We did What?! Now What? – Nonprofit Organizations and Excess Benefit Transactions

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Cory D. Halliburton

Cory D. Halliburton



Cory Halliburton serves as general counsel and business adviser to a nationwide nonprofit / tax-exempt client base, as well as for multi-state professional service companies. He is a results-oriented attorney, with executive-level strategy and an understanding of the intersection of law and business judgment. With a practical upbringing, he pushes for process-driven results in internal governance, strategy and compliance with employment law, and complex or unique contracts and business relationships.

He dedicated the first ten years of his practice to mainly commercial litigation matters in West Texas and the Dallas-Fort Worth Metroplex. During that experience, Mr. Halliburton transitioned his practice to a more general counsel role, with an emphasis on nonprofit and tax-exempt organizations, advising those organizations through formation, dissolution, litigation, governance, leadership succession, employment law, contracts, intellectual property, tax exemption issues, policy creation, mergers and other. He has served as borrower’s counsel for tax-exempt bond and loan transactions near $100 million aggregate; some with complex pre-issue construction, debt payoff and other debt financing challenges.

Mr. Halliburton also serves as outside legal and business advisor for executive professionals in multi-state engineering firms, with a focus on drafting and counsel on significant service agreements, employment law matters, and protection of trade secrets.

This Freeman Law Insights blog provides an overview of the excess benefit transaction rules of 26 U.S.C. § 4958 and corresponding Treasury Regulations, 26 C.F.R. § 53.4958-1, et. seq.

Excess Benefit Transaction. Under the Internal Revenue Code, an excess benefit is an amount by which the value of the economic benefit provided by a tax-exempt organization directly or indirectly to or for the use of a “disqualified person” (i.e., a control person, director, officer, etc.) exceeds the value of the consideration, including the performance of services, received by the organization for providing such benefit.

Taxes Triggered. The Internal Revenue Code imposes a tax equal to 25% of the excess benefit on each excess benefit transaction. That 25% tax “shall be paid by” the disqualified person. In addition, the Code imposes a tax equal to 200% of the excess benefit in any case in which the 25% tax is imposed, and the transaction is not corrected within the applicable taxable period. Thus, the amount of excess in an excess benefit transaction can trigger excise taxes assessed against the disqualified person who benefits from the transaction up to 225% of the excess involved.

Taxes Assessed Against the Organization’s Manager(s). The organization’s managers (i.e., those serving on the governing board or otherwise approving the transaction, as applicable) who knowingly participate in the approval of, or who acquiesce by silence to such a transaction can be assessed with an excise tax of up to 10% (up to $20,000) of the excess. The term “knowing” includes actual knowledge of and/or negligently failing to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.

Reasonable Cause. The managers may avoid the excise taxes under section 4958 of the Code if their participation is due to “reasonable cause,” meaning the manager exercised responsibility on behalf of the organization with ordinary business care and prudence.

Joint and Several Liability. In any case where more than one “manager” is liable for a tax imposed under section 4958, “all such persons shall be jointly and severally liable for the taxes” so imposed with respect to that excess benefit transaction.

Correction. An excess benefit transaction is (and should be) corrected by undoing the excess benefit to the extent possible. This is done by executing any measures necessary to place the applicable tax-exempt organization involved in the excess benefit transaction in a financial position not worse than that in which it would be if the disqualified person were dealing under the “highest fiduciary standards.” Correction may include return of cash or property or modifying any contractual arrangement that created the excess benefit. And, the cash amount of correction should include interest in order to make the tax-exempt organization whole.

IRS Form for Reporting. The transaction and taxes arising from same may be required by law to be reported to the IRS. The reporting process is through IRS Form 4720.

Insights. Due care should be taken in, for starters, not authorizing a transaction that constitutes an excess benefit transaction under the Code. And, if such a transaction happens to have been approved for the applicable tax-exempt organization, due care should be taken to identify, unravel, and report the transaction (as the circumstances require) so as to comply with U.S. federal tax laws and to avoid the deeper tax, penalties, and interest consequences to the disqualified person in issue and those at the governing helm of the organization. Competent legal and tax counsel is advisable in these situations because the price of U.S. tax poker in these situations can be extreme. Many times the good will of the organization and the relationship among leaders involved in the excess benefit transaction can be eroded, sometimes to the point of no return, absent a remedy rendered by a court of law. But, the bold stand righteous like a lion, and it is best to face the federal income tax issues head-on so as to fortify the integrity of the organization and of those in leadership positions that drive the organization’s mission forward.