The Georgia Scroll
October 1997
Much has been written about the intermediate sanctions portion of the Taxpayer Bill of Rights 2 which was signed into law July 30, 1996. The intermediate sanctions provide a new revenue raising device and a method of addressing the public impression that far too often insiders of tax-exempt organizations take unfair advantage of the exempt organizations to benefit themselves. Affecting over 500,000 organizations and the manner in which they conduct their daily operations, this is perhaps the most significant new law to affect tax-exempt organizations in 20 years.
The Cornerstone of Section 4958
Internal Revenue Code ("Code") Section 4958 provides the backbone of the intermediate sanctions enforcement. Specifically, the section imposes actual monetary penalties upon the disqualified persons and organizational managers who engage in excess benefit transactions. The risk of personal financial penalty to directors greatly heightens the sensitivity of the issue. As defined by the Code, the excess benefit transaction is that in which, ". . . an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person, if the value of the economic benefit provided exceeds the value of the consideration received from providing such benefit." The definition requires an economic balancing analysis, weighing the costs to the organization against the benefits received by the "disqualified person" (defined below).
Treasury Regulations will most likely further define the content of an excess benefit, but many commentators suggest that the benefit must have a measurable fair market value, be provided outside the ordinary course of business and not be incidental.
The tax imposed upon the disqualified persons is a two-tiered tax, in addition to the correction of the excess benefit by the return of the benefit to the tax-exempt organization:
The organization's managers who knowingly participate in the attainment of an excess benefit by a disqualified person shall also be subject to a tax equal to 10% of the excess benefit, unless the manager's participation is not willful and is due to reasonable cause. The Code specifically limits the organizational manager's liability under this section to $10,000.
Current Planning and Operational Action
The law is retroactive to September 14, 1995 thus tax-exempt organizations should have already taken steps to approach the intermediate sanctions and the parameters of operations contained therein. Treasury Regulations are currently unavailable (though eagerly anticipated), but there are several steps that tax-exempt organizations should be taking now to meet the anticipated guidelines.
Develop a Comprehensive Compliance Plan
The initial step in addressing the intermediate sanctions law is to identify individuals who may be characterized as "disqualified persons." Individuals who are typically disqualified persons include:
The Committee Reports note that an individual who holds the title of officer, director, or trustee is not automatically considered a disqualified person. Officers may be disqualified depending upon their level of authority and influence. Physicians are not "per se" disqualified, as their status will depend upon their ability to exercise "substantial influence" over the organization. Illustrative of the degree of substantial influence necessary to derive the character of a disqualified person, an organizational officer who controls (i.e. exercises substantial influence over the apportionment and utilization of) 60% of the organization's budget would be regarded as a disqualified person whereas an officer who oversees only 1% may not be considered as such.
Building a Rebuttable Presumption of Reasonableness
The legislation outlines particular safe harbors which allow disqualified individuals to protect themselves and their decisions from the intermediate sanctions penalty. A presumption of reasonableness will exist if the organization can establish that the decision was made by:
Connducting various decision-making process within this framework should sufficiently meet Congress' intent of the law:
To meet these demands of safe harbor, tax-exempt organizations should take the following proactive steps:
Construct an Active Conflicts Policy
In what has become a threshold issue for the IRS in the application of tax-exempt status, the construction and application of a conflict of interest policy is vital to the avoidance of intermediate sanctions liability. An effective policy will actively assist board members and other potentially disqualified individuals in their decision making process and will provide the necessary checks and balances documentation that the Service will review upon audit.
The enactment and enforcement of the intermediate sanctions provisions will have a dramatic impact on the operation of modern tax-exempt healthcare providers. Where once only the organizations themselves were concerned with whether or not a proposed transaction would harm their tax-exempt status, the current burden of concern lies with the individuals driving the transactions, both within the organization's formal leadership and outside of the general channels of recognized leadership. The net effect is most probably to enhance the negotiating posture of the tax-exempt organization with respect to its transactions with individuals and other taxable organizations. Taking the proactive steps defined above will further define this posture and reduce the potential tax exposure of the parties involved.
Charles S. Mann, CPA is a senior tax manager with Arthur Andersen LLP in Atlanta, specializing in healthcare.
R. Michael Barry, JD is a tax consultant with Arthur Andersen LLP in Atlanta, specializing in healthcare.