Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 53599 

Additionally, any person may obtain 

a copy of this notice by submitting a 

request to the Federal Aviation 

Administration, Office of Air Traffic 

Airspace Management, ATA–400, 800 

Independence Avenue, SW., 

Washington, DC 20591 or by calling 

(202) 267–8783. Communications must 

identify both docket numbers for this 

notice. Persons interested in being 

placed on a mailing list for future 

NPRM’s should contact the FAA’s 

Office of Rulemaking, (202) 267–9677, 

to request a copy of Advisory Circular 

No. 11–2A, Notice of Proposed 

Rulemaking Distribution System, which 

describes the application procedure. 

The Proposal 

The FAA is considering an 

amendment to the Code of Federal 

Regulations (14 CFR part 71), by 

establishing Class E airspace at Nikolai, 

AK. The intended effect of this proposal 

is to establish new Class E airspace 

upward from 700 feet (ft.) above the 

surface within a 6.4 nautical mile (NM) 

radius of the Nikolai Airport. 

The FAA Instrument Flight 

Procedures Production and 

Maintenance Branch has developed two 

SIAPs for the Nikolai Airport. The two 

approaches are: (1) Area Navigation 

(Global Positioning System) (RNAV 

(GPS)) Runway (RWY) 04, original, and 

(2) RNAV (GPS) RWY 20, original. Class 

E controlled airspace extending upward 

from 700 ft above the surface is needed 

to provide air traffic control services 

and would be established by this action. 

The proposed airspace is sufficient to 

contain aircraft executing the 

instrument procedures for the Nikolai 

Airport. 

The area would be depicted on 

aeronautical charts for pilot reference. 

The coordinates for this airspace docket 

are based on North American Datum 83. 

The Class E airspace areas designated as 

700/1200 foot transition areas are 

published in paragraph 6005 in FAA 

Order 7400.9M, Airspace Designations 

and Reporting Points, dated August 30, 

2004, and effective September 16, 2004, 

which is incorporated by reference in 14 

CFR 71.1. The Class E airspace 

designations listed in this document 

would be published subsequently in the 

Order. 

The FAA has determined that this 

proposed regulation only involves an 

established body of technical 

regulations for which frequent and 

routine amendments are necessary to 

keep them operationally current. It, 

therefore—(1) is not a ‘‘significant 

regulatory action’’ under Executive 

Order 12866; (2) is not a ‘‘significant 

rule’’ under DOT Regulatory Policies 

and Procedures (44 FR 11034; February 

26, 1979); and (3) does not warrant 

preparation of a regulatory evaluation as 

the anticipated impact is so minimal. 

Since this is a routine matter that will 

only affect air traffic procedures and air 

navigation, it is certified that this rule, 

when promulgated, will not have a 

significant economic impact on a 

substantial number of small entities 

under the criteria of the Regulatory 

Flexibility Act. 

The FAA’s authority to issue rules 

regarding aviation safety is found in 

Title 49 of the United States Code. 

Subtitle 1, section 106 describes the 

authority of the FAA Administrator. 

Subtitle VII, Aviation Programs, 

describes in more detail the scope of the 

agency’s authority. 

This rulemaking is promulgated 

under the authority described in subtitle 

VII, part A, subpart 1, section 40103, 

Sovereignty and use of airspace. Under 

that section, the FAA is charged with 

prescribing regulations to ensure the 

safe and efficient use of the navigable 

airspace. This regulation is within the 

scope of that authority, because it 

proposes to establish Class E airspace 

sufficient to contain aircraft executing 

instrument procedures at Nikolai 

Airport and represents the FAA’s 

continuing effort to safely and 

efficiently manage the navigable 

airspace. 

List of Subjects in 14 CFR Part 71 

Airspace, Incorporation by reference, 

Navigation (air). 

The Proposed Amendment 

In consideration of the foregoing, the 

Federal Aviation Administration 

proposes to amend 14 CFR part 71 as 

follows: 

PART 71—DESIGNATION OF CLASS A, 

CLASS B, CLASS C, CLASS D, AND 

CLASS E AIRSPACE AREAS; 

AIRWAYS; ROUTES; AND REPORTING 

POINTS 

1. The authority citation for 14 CFR 

part 71 continues to read as follows: 

Authority: 49 U.S.C. 106(g), 40103, 40113, 

40120; E.O. 10854, 24 FR 9565, 3 CFR, 1959–

1963 Comp., p. 389. 

§ 71.1 [Amended] 

2. The incorporation by reference in 

14 CFR 71.1 of Federal Aviation 

Administration Order 7400.9M, 

Airspace Designations and Reporting 

Points, dated August 30, 2004, and 

effective September 16, 2004, is to be 

amended as follows: 

* * * * * 

Paragraph 6005 Class E airspace extending 

upward from 700 or more feet above the 

surface of the earth. 

* * * * * 

AAL AK E5 Nikolai, AK [New] 

Nikolai Airport, AK 

(Lat. 63°01′07′′ N., long. 154°21′30′′ W.) 

That airspace extending upward from 700 

feet (ft.) above the surface within a 6.4 

nautical mile (NM) radius of the Nikolai 

Airport. 

* * * * * 

Issued in Anchorage, AK, on August 30, 

2005. 

Joseph Rollins, 

Acting Director, Alaska Flight Services Area 

Office. 

[FR Doc. 05–17839 Filed 9–8–05; 8:45 am] 

BILLING CODE 4910–13–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Parts 1 and 53 

[REG–111257–05] 

RIN 1545–BE37 

Standards for Recognition of TaxExempt Status if Private Benefit Exists 

or If an Applicable Tax-Exempt 

Organization Has Engaged in Excess 

Benefit Transaction(s) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations that clarify the 

substantive requirements for tax 

exemption under section 501(c)(3) of the 

Internal Revenue Code (Code). This 

document also contains provisions that 

clarify the relationship between the 

substantive requirements for tax 

exemption under section 501(c)(3) and 

the imposition of section 4958 excise 

taxes. 

DATES: Written comments and requests 

for a public hearing must be received by 

December 8, 2005. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–111257–05), room 

5203, Internal Revenue Service, POB 

7604, Ben Franklin Station, Washington, 

DC 20044. Submissions may be hand 

delivered Monday through Friday 

between the hours of 8 a.m. and 4 p.m. 

to: CC:PA:LPD:PR (REG–111257–05), 

Courier’s Desk, Internal Revenue 

Service, 1111 Constitution Avenue, 

NW., Washington, DC. Alternatively, 

taxpayers may submit comments 

electronically via the IRS Internet site at 

http://www.irs.gov/regs or the Federal 

53600 Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 

eRulemaking Portal at http:// 

www.regulations.gov (IRS–REG–

111257–05). A public hearing may be 

scheduled if requested. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the regulations, Galina 

Kolomietz, (202) 622–4441; Concerning 

submission of comments and requests 

for a public hearing, Richard Hurst, 

(202) 622–7180 (not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

A. Section 501(c)(3) and the Regulations 

Thereunder 

To be described in section 501(c)(3), 

an organization must be organized and 

operated exclusively for religious, 

charitable, scientific, or educational 

purposes. In addition, no part of the net 

earnings of the organization may inure 

to the benefit of any private shareholder 

or individual, no substantial part of the 

organization’s activities may include 

attempts to influence legislation, and 

the organization may not intervene in 

political campaigns. 

Existing regulations under section 

501(c)(3) were adopted in substantially 

their present form in 1959. In explaining 

and clarifying the statutory 

requirements, these regulations provide 

that, to be described in section 501(c)(3), 

an organization must be both organized 

and operated for exempt purposes. An 

organization is not operated exclusively 

for exempt purposes and, thus, is not 

described in section 501(c)(3), if any of 

its net earnings inure to the benefit of 

a private shareholder or individual. 

§ 1.501(c)(3)–1(c)(2). The regulations 

define private shareholder or individual 

as referring to persons having a personal 

and private interest in the activities of 

the organization. § 1.501(a)–1(c). 

In addition, an organization is not 

organized or operated for one or more of 

the exempt purposes enumerated in 

§ 1.501(c)(3)–1(d)(1)(i) and, thus, is not 

described in section 501(c)(3), if it is 

organized or operated for the benefit of 

private interests such as designated 

individuals, the creator or his family, 

shareholders of the organization, or 

persons controlled, directly or 

indirectly, by such interests. 

§ 1.501(c)(3)–1(d)(1)(ii). 

These proposed regulations amend 

the regulations under section 501(c)(3), 

adding several examples to illustrate the 

requirement in § 1.501(c)(3)–1(d)(1)(ii) 

that an organization serve a public 

rather than a private interest. The 

examples illustrate that prohibited 

private benefits may involve noneconomic benefits as well as economic 

benefits. In addition, prohibited private 

benefit may arise regardless of whether 

payments made to private interests are 

reasonable or excessive. The examples 

reflect current law. 

B. Section 4958 and the Regulations 

Thereunder 

Section 4958 was added to the Code 

by the Taxpayer Bill of Rights 2, Public 

Law 104–168 (110 Stat. 1452, July 30, 

1996). Section 4958 imposes certain 

excise taxes on transactions that provide 

excess economic benefits to disqualified 

persons with respect to public charities 

and social welfare organizations 

described in sections 501(c)(3) and 

501(c)(4), respectively. These 

organizations are collectively referred to 

as applicable tax-exempt organizations. 

Section 4958(e). An excess benefit is the 

amount by which the value of an 

economic benefit provided by an 

applicable tax-exempt organization 

directly or indirectly to or for the use of 

a disqualified person exceeds the value 

of the consideration (including the 

performance of services) received for 

providing such benefit. § 53.4958–1(b). 

A disqualified person is defined as a 

person who is in a position to exercise 

substantial influence over the affairs of 

an applicable tax-exempt organization. 

Section 4958(f)(1). Section 4958(a) 

imposes the liability for excise taxes on 

disqualified persons who receive an 

excess benefit from, and on certain 

organization managers who knowingly 

participate in, an excess benefit 

transaction. Section 4958 imposes no 

corresponding sanctions on exempt 

organizations. The section 4958 excise 

taxes generally apply to excess benefit 

transactions occurring on or after 

September 14, 1995. 

On August 4, 1998, a notice of 

proposed rulemaking (REG–246256–96) 

clarifying certain definitions and rules 

contained in section 4958 was 

published in the Federal Register (63 

FR 41486). Those 1998 proposed 

regulations were revised in response to 

written and oral comments and replaced 

by temporary and proposed regulations 

on January 10, 2001 (TD 8920, 66 FR 

2144, and REG–246256–96, 66 FR 2173). 

Final regulations under section 4958 

were published on January 23, 2002 (TD 

8978, 67 FR 3076). 

C. History of the Relationship Between 

Section 4958 Taxes and Tax-Exempt 

Status 

Section 501(c)(3) and the 

longstanding regulations thereunder 

establish certain tests that an 

organization must meet to qualify for 

tax-exempt status. § 1.501(c)(3)–1(a)(1). 

Section 4958, by its terms, does not 

address the tax-exempt status of 

applicable tax-exempt organizations, but 

instead imposes excise tax liability on 

disqualified persons and certain 

organization managers. 

In the 1996 House Report on section 

4958, Congress briefly addressed the 

relationship between section 4958 and 

tax-exempt status. Specifically, the 

Report stated that these ‘‘intermediate 

sanctions for excess benefit transactions 

may be imposed by the IRS in lieu of (or 

in addition to) revocation of the 

organization’s tax-exempt status.’’ H. 

Rep. No. 104–506, 104th Cong., 2d 

Sess., at 59 (1996) (emphasis added). 

The Report also stated, in a footnote, 

that, in general, revocation of taxexempt status, with or without the 

imposition of excise taxes, would occur 

only if an organization no longer 

operates as a charitable organization. H. 

Rep. No. 104–506, 104th Cong., 2d 

Sess., at 59, note 15. 

In keeping with the differences 

between section 501(c)(3) and section 

4958, the Treasury Department and the 

IRS consistently have taken the position 

that the imposition of excise taxes under 

section 4958 does not foreclose 

revocation of tax-exempt status in 

appropriate cases. The 1998 proposed 

regulations under section 4958 stated 

that ‘‘[t]he excise taxes imposed by 

section 4958 do not affect the 

substantive statutory standards for tax 

exemption under section 501(c)(3) or 

(4).’’ Proposed § 53.4958–7(a), (63 FR 

41,505). Both the 2001 temporary and 

the 2002 final regulations stated that—

Section 4958 does not affect the 

substantive standards for tax exemption 

under section 501(c)(3) or (4), including the 

requirements that the organization be 

organized and operated exclusively for 

exempt purposes, and that no part of its net 

earnings inure to the benefit of any private 

shareholder or individual. Thus, regardless of 

whether a particular transaction is subject to 

excise taxes under section 4958, existing 

principles and rules may be implicated, such 

as the limitation on private benefit. (26 CFR 

53.4958–8(a)). 

The preamble to the 1998 proposed 

regulations under section 4958 stated 

that the IRS will exercise its 

administrative discretion in enforcing 

the requirements of sections 4958, 

501(c)(3), and 501(c)(4). The preamble 

to the 1998 proposed regulations listed 

the following four factors the IRS will 

consider in determining whether an 

applicable tax-exempt organization 

described in section 501(c)(3) continues 

to be described in section 501(c)(3) in 

cases in which section 4958 excise taxes 

are also imposed: (1) Whether the 

organization has been involved in 

repeated excess benefit transactions; (2) 

the size and the scope of the excess 

Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 53601 

benefit transactions; (3) whether, after 

concluding that it has been party to an 

excess benefit transaction, the 

organization has implemented 

safeguards to prevent future 

recurrences; and (4) whether there was 

compliance with other applicable laws. 

(63 FR 41,488 through 41,489). 

The preamble to the 2001 temporary 

regulations stated that the IRS intends to 

publish guidance regarding the factors it 

will consider as it gains more 

experience in administering section 

4958. The preamble to the 2002 final 

regulations stated that, until such 

guidance is published, the IRS will 

consider all relevant facts and 

circumstances in the administration of 

section 4958 cases. These proposed 

regulations amend the regulations under 

section 501(c)(3) to provide guidance on 

certain factors that the IRS will consider 

in determining whether an applicable 

tax-exempt organization described in 

section 501(c)(3) that engages in one or 

more excess benefit transactions 

continues to be described in section 

501(c)(3). 

D. Section 4958 and Application for 

Recognition of Tax-Exempt Status 

Under Section 501(c)(3) 

Section 4958 and the regulations 

thereunder do not apply to 

organizations that are not applicable 

tax-exempt organizations as defined 

therein. These proposed regulations 

amend the regulations under section 

4958 to clarify that the IRS has 

discretion to refuse to issue a ruling 

recognizing exemption under section 

501(c)(3) to any applicant whose 

purpose or activities violate any 

provision of section 501(c)(3), including 

the inurement prohibition and the 

limitation on private benefit, even 

though such violation could serve as 

grounds for imposing section 4958 

excise taxes if the applicant’s taxexempt status were recognized. 

E. Proposed Effective Date 

These regulations are proposed to be 

applicable on the date of publication in 

the Federal Register of a Treasury 

Decision adopting them as final 

regulations. 

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. It 

also has been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to this notice of proposed rulemaking, 

and because this notice of proposed 

rulemaking does not impose a collection 

of information on small entities, the 

Regulatory Flexibility Act (5 U.S.C. 

chapter 6) does not apply. Pursuant to 

section 7805(f) of the 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 

comments (a signed original and eight 

(8) copies) that are submitted timely to 

the IRS. The IRS and the Treasury 

Department specifically request 

comments on the clarity of the proposed 

rule and how it may be made easier to 

understand. All comments will be 

available for public inspection and 

copying. 

A public hearing may be scheduled if 

requested in writing by a person who 

timely submits written comments. If a 

public hearing is scheduled, notice of 

the date, time, and place will be 

published in the Federal Register. 

Drafting Information 

The principal authors of these 

regulations are Galina Kolomietz and 

Phyllis Haney, Office of Division 

Counsel/Associate Chief Counsel (Tax 

Exempt and Government Entities). 

However, other personnel from the IRS 

and the Treasury Department 

participated in their development. 

List of Subjects 

26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

26 CFR Part 53 

Excise taxes, Foundations, 

Investments, Lobbying, Reporting and 

recordkeeping requirements. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR parts 1 and 53 

are proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 continues to read, in part, as 

follows: 

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

Par. 2. In § 1.501(c)(3)–1, paragraph 

(d)(1)(iii) is redesignated as paragraph 

(d)(1)(iv). 

Par. 3. In § 1.501(c)(3)–1, paragraphs 

(d)(1)(iii) and (g) are added to read as 

follows: 

§ 1.501(c)(3)–(1) Organizations organized 

and operated for religious, charitable, 

scientific, testing for public safety, literary, 

or educational purposes, or for the 

prevention of cruelty to children or animals. 

* * * * * 

(d) * * * 

(1) * * * 

(iii) Examples. The following 

examples illustrate the requirement of 

paragraph (d)(1)(ii) of this section that 

an organization serve a public rather 

than a private interest: 

Example 1. (i) O is an educational 

organization the purpose of which is to study 

history and immigration. The focus of O’s 

historical studies is the genealogy of one 

family, tracing the descent of its present 

members. O actively solicits for membership 

only individuals who are members of that 

one family. O’s research is directed toward 

publishing a history of that family that will 

document the pedigrees of family members. 

A major objective of O’s research is to 

identify and locate living descendants of that 

family to enable those descendants to become 

acquainted with each other. 

(ii) O’s educational activities primarily 

serve the private interests of members of a 

single family rather than a public interest. 

Therefore, O is operated for the benefit of 

private interests in violation of the restriction 

on private benefit in § 1.501(c)(3)–1(d)(1)(ii). 

Based on these facts and circumstances, O is 

not operated exclusively for exempt purposes 

and, therefore, is not described in section 

501(c)(3). 

Example 2. (i) O is an art museum. O’s sole 

activity is exhibiting art created by a group 

of unknown but promising local artists. O is 

governed by a board of trustees unrelated to 

the artists whose work O exhibits. All of the 

art exhibited is offered for sale at prices set 

by the artist. Each artist whose work is 

exhibited has a consignment arrangement 

with O. Under this arrangement, when art is 

sold, the museum retains 10 percent of the 

selling price to cover the costs of operating 

the museum and gives the artist 90 percent. 

(ii) The artists in this situation directly 

benefit from the exhibition and sale of their 

art. As a result, the sole activity of O serves 

the private interests of these artists. Because 

O gives 90 percent of the proceeds from its 

sole activity to the individual artists, the 

direct benefits to the artists are substantial 

and O’s provision of these benefits to the 

artists is more than incidental to its other 

purposes and activities. This arrangement 

causes O to be operated for the benefit of 

private interests in violation of the restriction 

on private benefit in § 1.501(c)(3)–1(d)(1)(ii). 

Based on these facts and circumstances, O is 

not operated exclusively for exempt purposes 

and, therefore, is not described in section 

501(c)(3). 

Example 3. (i) O is an educational 

organization the purpose of which is to train 

individuals in a program developed by P, O’s 

president. All of the rights to the program are 

owned by Company K, a for-profit 

corporation owned by P. Prior to the 

existence of O, the teaching of the program 

was conducted by Company K. O licenses, 

from Company K, the right to use a reference 

53602 Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 

to the program in O’s name and the right to 

teach the program, in exchange for specified 

royalty payments. Under the license 

agreement, Company K provides O with the 

services of trainers and with course materials 

on the program. O may develop and 

copyright new course materials on the 

program but all such materials must be 

assigned to Company K without 

consideration if the license agreement is 

terminated. Company K sets the tuition for 

the seminars and lectures on the program 

conducted by O. O has agreed not to become 

involved in any activity resembling the 

program or its implementation for 2 years 

after the termination of O’s license 

agreement. 

(ii) O’s sole activity is conducting seminars 

and lectures on the program. This 

arrangement causes O to be operated for the 

benefit of P and Company K in violation of 

the restriction on private benefit in 

§ 1.501(c)(3)–1(d)(1)(ii), regardless of whether 

the royalty payments from O to Company K 

for the right to teach the program are 

reasonable. Based on these facts and 

circumstances, O is not operated exclusively 

for exempt purposes and, therefore, is not 

described in section 501(c)(3). 

* * * * * 

(g) Interaction with section 4958—(1) 

Application process. An organization 

that applies for recognition of 

exemption under section 501(a) as an 

organization described in section 

501(c)(3) must establish its eligibility 

under this section. The Commissioner 

may deny an application for exemption 

for failure to establish any of this 

section’s requirements for exemption. 

Section 4958 does not apply to 

transactions with an organization that 

has failed to establish that it satisfies all 

of the requirements for exemption under 

section 501(c)(3). See § 53.4958–2 of this 

chapter. 

(2) Substantive requirements for 

exemption still apply to applicable taxexempt organizations described in 

section 501(c)(3)—(i) In general. 

Regardless of whether a particular 

transaction is subject to excise taxes 

under section 4958, the substantive 

requirements for tax exemption under 

section 501(c)(3) still apply to an 

applicable tax-exempt organization (as 

defined in section 4958(e) and 

§ 53.4958–2 of this chapter) described in 

section 501(c)(3) whose disqualified 

persons or organization managers are 

subject to excise taxes under section 

4958. Accordingly, an organization may 

no longer meet the requirements for taxexempt status under section 501(c)(3) 

because the organization fails to satisfy 

the requirements of paragraph (b), (c) or 

(d) of this section. See § 53.4958–8(a) of 

this chapter. 

(ii) Determining whether revocation of 

tax-exempt status is appropriate when 

section 4958 excise taxes also apply. In 

determining whether to continue to 

recognize the tax-exempt status of an 

applicable tax-exempt organization (as 

defined in section 4958(e) and 

§ 53.4958–2 of this chapter) described in 

section 501(c)(3) that engages in one or 

more excess benefit transactions (as 

defined in section 4958(c) and 

§ 53.4958–4 of this chapter) that violate 

the prohibition on inurement under this 

section, the Commissioner will consider 

all relevant facts and circumstances, 

including, but not limited to, the 

following—

(A) The size and scope of the 

organization’s regular and ongoing 

activities that further exempt purposes 

before and after the excess benefit 

transaction or transactions occurred; 

(B) The size and scope of the excess 

benefit transaction or transactions 

(collectively, if more than one) in 

relation to the size and scope of the 

organization’s regular and ongoing 

activities that further exempt purposes; 

(C) Whether the organization has been 

involved in repeated excess benefit 

transactions; 

(D) Whether the organization has 

implemented safeguards that are 

reasonably calculated to prevent future 

violations; and 

(E) Whether the excess benefit 

transaction has been corrected (within 

the meaning of section 4958(f)(6) and 

§ 53.4958–7 of this chapter), or the 

organization has made good faith efforts 

to seek correction from the disqualified 

persons who benefited from the excess 

benefit transaction. 

(iii) All factors will be considered in 

combination with each other. 

Depending on the particular situation, 

the Commissioner may assign greater or 

lesser weight to some factors than to 

others. The factors listed in paragraphs 

(g)(2)(ii)(D) and (E) of this section will 

weigh more strongly in favor of 

continuing to recognize exemption 

where the organization discovers the 

excess benefit transaction or 

transactions and takes action before the 

Commissioner discovers the excess 

benefit transaction or transactions. 

Further, with respect to the factor listed 

in paragraph (g)(2)(ii)(E) of this section, 

correction after the excess benefit 

transaction or transactions are 

discovered by the Commissioner, by 

itself, is never a sufficient basis for 

continuing to recognize exemption. 

(iv) Examples. The following 

examples illustrate the principles of 

paragraph (g)(2)(ii) of this section. For 

purposes of each example, assume that 

O is an applicable tax-exempt 

organization (as defined in section 

4958(e) and § 53.4958–2 of this chapter) 

described in section 501(c)(3) for all 

relevant periods. The examples are as 

follows: 

Example 1. (i) O was created as a museum 

for the purpose of exhibiting art to the 

general public. In Years 1 and 2, O engages 

in fundraising and in selecting, leasing, and 

preparing an appropriate facility for a 

museum. In Year 3, a new board of trustees 

is elected. All of the new trustees are local 

art dealers. Beginning in Year 3 and 

continuing to the present, O uses almost all 

of its revenues to purchase art solely from its 

trustees at prices that exceed fair market 

value. O exhibits and offers for sale all of the 

art it purchases. O’s Form 1023, ‘‘Application 

for Recognition of Exemption,’’ did not 

disclose the possibility that O’s trustees 

would be selling art to O. 

(ii) O’s purchases of art from its trustees at 

more than fair market value constitute excess 

benefit transactions between an applicable 

tax-exempt organization and disqualified 

persons under section 4958. Therefore, these 

transactions are subject to the appropriate 

excise taxes provided in that section. In 

addition, O’s purchases of art from its 

trustees at more than fair market value 

violate the proscription against inurement 

under section 501(c)(3) and § 1.501(c)(3)–

1(c)(2). 

(iii) The application of the factors in 

§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as 

follows. Beginning in Year 3, O does not 

engage in any regular and ongoing activities 

that further exempt purposes because almost 

all of O’s activities consist of purchasing art 

from its trustees and exhibiting and offering 

for sale all of the art it purchases. The size 

and scope of the excess benefit transactions 

collectively are significant in relation to the 

size and scope of any of O’s ongoing 

activities that further exempt purposes. O has 

been involved in repeated excess benefit 

transactions, namely, purchases of art from 

its trustees at more than fair market value. O 

has not implemented safeguards that are 

reasonably calculated to prevent such 

improper purchases in the future. The excess 

benefit transactions have not been corrected, 

nor has O made good faith efforts to seek 

correction from the disqualified persons who 

benefited from the excess benefit transactions 

(the trustees). The trustees continue to 

control O’s Board. Based on the application 

of the factors to these facts, O is no longer 

described in section 501(c)(3) effective in 

Year 3. 

Example 2. (i) The facts are the same as in 

Example 1, except that in Year 4, O’s entire 

board of trustees resigns, and O no longer 

offers all exhibited art for sale. The former 

board is replaced with members of the 

community who are not in the business of 

buying or selling art and who have skills and 

experience running educational programs 

and institutions. O promptly discontinues 

the practice of purchasing art from current or 

former trustees, adopts a written conflicts of 

interest policy, adopts written art valuation 

guidelines, hires legal counsel to recover the 

excess amounts O had paid its former 

trustees, and implements a new program of 

educational activities. 

(ii) O’s purchases of art from its former 

trustees at more than fair market value 

constitute excess benefit transactions 

Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 53603 

between an applicable tax-exempt 

organization and disqualified persons under 

section 4958. Therefore, these transactions 

are subject to the appropriate excise taxes 

provided in that section. In addition, O’s 

purchases of art from its trustees at more than 

fair market value violate the proscription 

against inurement under section 501(c)(3) 

and § 1.501(c)(3)–1(c)(2). 

(iii) The application of the factors in 

§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as 

follows. In Year 3, O does not engage in any 

regular and ongoing activities that further 

exempt purposes. However, in Year 4, O 

elects a new board of trustees comprised of 

individuals who have skills and experience 

running educational programs and 

implements a new program of educational 

activities. As a result of these actions, 

beginning in Year 4, O engages in regular and 

ongoing activities that further exempt 

purposes. The size and scope of the excess 

benefit transactions that occurred in Year 3, 

taken collectively, are significant in relation 

to the size and scope of O’s regular and 

ongoing exempt function activities that were 

conducted in Year 3. Beginning in Year 4, 

however, as O’s exempt function activities 

are established and grow, the size and scope 

of the excess benefit transactions that 

occurred in Year 3 become less and less 

significant as compared to the size and extent 

of O’s regular and ongoing exempt function 

activities that began in Year 4 and continued 

thereafter. O was involved in repeated excess 

benefit transactions in Year 3. However, by 

discontinuing its practice of purchasing art 

from its current and former trustees, by 

replacing its former board with independent 

members of the community, and by adopting 

a conflicts of interest policy and art valuation 

guidelines, O has implemented safeguards 

that are reasonably calculated to prevent 

future violations. In addition, O has made a 

good faith effort to seek correction from the 

disqualified persons who benefited from the 

excess benefit transactions (its former 

trustees). Based on the application of the 

factors to these facts, O continues to meet the 

requirements for tax exemption under section 

501(c)(3). 

Example 3. (i) O conducts educational 

programs for the benefit of the general public. 

Since its formation, O has employed its 

founder, C, as its Chief Executive Officer. 

Beginning in Year 5 of O’s operations and 

continuing to the present, C caused O to 

divert significant portions of O’s funds to pay 

C’s personal expenses. The diversions by C 

significantly reduced the funds available to 

conduct O’s ongoing educational programs. 

The board of trustees never authorized C to 

cause O to pay C’s personal expenses from 

O’s funds. Certain members of the board were 

aware that O was paying C’s personal 

expenses. However, the board did not 

terminate C’s employment and did not take 

any action to seek repayment from C or to 

prevent C from continuing to divert O’s funds 

to pay C’s personal expenses. C claimed that 

O’s payments of C’s personal expenses 

represented loans from O to C. However, no 

contemporaneous loan documentation exists, 

and C never made any payments of principal 

or interest. 

(ii) The diversions of O’s funds to pay C’s 

personal expenses constituted excess benefit 

transactions between an applicable taxexempt organization and a disqualified 

person under section 4958. Therefore, these 

transactions are subject to the appropriate 

excise taxes provided in that section. In 

addition, these transactions violate the 

proscription against inurement under section 

501(c)(3) and § 1.501(c)(3)–1(c)(2). 

(iii) The application of the factors in 

§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as 

follows. O has engaged in regular and 

ongoing activities that further exempt 

purposes both before and after the excess 

benefit transactions occurred. However, the 

size and scope of the excess benefit 

transactions engaged in by O beginning in 

Year 5, collectively, are significant in relation 

to the size and scope of O’s activities that 

further exempt purposes. Moreover, O has 

been involved in repeated excess benefit 

transactions. O has not implemented any 

safeguards that are reasonably calculated to 

prevent future diversions. The excess benefit 

transactions have not been corrected, nor has 

O made good faith efforts to seek correction 

from C, the disqualified person who 

benefited from the excess benefit 

transactions. Based on the application of the 

factors to these facts, O is no longer described 

in section 501(c)(3) effective in Year 5. 

Example 4. (i) O conducts activities that 

further exempt purposes. O employs C as its 

Chief Executive Officer. C, on behalf of O, 

entered into a contract with Company K to 

construct an addition to O’s existing 

building. The addition to O’s building is a 

significant undertaking in relation to O’s 

other activities. C owns all of the voting stock 

of Company K. Under the contract, O paid 

Company K an amount that substantially 

exceeded the fair market value of the services 

Company K provided. When O’s board of 

trustees approved the contract with Company 

K, the board did not perform due diligence 

that could have made it aware that the 

contract price for Company K’s services was 

excessive. Subsequently, but before the IRS 

commences an examination of O, O’s board 

of trustees determines that the contract price 

was excessive. Thus, O concludes that an 

excess benefit transaction has occurred. After 

the board makes this determination, it 

promptly removes C as Chief Executive 

Officer, terminates C’s employment with O, 

and hires legal counsel to recover the excess 

payments to Company K. In addition, O 

promptly adopts a conflicts of interest policy 

and significant new contract review 

procedures designed to prevent future 

recurrences of this problem. 

(ii) The purchase of services by O from 

Company K at more than fair market value 

constitutes an excess benefit transaction 

between an applicable tax-exempt 

organization and disqualified persons under 

section 4958. Therefore, this transaction is 

subject to the appropriate excise taxes 

provided in that section. In addition, this 

transaction violates the proscription against 

inurement under section 501(c)(3) and 

§ 1.501(c)(3)–1(c)(2). 

(iii) The application of the factors in 

§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as 

follows. O has engaged in regular and 

ongoing activities that further exempt 

purposes both before and after the excess 

benefit transaction occurred. Although the 

size and scope of the excess benefit 

transaction were significant in relation to the 

size and scope of O’s activities that further 

exempt purposes, the transaction with 

Company K was a one-time occurrence. By 

adopting a conflicts of interest policy and 

significant new contract review procedures 

and by terminating C, O has implemented 

safeguards that are reasonably calculated to 

prevent future violations. Moreover, O took 

corrective actions before the IRS commenced 

an examination of O. In addition, O has made 

a good faith effort to seek correction from 

Company K, the disqualified person who 

benefited from the excess benefit transaction. 

Based on the application of the factors to 

these facts, O continues to be described in 

section 501(c)(3). 

Example 5. (i) O is a large organization 

with substantial assets and revenues. O 

conducts activities that further exempt 

purposes. O employs C as its Chief Financial 

Officer. During Year 1, O pays $2,500 of C’s 

personal expenses. O does not make these 

payments under an accountable plan under 

§ 53.4958–4(a)(4) of this chapter. In addition, 

O does not report any of these payments on 

C’s Form W–2, ‘‘Wage and Tax Statement,’’

or on a Form 1099–MISC, ‘‘Miscellaneous 

Income,’’ for C for Year 1, and O does not 

report these payments as compensation on its 

Form 990, ‘‘Return of Organization Exempt 

From Income Tax,’’ for Year 1. Moreover, 

none of these payments can be disregarded 

under section 4958 as nontaxable fringe 

benefits and none consisted of fixed 

payments under an initial contract under 

§ 53.4958–4(a)(3) of this chapter. C does not 

report the $2,500 of payments as income on 

his individual federal income tax return for 

Year 1. O does not repeat this reporting 

omission in subsequent years and, instead, 

reports all payments of C’s personal expenses 

not made under an accountable plan as 

income to C. 

(ii) O’s payment in Year 1 of $2,500 of C’s 

personal expenses constitutes an excess 

benefit transaction between an applicable 

tax-exempt organization and a disqualified 

person under section 4958. Therefore, this 

transaction is subject to the appropriate 

excise taxes provided in that section. In 

addition, this transaction violates the 

proscription against inurement in section 

501(c)(3) and § 1.501(c)(3)–1(c)(2). 

(iii) The application of the factors in 

§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as 

follows. O engages in regular and ongoing 

activities that further exempt purposes. The 

payment of $2,500 of C’s personal expenses 

represented only a de minimis portion of O’s 

assets and revenues; thus, the size and scope 

of the excess benefit transaction were not 

significant in relation to the size and scope 

of O’s activities that further exempt purposes. 

The reporting omission that resulted in the 

excess benefit transaction in Year 1 is not 

repeated in subsequent years. Based on the 

application of the factors to these facts, O 

continues to be described in section 

501(c)(3). 

(3) Effective date. The rules in 

paragraph (g) of this section will apply 

with respect to excess benefit 

53604 Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules 

transactions occurring after the date of 

publication in the Federal Register of a 

Treasury Decision adopting these rules 

as final regulations. 

PART 53—FOUNDATION AND SIMILAR 

EXCISE TAXES 

Par. 3. The authority citation for part 

53 continues to read, in part, as follows: 

Authority: 26 U.S.C. 7805. 

Par. 4. In § 53.4958–2, paragraph 

(a)(6) is added to read as follows: 

§ 53.4958–2 Definition of applicable taxexempt organization. 

(a) * * * 

(6) Examples. The following examples 

illustrate the principles of this section, 

which defines an applicable tax-exempt 

organization for purposes of section 

4958: 

Example 1. O is a nonprofit corporation 

formed under state law. O filed its 

application for recognition of exemption 

under section 501(c)(3) within the time 

prescribed under section 508(a). In its 

application, O described its plans for 

purchasing property from some of its 

directors at prices that would exceed fair 

market value. After reviewing the 

application, the IRS determined that because 

of the proposed property purchase 

transactions, O failed to establish that it met 

the requirements for an organization 

described in section 501(c)(3). Accordingly, 

the IRS denied O’s application. While O’s 

application was pending, O engaged in the 

purchase transactions described in its 

application at prices that exceeded the fair 

market value of the property. Although these 

transactions would constitute excess benefit 

transactions under section 4958, because the 

IRS never recognized O as an organization 

described in section 501(c)(3), O was never 

an applicable tax-exempt organization under 

section 4958. Therefore, these transactions 

are not subject to the excise taxes provided 

in section 4958. 

Example 2. O is a nonprofit corporation 

formed under state law. O files its 

application for recognition of exemption 

under section 501(c)(3) within the time 

prescribed under section 508(a). The IRS 

issues a favorable determination letter in 

Year 1 that recognizes O as an organization 

described in section 501(c)(3). Subsequently, 

in Year 5 of O’s operations, O engages in 

certain transactions that constitute excess 

benefit transactions under section 4958 and 

violate the proscription against inurement 

under section 501(c)(3) and § 1.501(c)(3)–

1(c)(2). The IRS examines the Form 990, 

‘‘Return of Organization Exempt From 

Income Tax’’, that O filed for Year 5. After 

considering all the relevant facts and 

circumstances in accordance with 

§ 1.501(c)(3)–1(g), the IRS concludes that O is 

no longer described in section 501(c)(3) 

effective in Year 5. The IRS does not examine 

the Forms 990 that O filed for its first four 

years of operations and, accordingly, does 

not revoke O’s exempt status for those years. 

Although O’s tax-exempt status is revoked 

effective in Year 5, under the lookback rules 

in § 53.4958–2(a)(1) and § 53.4958–3(a)(1) of 

this chapter, for a period of five years prior 

to the excess benefit transactions that 

occurred in Year 5, O was an applicable taxexempt organization and O’s directors were 

disqualified persons as to O. Therefore, the 

transactions between O and its directors 

during Year 5 are subject to the appropriate 

excise taxes provided in section 4958. 

* * * * * 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 05–17858 Filed 9–8–05; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 117 

[USCG–2005–22362; Formerly CGD08–05–

046] 

RIN 1625–AA09 

Drawbridge Operation Regulation; Gulf 

Intracoastal Waterway, West Larose, 

LA 

AGENCY: Coast Guard, DHS. 

ACTION: Notice of proposed rulemaking; 

change of address and docket number 

for comments. 

SUMMARY: On September 2, 2005, the 

Coast Guard published a notice and 

requested comments on a proposed 

change to regulations governing the 

operation of the SR 1 (West Larose) 

vertical lift bridge across the Gulf 

Intracoastal Waterway, mile 35.6 west of 

Harvey Lock, at Larose, Louisiana. The 

proposed rule would change the 

bridge’s schedule so that it would 

remain closed to navigation at various 

times on weekdays during the school 

year to facilitate the safe, efficient 

movement of staff, students and other 

residents within the parish. That notice 

was issued August 26, 2005, before 

Hurricane Katrina struck New Orleans 

and caused that city to be flooded. We 

have changed the address and docket 

number where comments on the 

proposed rule should be sent because of 

flood conditions in New Orleans. 

DATES: Comments and related material 

must reach the Coast Guard on or before 

November 1, 2005. 

ADDRESSES: You may submit comments 

identified by Coast Guard docket 

number USCG–2005–22362 to the 

Docket Management Facility at the U.S. 

Department of Transportation. To avoid 

duplication, please use only one of the 

following methods: 

(1) Web Site: http://dms.dot.gov. 

(2) Mail: Docket Management Facility, 

U.S. Department of Transportation, 400 

Seventh Street SW., Washington, DC 

20590–0001. 

(3) Fax: 202–493–2251. 

(4) Delivery: Room PL–401 on the 

Plaza level of the Nassif Building, 400 

Seventh Street SW., Washington, DC, 

between 9 a.m. and 5 p.m., Monday 

through Friday, except Federal holidays. 

The telephone number is 202–366–

9329. 

(5) Federal eRulemaking Portal: 

http://www.regulations.gov. 

FOR FURTHER INFORMATION CONTACT: 

Roger Wiebusch, Bridge Administration 

Branch, telephone 314 539–3900, ext. 

2378. 

SUPPLEMENTARY INFORMATION: 

Request for Comments 

We encourage you to participate in 

this rulemaking by submitting 

comments and related material. If you 

do so, please include your name and 

address, identify the docket number for 

this rulemaking (USCG–2005–22362), 

indicate the specific section of this 

document to which each comment 

applies, and give the reason for each 

comment. Please submit all comments 

and related material in an unbound 

format, no larger than 81⁄2 by 11 inches, 

suitable for copying. If you would like 

to know they reached us, please enclose 

a stamped, self-addressed postcard or 

envelope. We will consider all 

comments and material received during 

the comment period. We may change 

this proposed rule in view of them. 

Change of Address and Docket 

The notice of proposed rulemaking 

published September 2, 2005 (70 FR 

52343) entitled, ‘‘Drawbridge Operation 

Regulation; Gulf Intracoastal Waterway, 

West Larose, LA’’, listed an address in 

New Orleans, LA, as the place to send 

your comments on the proposed rule. 

That rulemaking notice was issued 

August 26, 2005, before Hurricane 

Katrina struck New Orleans and flooded 

that city. We have changed the location 

for receiving comments because of flood 

conditions in New Orleans. If you wish 

to comment on the proposed rule, send 

your comment to the Docket 

Management Facility in Washington, 

DC, by one of the means indicated in the 

ADDRESSES section above in this notice. 

With this change of address, we have 

also changed the docket number to 

USCG–2005–22362. Please use this new 

docket number.