but are not limited to--
    (A) All forms of cash and noncash compensation, including salary, 
fees, bonuses, and severance payments paid;
    (B) All forms of deferred compensation that is earned and vested, 
whether or not funded, and whether or not paid under a deferred 
compensation plan that is a qualified plan under section 401(a), but if 
deferred compensation for services performed in multiple prior years 
vests in a later year, then that compensation is attributed to the 
years in which the services were performed;
    (C) The amount of premiums paid for liability or any other 
insurance coverage, as well as any payment or reimbursement by the 
organization of charges, expenses, fees, or taxes not covered 
ultimately by the insurance coverage;
    (D) All other benefits, whether or not included in income for tax 
purposes, including payments to welfare benefit plans on behalf of the 
persons being compensated, such as plans providing medical, dental, 
life insurance, severance pay, and disability benefits, and both 
taxable and nontaxable fringe benefits (other than working condition 
fringe benefits described in section 132(d) and de minimis fringe 
benefits described in section 132(e)), including expense allowances or 
reimbursements or foregone interest on loans that the recipient must 
report as income on his separate income tax return; and
    (E) Any economic benefit provided by an applicable tax-exempt 
organization, whether provided directly or through another entity 
owned, controlled by or affiliated with the applicable tax-exempt 
organization, whether such other entity is taxable or tax-exempt.
    (iii) Examples. The following examples illustrate whether the 
reasonableness of compensation can be determined based on circumstances 
existing at the time a contract for the performance of services was 
made under the rules of this paragraph (b)(3):

    Example 1. G is an applicable tax-exempt organization for 
purposes of section 4958. H is an employee of G and a disqualified 
person with respect to any transaction involving G that provides 
economic benefits to H directly

[[Page 41502]]

or indirectly. H's multi-year employment contract provides for 
payment of a salary and provision of specific amounts of health and 
retirement benefits. The contract provides for an annual increase in 
H's salary equal to the percentage increase, if any, over the 
preceding year in the Consumer Price Index (CPI). The CPI for a year 
is determined using an average of the monthly CPI as determined for 
each month in that calendar year. The health benefits consist of 
insurance coverage under a plan that is available to all of G's 
employees. The retirement benefits are equal to the maximum amount G 
is permitted to contribute under the rules applicable to qualified 
retirement plans. Under these facts, the reasonableness of H's 
compensation can be determined based on the circumstances existing 
at the time G and H enter into the employment contract.
    Example 2. N is an applicable tax-exempt organization for 
purposes of section 4958. N uses the cash method of accounting and a 
calendar year as its taxable year. On January 2, N's governing body 
enters into a one-year employment contract for K, its new executive 
director, who is a disqualified person with respect to any 
transaction involving N and K. In addition to providing that K will 
receive a specified amount of salary, deferred compensation, and 
other health and retirement benefits from N in return for K's 
services, the terms of the contract permit N's governing body to 
declare a bonus to be paid to K at any time during the year covered 
by the contract. Declaration and payment of any bonus is within the 
governing body's discretion, with no specified limitations or 
guidelines. The reasonableness of K's compensation cannot be 
determined based on the circumstances existing as of the date the 
contract was made because there were no guidelines in the contract 
for the bonus that N may potentially pay. Therefore, the 
determination of whether N's compensation is reasonable must be made 
based on all circumstances, up to and including circumstances as of 
the date of payment of any bonus actually paid under the contract. 
If N pays K a bonus on December 31, the reasonableness of K's 
compensation must be based on all circumstances from January 2 
through December 31.

    (c) Establishing intent to treat economic benefit as consideration 
for the performance of services--(1) In general. An applicable tax-
exempt organization will be treated as having intended to provide an 
economic benefit as compensation for services only if the organization 
provides clear and convincing evidence that it intended to so treat the 
economic benefit when the benefit was paid.
    (2) Clear and convincing evidence of intent--(i) In general. If an 
applicable tax-exempt organization or a disqualified person reports an 
economic benefit as described in paragraph (c)(2)(ii) of this section 
then the organization will have provided clear and convincing evidence 
that it intended to provide an economic benefit as compensation for 
services when the benefit was paid. If an applicable tax-exempt 
organization's failure to report an economic benefit as required under 
the Internal Revenue Code is due to reasonable cause (within the 
meaning Sec. 301.6724-1 of this chapter and paragraph (c)(2)(iii) of 
this section), then the organization will be treated as having provided 
clear and convincing evidence of the requisite intent. An organization 
may use methods other than those described in paragraphs (c)(2)(ii) and 
(iii) of this section to provide clear and convincing evidence of its 
intent.
    (ii) Reporting of benefit. The organization reports the economic 
benefit as compensation on original or amended federal tax information 
returns with respect to the payment (e.g., Form W-2 or 1099) or with 
respect to the organization (e.g., Form 990), filed before the 
commencement of an Internal Revenue Service examination in which the 
reporting of the benefit is questioned. For purposes of section 4958 
and this section, an Internal Revenue Service examination of an 
applicable tax-exempt organization has commenced if the organization 
has received written notification from the Exempt Organizations 
Division of an impending Exempt Organizations examination, or written 
notification of an impending referral for an Exempt Organizations 
examination, and also includes having been under an Exempt 
Organizations examination that is now in Appeals or in litigation for 
issues raised in an Exempt Organizations examination of the period in 
which the excess benefit transaction occurred. Reporting of an economic 
benefit to provide clear and convincing evidence of intent is also 
accomplished if the recipient disqualified person reports the benefit 
as income on the person's Form 1040 for the year in which the benefit 
is received.
    (iii) Failure to report due to reasonable cause. To show that its 
failure to report an economic benefit that should have been reported on 
an information return was due to reasonable cause, an applicable tax-
exempt organization must establish that there were significant 
mitigating factors with respect to its failure to report (as described 
in Sec. 301.6724-1(b) of this chapter), or the failure arose from 
events beyond the organization's control (as described in 
Sec. 301.6724-1(c) of this chapter), and that the organization acted in 
a responsible manner both before and after the failure occurred (as 
described in Sec. 301.6724-1(d) of this chapter).
    (3) Effect of failing to establish intent. If an organization fails 
to provide clear and convincing evidence that it intended to provide an 
economic benefit as compensation for services when paid, any services 
provided by the disqualified person will not be treated as provided in 
consideration for the economic benefit.
    (4) Examples. The following examples illustrate the rules for an 
organization to establish its intent to treat an economic benefit as 
consideration for the performance of services as defined in this 
paragraph (c):

    Example 1. G is an applicable tax-exempt organization for 
purposes of section 4958. G hires an individual contractor, P, to 
design a computer program for it, executes a contract for that 
purpose, and pays P $1,000 in a timely manner pursuant to the 
contract. Before January 31 of the next year, G reports the full 
amount paid to P under the contract on a Form 1099 filed with the 
Internal Revenue Service. G has provided clear and convincing 
evidence of its intent to provide the $1,000 paid to P as 
compensation for the services P performed under the contract.
    Example 2. The facts are the same as in Example 1, except that 
the services are provided by Corporation V. The contract executed by 
Corporation V and G and placed in G's files indicates that the 
payment made to Corporation V is in return for computer programming 
services provided by employees of Corporation V. G does not issue an 
information return to Corporation V because Corporation V is not an 
individual taxpayer. The contract constitutes clear and convincing 
evidence of G's intent to provide the payment as compensation for 
Corporation V's services.
    Example 3. G is an applicable tax-exempt organization for 
purposes of section 4958. D is the chief operating officer of G, and 
a disqualified person with respect to any transaction involving G 
that provides economic benefits to D directly or indirectly. D 
receives a bonus at the end of the year. A copy of the letter from G 
to D describing the amount and the basis for D's bonus is placed in 
D's personnel file. Information provided to all employees in the 
personnel handbook clearly states that bonuses are treated as 
taxable income, and included in the total wages figure reported on 
each employee's Form W-2. G's accounting department determines that 
the bonus is to be reported on D's Form W-2. Due to a computer 
malfunction after data was entered incorrectly by personnel of G's 
accounting department, the bonus is not reflected on D's Form W-2. 
As a result, D fails to report the bonus on his individual income 
tax return. G acts to amend Forms W-2 affected as soon as G becomes 
aware of the data entry error and consequent computer malfunction. 
G's failure to report the bonus on an information return issued to D 
arose from events beyond G's control, and G acted in a responsible 
manner both before and after the failure occurred. Thus, because G 
had reasonable cause for failing to report D's bonus, G will be 
treated as having clear and convincing evidence of its intent to 
provide the bonus as compensation for services when paid.

[[Page 41503]]

Sec. 53.4958-5  Transaction in which amount of economic benefit 
determined in whole or in part by the revenues of one or more 
activities of the organization.

    (a) In general. Whether a transaction in which the amount of an 
economic benefit provided by an applicable tax-exempt organization to 
or for the use of a disqualified person is determined in whole or in 
part by the revenues of one or more activities of the applicable tax-
exempt organization (revenue-sharing transaction) results in inurement 
and therefore constitutes an excess benefit transaction, depends upon 
all relevant facts and circumstances. A revenue-sharing transaction may 
constitute an excess benefit transaction regardless of whether the 
economic benefit provided to the disqualified person exceeds the fair 
market value of the consideration provided in return if, at any point, 
it permits a disqualified person to receive additional compensation 
without providing proportional benefits that contribute to the 
organization's accomplishment of its exempt purpose. If the economic 
benefit is provided as compensation for services, relevant facts and 
circumstances include, but are not limited to, the relationship between 
the size of the benefit provided and the quality and quantity of the 
services provided, as well as the ability of the party receiving the 
compensation to control the activities generating the revenues on which 
the compensation is based.
    (b) Special rule for allocation or return of net margins or capital 
to members of certain cooperatives. The allocation or return of net 
margins or capital to the members of certain cooperatives in accordance 
with their incorporating statute and bylaws does not result in 
inurement of the net earnings to the benefit of any private shareholder 
or individual, and therefore does not constitute an excess benefit 
transaction for section 4958 purposes. The preceding sentence applies 
to cooperatives that were determined by the Secretary of the Treasury 
or his delegate to be described in section 501(c)(4) and exempt from 
tax under section 501(a) before July 30, 1996, and have substantially 
the same incorporating statute and bylaws as existed on July 30, 1996.
    (c) Rules effective prospectively. The rules in this section apply 
to any revenue-sharing transaction described in this section that 
occurs on or after the date of publication of final regulations. The 
excess benefit shall consist of the entire economic benefit provided in 
any transaction described in this section. Any revenue-sharing 
transaction occurring after September 13, 1995, may still constitute an 
excess benefit transaction if the economic benefit provided to the 
disqualified person exceeds the fair market value of the consideration 
provided in return. Before the date of publication of final 
regulations, however, the excess benefit shall consist only of that 
portion of the economic benefit that exceeds the fair market value of 
the consideration provided in return.
    (d) Examples. The following examples illustrate the principles used 
in determining whether a revenue-sharing transaction constitutes an 
excess benefit transaction under the rules of this section:

    Example 1. A is the manager of the investment portfolio of M, an 
applicable tax-exempt organization for purposes of section 4958. A 
and several other professional investment managers work exclusively 
for M in an office in M's building. A's compensation consists of a 
flat base annual salary, health insurance, eligibility to 
participate in a retirement plan, and a bonus that is equal to a 
percentage of any increase in the value of M's portfolio over the 
year (net of expenses for investment management other than the in-
house managers' compensation). The revenue-based portion of A's 
compensation gives A an incentive to provide the highest quality 
service in order to maximize benefits and minimize expenses to M. A 
has a measure of control over the activities generating the revenues 
on which his bonus is based, but A can increase his own compensation 
only if M also receives a proportional benefit. Under these facts 
and circumstances, the payment to A of the bonus described above 
does not constitute an excess benefit transaction under the rules of 
this section.
    Example 2. L, an applicable tax-exempt organization for purposes 
of section 4958, enters into a contract with H, a company who 
manages charitable gaming activities for public charities. As a 
result of the contractual relationship, H becomes a disqualified 
person with respect to any transaction involving L that provides 
economic benefits to H directly or indirectly. Under the contract, H 
agrees to provide all of the staff and equipment necessary to carry 
out charitable gaming operations on behalf of L, and to pay L z 
percent of the net profits, which are calculated as the gross 
revenue less rental for the equipment, wages for the staff, prizes 
for the winners, and other specified operating expenses. H retains 
the balance of the proceeds after expenses and after paying L its z 
percent of the net profits. As manager, H controls the activities 
generating the revenue on which its compensation is based. In 
addition, because H owns the equipment and employs the staff needed 
to operate the charitable gaming activities, H controls what L is 
charged, including the profit H makes above the cost of these items. 
Therefore, H can also control the net revenues relative to the gross 
revenues from the gaming activity. The structure of the compensation 
H receives for its services does not provide H with an appropriate 
incentive to maximize benefits and minimize costs to L. H benefits 
whether expenses are high and net revenues are low or expenses are 
low and net revenues are high. By contrast, L suffers if expenses 
for the charitable gaming operation are high and net revenues are 
low. All of the gross revenues generated by the charitable gaming 
operation belong to L. The arrangement between H and L allows a 
portion of those revenues to inure to H. Therefore, this arrangement 
results in the inurement of L's net earnings to the benefit of H, 
and the entire amount paid to H under this arrangement constitutes 
an excess benefit under the rules of this section.
    Example 3. R, a professor and faculty member at S, a university 
that is an applicable tax-exempt organization for purposes of 
section 4958, is the principal investigator in charge of certain 
scientific research at S. The research produces an invention. In 
accordance with S's agreement with its faculty, S owns the 
invention. R assists S in preparing a patent application. S receives 
a patent for R's invention, which S owns. Also in accordance with 
S's agreement with its faculty, S grants R the right to receive v 
percent of S's royalties on the patent, payable semi-annually. R 
also receives an annual compensation package of salary and benefits. 
The availability of revenue-based compensation under these 
circumstances does not give R any incentive or opportunity to act 
contrary to S's interests in accomplishing its exempt purpose. R 
receives the revenue-based compensation, i.e., the percentage of 
royalties, as an incentive and a reward for producing work of 
especially high quality. In addition, any time R benefits by 
receiving royalties, S benefits as well and to a proportionate 
degree. Finally, because the patent belongs to S, R has no control 
over how the patent is used nor the stream of revenue it generates. 
Under these facts and circumstances, S's payment of revenue-based 
compensation to R does not constitute an excess benefit transaction 
under the rules of this section.


Sec. 53.4958-6  Rebuttable presumption that transaction is not an 
excess benefit transaction.

    (a) In general. Payments under a compensation arrangement between 
an applicable tax-exempt organization and a disqualified person shall 
be presumed to be reasonable, and a transfer of property, right to use 
property, or any other benefit or privilege between an applicable tax-
exempt organization and a disqualified person shall be presumed to be 
at fair market value, if the following conditions are satisfied--
    (1) The compensation arrangement or terms of transfer are approved 
by the organization's governing body or a committee of the governing 
body composed entirely of individuals who do not have a conflict of 
interest with respect to the arrangement or transaction;
    (2) The governing body, or committee thereof, obtained and relied 
upon

[[Page 41504]]

appropriate data as to comparability prior to making its determination; 
and
    (3) The governing body or committee adequately documented the basis 
for its determination concurrently with making that determination.
    (b) Delegation pursuant to procedures. To the extent permitted 
under local law, the governing body of an applicable tax-exempt 
organization may authorize other parties to act on its behalf by 
following specified procedures that satisfy the three requirements for 
invoking the rebuttable presumption of reasonableness. An arrangement 
or transaction that is subsequently approved by the board's designee or 
designees in accordance with those procedures shall be subject to the 
rebuttable presumption even though the governing body does not vote 
separately on the specific arrangement or transaction.
    (c) Rebutting the presumption. The presumption established by 
satisfying the three requirements of paragraph (a) of this section may 
be rebutted by additional information showing that the compensation was 
not reasonable or that the transfer was not at fair market value.
    (d) Requirements for invoking rebuttable presumption--(1) 
Disinterested governing body or committee--(i) In general. The 
governing body is the board of directors, board of trustees, or 
equivalent controlling body of the applicable tax-exempt organization. 
A committee of the governing body may be composed of any individuals 
permitted under state law to serve on such a committee, and may act on 
behalf of the governing body to the extent permitted by state law. 
However, if the rebuttable presumption arises as the result of actions 
taken by a committee, any members of such a committee who are not 
members of the governing body are deemed to be organization managers 
for purposes of the tax imposed by section 4958(a)(2), subject to the 
rules of Sec. 53.4958-1(d).
    (ii) Persons not included on governing body or committee. For 
purposes of determining whether the requirements of paragraph (a) of 
this section have been met with respect to a specific transaction or 
compensation arrangement, a person is not included on the governing 
body or committee when it is reviewing a transaction if that person 
meets with other members only to answer questions, and otherwise 
recuses himself from the meeting and is not present during debate and 
voting on the transaction or compensation arrangement.
    (iii) Absence of conflict of interest. A member of the governing 
body, or committee thereof, does not have a conflict of interest with 
respect to a compensation arrangement or transaction if the member--
    (A) Is not the disqualified person and is not related to any 
disqualified person participating in or economically benefiting from 
the compensation arrangement or transaction by a relationship described 
in section 4958(f)(4) or Sec. 53.4958-3(b)(1);
    (B) Is not in an employment relationship subject to the direction 
or control of any disqualified person participating in or economically 
benefiting from the compensation arrangement or transaction;
    (C) Is not receiving compensation or other payments subject to 
approval by any disqualified person participating in or economically 
benefiting from the compensation arrangement or transaction;
    (D) Has no material financial interest affected by the compensation 
arrangement or transaction; and
    (E) Does not approve a transaction providing economic benefits to 
any disqualified person participating in the compensation arrangement 
or transaction, who in turn has approved or will approve a transaction 
providing economic benefits to the member.
    (iv) Rule where ratification by full governing body required. An 
arrangement or transaction has not been approved by a committee of a 
governing body if, under the governing documents of the organization or 
state law, the committee's decision must be ratified by the full 
governing body in order to become effective.
    (2) Appropriate data as to comparability--(i) In general. A 
governing body or committee has appropriate data as to comparability 
if, given the knowledge and expertise of its members, it has 
information sufficient to determine whether, under the standards set 
forth in Sec. 53.4958-4(b), a compensation arrangement will result in 
the payment of reasonable compensation or a transaction will be for 
fair market value. Relevant information would include, but not be 
limited to, compensation levels paid by similarly situated 
organizations, both taxable and tax-exempt, for functionally comparable 
positions; the availability of similar services in the geographic area 
of the applicable tax-exempt organization; independent compensation 
surveys compiled by independent firms; actual written offers from 
similar institutions competing for the services of the disqualified 
person; and independent appraisals of the value of property that the 
applicable organization intends to purchase from, or sell or provide 
to, the disqualified person.
    (ii) Special rule for compensation paid by small organizations. For 
organizations with annual gross receipts of less than $1 million 
reviewing compensation arrangements, the governing body or committee 
will be considered to have appropriate data as to comparability if it 
has data on compensation paid by five comparable organizations in the 
same or similar communities for similar services. No inference is 
intended with respect to whether circumstances falling outside this 
safe harbor will meet the requirement with respect to the collection of 
appropriate data.
    (iii) Additional rules for special rule for small organizations. 
For purposes of determining applicability of the special rule for small 
organizations described in paragraph (d)(2)(ii) of this section, a 
rolling average based on the three prior taxable years may be used to 
calculate annual gross receipts of an organization. If any applicable 
tax-exempt organization is affiliated with another entity by common 
control or governing documents, the annual gross receipts of all such 
related organizations must be aggregated to determine applicability of 
the special rule stated in paragraph (d)(2)(ii) of this section.
    (iv) Examples. The following examples illustrate the rules for 
appropriate data as to comparability for purposes of invoking the 
rebuttable presumption of reasonableness described in this section:

    Example 1. Z is a large university that is an applicable tax-
exempt organization for purposes of section 4958. Z has had gross 
receipts of $200 million for the preceding three taxable years. Z is 
negotiating a new contract with its president because the old 
contract will expire at the end of the year. In determining the 
compensation for its president, the executive committee of the Board 
of Trustees relies on a national survey of compensation for 
university presidents; this survey does not divide its data by any 
measure of university size or any other criteria. None of the 
members of the executive committee has any particular expertise in 
higher education compensation matters, although many members have 
significant business experience. Given the lack of specificity in 
the data collected and the lack of relevant expertise and experience 
of the executive committee members, the data relied on by the 
executive committee does not constitute appropriate data as to 
comparability.
    Example 2. X, a tax-exempt hospital that is an applicable tax-
exempt organization for purposes of section 4958, has average annual 
gross receipts of $250 million. Before renewing the contracts of X's 
chief executive officer and chief financial officer, X's governing 
board commissioned a customized

[[Page 41505]]

compensation survey from an independent firm that specializes in 
consulting on issues related to executive placement and 
compensation. The survey covered executives with comparable 
responsibilities at a significant number of hospitals. The survey 
data are sorted by a number of different variables, including the 
size of the hospitals and the nature of the services they provide, 
the level of experience and specific responsibilities of the 
executives, and the composition of the compensation packages. The 
board members were provided with the survey results, a detailed 
written analysis comparing the hospital's executives to those 
covered by the survey and an opportunity to ask questions of a 
member of the firm that prepared the survey. The survey, as prepared 
and presented to X's board, constitutes appropriate data as to 
comparability.
    Example 3. W is a local repertory theater and an applicable tax-
exempt organization for purposes of section 4958. W has had annual 
gross receipts ranging from $400,000 to $800,000 over its past three 
taxable years. In determining the next year's compensation for W's 
artistic director, the board relies on data compiled from a 
telephone survey of six other unrelated repertory theaters of 
similar size in various communities throughout the same geographic 
region. A member of the board drafts a brief written summary of the 
salary information obtained from this informal survey. This 
information is later included in a written report that also includes 
information about the membership of the board of directors, and an 
evaluation of the artistic director's prior salary and performance 
that is discussed and voted on by the board. The salary information 
obtained in the telephone survey is appropriate data as to 
comparability.

    (3) Documentation--(i) For a decision to be documented adequately, 
the written or electronic records of the governing body or committee 
must note--
    (A) The terms of the transaction that was approved and the date it 
was approved;
    (B) The members of the governing body or committee who were present 
during debate on the transaction or arrangement that was approved and 
those who voted on it;
    (C) The comparability data obtained and relied upon by the 
committee and how the data was obtained; and
    (D) The actions taken with respect to consideration of the 
transaction by anyone who is otherwise a member of the governing body 
or committee but who had a conflict of interest with respect to the 
transaction or arrangement.
    (ii) If the governing body or committee determines that reasonable 
compensation for a specific arrangement or fair market value in a 
specific transaction is higher or lower than the range of comparable 
data obtained, the governing body or committee must record the basis 
for its determination. For a decision to be documented concurrently, 
records must be prepared by the next meeting of the governing body or 
committee occurring after the final action or actions of the governing 
body or committee are taken. Records must be reviewed and approved by 
the governing body or committee as reasonable, accurate and complete 
within a reasonable time period thereafter.
    (e) No presumption until circumstances exist to determine 
reasonableness of compensation. If reasonableness of the compensation 
cannot be determined based on circumstances existing at the date when a 
contract for services was made, then the rebuttable presumption of this 
section cannot arise until circumstances exist so that reasonableness 
of compensation can be determined, and the three requirements for the 
presumption under paragraph (d) of this section subsequently are 
satisfied. See Sec. 53.4958-4(b)(3)(i).
    (f) No inference from absence of presumption. The fact that a 
transaction between an applicable tax-exempt organization and a 
disqualified person is not subject to the presumption described in this 
section shall not create any inference that the transaction is an 
excess benefit transaction. Neither shall the fact that a transaction 
qualifies for the presumption exempt or relieve any person from 
compliance with any federal or state law imposing any obligation, duty, 
responsibility, or other standard of conduct with respect to the 
operation or administration of any applicable tax-exempt organization.
    (g) Period of reliance on rebuttable presumption. The rebuttable 
presumption applies to all payments made or transactions completed in 
accordance with a contract provided that the three requirements of the 
rebuttable presumption were met at the time the contract was agreed 
upon.


Sec. 53.4958-7  Special rules.

    (a) Substantive requirements for exemption still apply. The excise 
taxes imposed by section 4958 do not affect the substantive statutory 
standards for tax exemption under sections 501(c)(3) or (4). 
Organizations are described in those sections only if no part of their 
net earnings inure to the benefit of any private shareholder or 
individual.
    (b) Interaction between section 4958 and section 7611 rules for 
church tax inquiries and examinations. The procedures of section 7611 
will be used in initiating and conducting any inquiry or examination 
into whether an excess benefit transaction has occurred between a 
church and a disqualified person. For purposes of this rule, the 
reasonable belief required to initiate a church tax inquiry is 
satisfied if there is a reasonable belief that a section 4958 tax is 
due from a disqualified person with respect to a transaction involving 
a church. See Sec. 301.7611-1 Q&A 19 of this chapter.


Sec. 53.4963-1  [Amended]

    Par. 3. In Sec. 53.4963-1, paragraphs (a), (b), and (c) are amended 
by adding the reference ``4958,'' immediately after the reference 
``4955,'' in each place it appears.

PART 301--PROCEDURE AND ADMINISTRATION

    Par. 4. The authority citation for part 301 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


Sec. 301.6213-1  [Amended]

    Par. 5. Section 301.6213-1, paragraph (e) is amended by adding the 
reference ``4958,'' immediately after the reference ``4955,'' in the 
first sentence.


Sec. 301.6501(e)-1  [Amended]

    Par. 6. Section 301.6501(e)-1 is amended as follows:
    1. Paragraph (c)(3)(ii), first and second sentences are amended by 
removing the language ``or trust'' and adding ``trust, or other 
organization'' in its place.
    2. Paragraph (c)(3)(ii), the first sentence is amended by removing 
the language ``and 4953'' and adding ``4953, and 4958'' in its place.


Sec. 301.6501(n)-1  [Amended]

    Par. 7. Section 301.6501(n)-1 is amended as follows:
    1. The paragraph heading for paragraph (a) is amended by removing 
the language ``or trust'' and adding ``trust, or other organization'' 
in its place.
    2. Paragraph (a)(1), the first sentence is amended by removing the 
language ``or trust'' and adding ``trust, or other organization'' in 
its place.
    3. Paragraph (b), the heading and the first sentence are amended by 
removing the language ``or trust'' and adding ``trust, or other 
organization'' in its place.


Sec. 301.7422-1  [Amended]

    Par. 8. In section 301.7422-1, paragraphs (a) introductory text, 
(c) introductory text and (d) are amended by adding the reference 
``4958,'' immediately after the reference ``4955,''.


Sec. 301.7611-1  [Amended]

    Par. 9. In Sec. 301.7611-1, the Table of Contents is amended by 
adding

[[Page 41506]]

``Application to Section 4958......19'' immediately after ``Effective 
Date......18''.
    Par. 10. In Sec. 301.7611-1, an undesignated centerheading and Q-19 
and A-19 are added to read as follows:


Sec. 301.7611-1  Questions and answers relating to church tax inquiries 
and examinations.

* * * * *

Application to Section 4958

    Q-19: When do the church tax inquiry and examination procedures 
described in section 7611 apply to a determination of whether there was 
an excess benefit transaction described in section 4958?
    A-19: See Sec. 53.4958-7(b) of this chapter for rules governing the 
interaction between section 4958 excise taxes on excess benefit 
transactions and section 7611 church tax inquiry and examination 
procedures.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-20419 Filed 7-30-98; 8:45 am]
BILLING CODE 4830-01-U