Intermediate Sanctions

Q3: What Transactions are Involved?

At the center of the intermediate-sanctions concept are the transactions that elicit the sanctions. These are called excess benefit transactions.

In social science and law, there are ideas about how transactions should occur. These concepts usually involve a balance between the parties. In social science, this is called the exchange theory.

For an exchange to work, each party must feel that he or she got a fair exchange. This fairness is based on the needs of each party for different things, AND each party's perception of the worth of what was contributed and what was received.

In the case of excess benefit transactions, there are two complicating facts:

1. There is a third party — the IRS. This party is present because the exchange is in the context of the tax-exempt organization wherein organizational assets should flow primarily to the people being served.
2. Rather than perceptions of the parties involved, there is a requirement for developing the exchange based on factual data.

Excess benefit transactions are based on the fundamental principle of the law of contracts that requires that there be consideration for a contract to be enforceable.

Element of knowledge

The above discussion might cause you to think that as long as the parties are satisfied, there's no excess benefit involved, but that's not generally correct.

The parties' knowledge of whether the transaction is or isn't excessive is irrelevant to the determination of excess. So, people may find that they're accused or even guilty of an excess benefit transaction even if they acted in good faith. This is particularly true when the subject is compensation.

Indirect excess benefit transactions

An excess benefit transaction may be either a direct or an indirect exchange. There are two ways in which a transaction may be indirect:

1. Through a controlled entity. If the tax-exempt organization owns more than a 50% interest in an organization (or controls at least 50% of the directors of a non-stock organization), that organization is a controlled entity. If it's a controlled entity, then the economic benefits provided will be treated as though they were provided by the tax-exempt organization.
2. Through an intermediary. An intermediary is any person (including another tax-exempt entity) that participates in a transaction with a disqualified person of the exempt organization. Economic benefits provided by the intermediary are treated as being provided by the tax-exempt organization when:
   • the tax-exempt organization provides an economic benefit to the intermediary

   • AND

   • in connection with receipt of the benefit by the intermediary, there is evidence of an oral or written agreement or understanding that the intermediary will provide benefits to or for the use of the disqualified person, or the intermediary provides benefits to or for the use of the disqualified person without a significant business or exempt purpose of its own.