How much do you know about excess benefit transactions (EBTs)? You probably understand that if your nonprofit provides financial benefits to certain people, it can result in IRS scrutiny and severe excise taxes. So you also probably have policies in place to curb or prohibit financial transactions with “disqualified persons.” 

But the truth is, not every transaction between a disqualified person and a nonprofit is necessarily prohibited. If the IRS questions one of your organization’s transactions, you may be able to fight back using a rebuttable presumption.

Defining terms

EBTs are generally defined as transactions in which a nonprofit (other than a private foundation) provides a benefit to a disqualified person that exceeds the value of the consideration received in exchange for the benefit. Let’s unpack some of these terms. 

In general, disqualified persons are:

• In a position to exercise substantial influence over the organization’s affairs over the past five years, such as voting board members and top management,
• Certain individuals who belong to a disqualified person’s family,
• Disqualified persons of the nonprofit’s supporting organization,
• Donors or donor advisors involved in the organization’s transaction with their donor-advised fund (DAF),
• Investment advisors to a DAF sponsoring organization, or
• Entities of which a disqualified person has a 35% or greater stake doing business with the nonprofit.

A disqualified person who engages in an EBT is liable for an excise tax equal to 25% of the excess benefit. If the transaction isn’t promptly corrected after the tax is imposed, an additional excise tax of 200% of the excess benefit is imposed. An organization manager who knowingly participates in an EBT could incur an excise tax equal to 10% of the excess benefit, up to $20,000. 

Consideration received by a disqualified person might include money, property or the performance of services. Although EBTs often involve unreasonable employment compensation, other transactions may also be off-limits.

EBT transactions can range from a nonprofit paying a disqualified person’s personal expenses to agreeing to let the person use its property for personal reasons to making a loan to (or accepting a loan from) the person. Other transactions that the IRS might flag are revenue-sharing arrangements, payments to for-profit corporations owned by disqualified individuals and the transfer of assets to or from an entity controlled by a disqualified person, including loans.

Rebutting presumptions

If the IRS accuses your organization of a prohibited transaction, you may be able to establish a “rebuttable presumption” that the transaction isn’t an illegal EBT. A rebuttable presumption is a legal principle that assumes something to be true unless proven otherwise.

EBT regulations presume fair market value in arrangements involving employment compensation, property transfers and property use rights. For a transaction to qualify, your organization’s authorized body (for example, its board of directors) must be composed entirely of individuals without a conflict of interest. The authorized body needs to do three things: 

1. Approve the transaction and its terms,
2. Obtain and rely on appropriate comparable data (such as an independent compensation survey) before making its determination,
3. Adequately and concurrently document the basis for its determination (including the terms and approval date).

Comparability data is particularly important. If you satisfy the above requirements, the IRS must produce significant contrary evidence about the data’s relevance to rebut the presumption. Be sure to consult your attorney about your legal position and any litigation strategies.

Obtaining adequate data

If you run a smaller nonprofit, you may worry you wouldn’t be able to obtain adequate comparability data. However, IRS regulations provide some relief to nonprofits with annual gross receipts of less than $1 million. If you qualify, your authorized body will be considered to have appropriate data if it details compensation paid for similar services by three similar organizations in your community or in communities like yours. Contact us for help with obtaining such data and for more information about avoiding potential EBTs.