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Mission Matters Insights

Avoid Private Inurement to Keep Your Tax Exempt Status

April 02, 2015

Manage your compensation arrangements to avoid a private inurement transaction, or you could be on the hook for hefty excise taxes.

Nonprofits enjoy a tax exempt status, as detailed in our recent blog, “Don’t Lose Your 501(c)(3) Tax Exempt Status: Nonprofit Update,” and part of maintaining that status is by regulating something called private inurement. The prohibition against inurement is contained in the Internal Revenue Code and prohibits the use of assets or income of a nonprofit organization for the direct or indirect benefit of an individual with a close connection to the nonprofit. This serves to regulate control over the organization and ensure that all employees and managers have honest intentions.

How the IRS views an Excess Benefit Transaction

As suggested by its other name, The Excess Benefit Transaction, private inurement is a serious deal to the IRS. Inurement could lead to substantial penalties for 501(c)(3) and (c)(4) organizations involved. The IRS takes any amount of inurement seriously, but it considers a number of circumstances when deciding if your organization is involved with inurement. The IRS will ask the following questions when reviewing potential inurement:

  • Have there been multiple excess benefit transactions with one or more individuals?
  • What are the size and extent of the organization’s regular and ongoing activities before and after the inurement?
  • How does the excess benefit transaction affect regular and ongoing exempt activities?
  • Has the inurement been remedied?
  • Is there planning in place to avoid another excess benefit transaction?

Penalties

There are varying tax consequences depending on the timeline of your inurement and when you get it resolved.

  • If the inurement is reported and resolved in the same time it occurred, the guilty person is charged a 25% excise tax.
  • If the inurement is not resolved in the same period in which it occurred, the guilty person is subject to an excise tax as high as 200%.

Managers who involve themselves in inurement can suffer a 10% tax on the excess benefit, in an amount up to $20,000.

Maintain your governance policies!

Compensation is the area that excess benefit transactions typically occur. To avoid inurement at all costs, your nonprofit should:

  • Make sure you have a governing body that approves compensation and that no one in that governing body has a conflict of interest regarding the compensation procedure.
  • Make sure that the governing body documents its actions properly.
  • Make sure that the governing body approves the compensation using comparable data.

Periodic adjustments to your existing governance will be helpful in the long run. Keeping detailed records is the basis for protection against inurement, be sure to maintain adequate records!

For more information on inurement and safeguarding your organization against it, contact any member of our Not-for-Profit Services Team.

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