DRESNER FINANCIAL PLANNING
Financial Advisor to clergy and religious educators 

Intermediate Sanctions and Presumption of Reasonableness

Not too long ago, a nondenominational independent church was founded by a minister and was given the power to select all the directors. The minister selected himself, his wife, and their two sons and a daughter as the church's directors. Over time, several homes and vehicles were paid for in cash by the church. Also, credit cards and cell phones were distributed to all family members.

The church never adopted an accountable reimbursable plan and no one at the church accounted for the personal use of the church assets and credit cards. Virtually no receipts or logs were kept. After an examination of the family's tax returns in 2004, the IRS asserted penalties and taxes that could exceed 265% of the benefits that the church gave the family.

Since the church did not have an accountable reimbursable plan, all expenses that benefited the family members, and were not substantiated as bona fide business-related, were considered excess benefit transactions. Since no logs were kept for the cell phone usage, they were considered excess benefit transactions. No mileage logs were kept, so the vehicles were also considered excess benefit transactions. The church provided several homes and paid some expenses related to them. But since the church provided more than one parsonage, the fair rental value of the additional homes was deemed an excess benefit transaction.

Prior to Congress passing "intermediate sanctions", the only recourse the IRS had was to revoke the church's tax exempt status. This can be considered a severe and harsh remedy which could cause more harm than good, since it tended to destroy the non-profit organization while doing nothing to the individual who received the excess benefit. Congress passed what is called "intermediate sanctions" in 1996. This kind of sanction provides for a new penalty tax imposed on insiders (called "disqualified persons") who exercise substantial influence over certain tax-exempt organizations and who use that influence to benefit themselves. Excess benefit transactions is defined as where an insider is paid more than what is considered reasonable, and receives a taxable benefit that is not included in the insider's taxable income.

There are two types of tax-exempt organizations that are affected: section 501 (c)(3) public charities; and section 501 (c)(4) social welfare organizations. The law applies to most officers and directors as well as their families.

What kind of penalties can be imposed? For the disqualified person who obtains an excess benefit from the charity, he or she can be fined 25% of the excessive benefit, and be required to "correct the transaction" (read, reimburse the amount of the excessive income as well as interest). Also, an additional tax of 200% of the excess benefit may be imposed if there is no correction of the excess benefit transaction within a specified time period.

The "organization managers" who participated in the transaction "knowing" that it was improper, can have a penalty tax equal to 10% of the excessive benefit imposed on them (up to a maximum of $10,000 per transaction)

A "rebuttable presumption of reasonableness" can be instituted when a three-step process is followed. An independent oversight board (or an independent committee comprised of board members) must:
1. be composed entirely of individuals unrelated to and not subject to the control of the disqualified person
2. obtain and rely upon "appropriate data" for comparability
3. adequately document the basis for their determination while making their decision

Now granted that this minister's case is an example of an egregious use of church property, but there's nothing to prevent the IRS from using intermediate transactions on cases far less flagrant (blatant).

In order to avoid the possibility of being penalized with intermediate sanctions:

  • Identify in advance all persons who are likely to be considered disqualified persons (in addition to that person's family members)
  • Institute an accountable reimbursable plan that is reviewed by a professional tax advisor Assiduously follow the plan
  • Have expense reports reviewed by an independent party for appropriateness and detail
  • Hire independent finance people to perform an audit to question any transaction, and ensure all taxable benefits are included on the clergy's W-2.
  • Periodically review all fringe benefits for appropriateness, and to determine if they are taxable.

 

Dresner Financial Planning Dresner@clergyplanning.com
2359 Salisbury Road Westbury, NY 11590
(888) 200-9670
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