Intermediate Sanctions

WHAT ARE THE PENALTIES?

We have examined the organizations, individuals, and decisions involved in excess benefit transactions. We've also looked at executive compensation data collection for tax-exempt organizations. Now let's look at the penalties that occur should a tax-exempt organization be found in violation of this law.

Intermediate sanctions don't prohibit transactions between the organization and the disqualified person, but they do require those transactions to be reasonable.

There are two sets of penalties levied:

• one set against the disqualified person
• the other set against the organization managers

These penalties are severe and can add up to a great deal of money payable by the disqualified person.

Penalties for Disqualified Persons

The penalties against the disqualified person fall into three categories:

• correction
• excise tax
• additional tax

Correction

Correction requires:

• the excess benefit to be reversed to the extent possible

• AND

• taking additional steps necessary to restore the organization to a financial position not worse than where it would be if the disqualified person had dealt under the highest fiduciary standards

An excess benefit is correctable only by the disqualified person making a payment in cash or cash equivalents equal to the correction amount. If the excess benefit transaction results, in whole or in part from the vesting of benefits under a nonqualified deferred compensation plan, then to the extent the benefits have not yet been distributed, the disqualified person may correct the portion of the excess benefit resulting from the undistributed deferred compensation by relinquishing any right to receive the excess portion of the undistributed deferred compensation. There's no need to terminate a contract that has not been completed. However, the terms of the contract may need to be re-negotiated.

Remedy. The amount to be repaid is the sum of the excess benefit, plus interest on the excess benefit at a rate that equals or exceeds the applicable federal interest rate, compounded annually. The period from the date the excess benefit transaction occurred to the date of correction determines whether to use the federal short-term rate, mid-term rate, or long-term rate. If the tax-exempt organization no longer exists, the disqualified person must make repayment to a like (similar) organization.

Excise tax. If the disqualified person has been found to receive an excess benefit, he or she must pay a tax of 25% of the excess benefit. This tax is also known as the Initial Tax or First Tier Tax. The excise tax is payable within a taxable period.

Additional tax. If unpaid within the taxable period, an additional tax of 200% of the excess benefit will be imposed. However, if the excess benefit is corrected within 90 days after the mailing of the notice of deficiency, the additional taxes will either not be assessed or be abated. If less than the full correction amount is paid, the 200% penalty will be imposed only on the unpaid portion. This tax is sometimes called a Second Tier Tax.

Reimbursement and insurance. The organization may choose to reimburse the disqualified person for the amount of the taxes. However, this reimbursement must itself be treated as an excess benefit unless it's included in the compensation of the disqualified person for the year in which the reimbursement is made. In that case, the total package (including the reimbursement) must be shown to be reasonable. Likewise, if the organization provides liability insurance to protect against excess benefit claims, those premiums are considered part of the disqualified person’s compensation for purposes of determining reasonableness.