The Internal Revenue Code (the “Code”) and IRS regulations impose penalty (“excise”) taxes on “excess benefits transactions” between tax-exempt organizations and “disqualified persons” as defined in the Code.  These taxes are referred to as “intermediate sanctions” because they allow the IRS to impose a penalty in between doing nothing and penalizing the organization by revoking its tax-exempt status.  Notably, “excess benefits transactions” include compensation for services where the value of the compensation exceeds the value of the services, and “all consideration and benefits” (with certain exceptions such as expense reimbursements and nontaxable fringe benefits) are taken into account.  

The taxes may be imposed on the person receiving the compensation and the organization’s managers.  These taxes are based on percentages of the amount involved.  The initial level of tax on the recipient is 25% of the amount involved, while the tax on organization managers is 10% with a maximum of $20,000 in the aggregate.  The tax increases significantly for failure to make timely corrections of improper payments or benefits.  In addition, excess amounts of compensation must be returned to the organization, with interest.  So the cost of noncompliance can be very substantial.  The effect of the penalty is magnified because if the excess must be returned, it may be long after the recipient has spent it – and indeed, the excess may have been received in the form of goods or services (such as use of a house or car, or health of other life insurance) that were not paid in cash originally.