Proposed regulations clarifying the relationship between the substantive requirements for exemption under Code section 501(c)(3) and the imposition of intermediate sanction excise taxes under Code section 4958 have been revised and published in final form. The final regulations, which became effective on March 27, 2008, provide guidance with respect to when a 501(c)(3) organization may risk losing its exempt status by engaging in one or more excess benefit transactions.

The proposed regulations included three examples used to illustrate the differences between activities that serve a private interest rather than a public interest. These examples indicated that prohibited private benefit may include non-economic and economic benefits, and may arise even if payments made to private interests are not excessive. The final regulations adopted the three examples without significant change.

The proposed regulations also identified several factors that the IRS will consider in determining whether to revoke an organization’s exempt status because of the organization’s engagement in excess benefit transactions. Such factors included: (1) the size and scope of the organization’s exempt activities before and after the excess benefit transaction(s); (2) the size and scope of the excess benefit transaction(s) in comparison to the size and scope of the organization’s exempt activities; (3) whether the organization engaged in repeated excess benefit transactions; (4) any safeguards the organization implemented to prevent future excess benefit transactions; and (5) any corrective measures taken by the organization.

The final regulations adopted the proposal with the following minor revisions:

  • In the third factor, the word “repeated” was replaced by the word “multiple.” The word “multiple” refers to both: (i) repeated instances of excess benefit transactions; and (ii) the presence of more than one excess benefit transaction.
  • The fourth factor was revised to provide that if an approved transaction is later determined to be an excess benefit transaction, an organization’s implementation of, and reliance on, safeguards to prevent excess benefit transactions will be treated as a factor weighing in favor of continuing to recognize exemption.
  • Under the fifth factor, the IRS will take into account an organization’s good faith with respect to correction. A new example was added to illustrate that even in the absence of correction of a non-de minimis excess benefit transactions an organization may retain its exempt status if the other factors favor continued exemption.
  • A new example was added to illustrate:
    • what constitutes reasonable compensation;
    • what factors, other than correction, would be sufficient to avoid revocation;
    • the effect of an excess benefit transaction that is not de minimis on an organization’s exempt status; and
    • that removal of a disqualified person is not a necessary condition for continued exemption.