At a recent conference on nonprofit governance sponsored by Georgetown Law Center, an IRS official stated that fringe benefits have become the most common trigger of intermediate sanctions under Section 4958 of the Code.
As most of you know, or should know, Section 4958 of the Code, enacted in 1996, imposes excise taxes on both “disqualified persons” who receive an “excess benefit” from an exempt organization and any organization manager who knowingly participates in an excess benefit transaction.
When an economic benefit is not treated as compensation by the organization, the benefit is presumed to constitute an excess benefit transaction in its entirety, unless the disqualified person can establish that it was properly excludable from income for income tax purposes, or involved a legitimate non-compensatory transaction with the organization.
In February of 2010, the IRS began its first Employment Tax National Research Project in 25 years. This three-year “study” focuses on uncollected taxes in the area of employment for both taxable and exempt entities. As part of this study, 2,000 taxpayers are being selected each year for a comprehensive audit. Fringe benefits are one of the main areas of focus in these audits, making this a priority issue for the IRS.
Exempt organizations should take note. While executives of charitable organizations often receive fringe benefits as part of their compensation package, organizations may fail to include the value of those benefits when calculating the total compensation paid to executives and may fail to report them on the executive’s W-2. If taxable fringe benefits are not included on the executive’s W-2, the omitted amount is an “automatic” excess benefit transaction.
Conference attendees report that Peter Lorenzetti, a manager in the Exempt Organizations division of the IRS, warned exempt organizations that for excludable working condition fringe benefits, organizations must put in place a comprehensive plan that provides guidance on reimbursements and requires employees to substantiate the expenses. A panelist at the conference noted that employees must present original receipts, rather than credit card statements, in order to meet these substantiation requirements. The panelist recommended that the board of an exempt organization should routinely review the CEO’s expense reimbursements to insure that they are appropriate. The IRS manager also reminded exempt organizations that with respect to any taxable fringe benefits, an organization must make its intent to treat such benefits as compensation clear in order to avoid the presumption that the provision of such benefits constitutes an excess benefit transaction.