Standards for Recognition of Tax-Exempt Status if Private Benefit Exists or If an Applicable Tax-Exempt Organization Has Engaged in Excess Benefit Transaction(s), 53599-53604 [05-17858]
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Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules
Additionally, any person may obtain
a copy of this notice by submitting a
request to the Federal Aviation
Administration, Office of Air Traffic
Airspace Management, ATA–400, 800
Independence Avenue, SW.,
Washington, DC 20591 or by calling
(202) 267–8783. Communications must
identify both docket numbers for this
notice. Persons interested in being
placed on a mailing list for future
NPRM’s should contact the FAA’s
Office of Rulemaking, (202) 267–9677,
to request a copy of Advisory Circular
No. 11–2A, Notice of Proposed
Rulemaking Distribution System, which
describes the application procedure.
The Proposal
The FAA is considering an
amendment to the Code of Federal
Regulations (14 CFR part 71), by
establishing Class E airspace at Nikolai,
AK. The intended effect of this proposal
is to establish new Class E airspace
upward from 700 feet (ft.) above the
surface within a 6.4 nautical mile (NM)
radius of the Nikolai Airport.
The FAA Instrument Flight
Procedures Production and
Maintenance Branch has developed two
SIAPs for the Nikolai Airport. The two
approaches are: (1) Area Navigation
(Global Positioning System) (RNAV
(GPS)) Runway (RWY) 04, original, and
(2) RNAV (GPS) RWY 20, original. Class
E controlled airspace extending upward
from 700 ft above the surface is needed
to provide air traffic control services
and would be established by this action.
The proposed airspace is sufficient to
contain aircraft executing the
instrument procedures for the Nikolai
Airport.
The area would be depicted on
aeronautical charts for pilot reference.
The coordinates for this airspace docket
are based on North American Datum 83.
The Class E airspace areas designated as
700/1200 foot transition areas are
published in paragraph 6005 in FAA
Order 7400.9M, Airspace Designations
and Reporting Points, dated August 30,
2004, and effective September 16, 2004,
which is incorporated by reference in 14
CFR 71.1. The Class E airspace
designations listed in this document
would be published subsequently in the
Order.
The FAA has determined that this
proposed regulation only involves an
established body of technical
regulations for which frequent and
routine amendments are necessary to
keep them operationally current. It,
therefore—(1) is not a ‘‘significant
regulatory action’’ under Executive
Order 12866; (2) is not a ‘‘significant
rule’’ under DOT Regulatory Policies
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and Procedures (44 FR 11034; February
26, 1979); and (3) does not warrant
preparation of a regulatory evaluation as
the anticipated impact is so minimal.
Since this is a routine matter that will
only affect air traffic procedures and air
navigation, it is certified that this rule,
when promulgated, will not have a
significant economic impact on a
substantial number of small entities
under the criteria of the Regulatory
Flexibility Act.
The FAA’s authority to issue rules
regarding aviation safety is found in
Title 49 of the United States Code.
Subtitle 1, section 106 describes the
authority of the FAA Administrator.
Subtitle VII, Aviation Programs,
describes in more detail the scope of the
agency’s authority.
This rulemaking is promulgated
under the authority described in subtitle
VII, part A, subpart 1, section 40103,
Sovereignty and use of airspace. Under
that section, the FAA is charged with
prescribing regulations to ensure the
safe and efficient use of the navigable
airspace. This regulation is within the
scope of that authority, because it
proposes to establish Class E airspace
sufficient to contain aircraft executing
instrument procedures at Nikolai
Airport and represents the FAA’s
continuing effort to safely and
efficiently manage the navigable
airspace.
List of Subjects in 14 CFR Part 71
Airspace, Incorporation by reference,
Navigation (air).
The Proposed Amendment
In consideration of the foregoing, the
Federal Aviation Administration
proposes to amend 14 CFR part 71 as
follows:
PART 71—DESIGNATION OF CLASS A,
CLASS B, CLASS C, CLASS D, AND
CLASS E AIRSPACE AREAS;
AIRWAYS; ROUTES; AND REPORTING
POINTS
1. The authority citation for 14 CFR
part 71 continues to read as follows:
Authority: 49 U.S.C. 106(g), 40103, 40113,
40120; E.O. 10854, 24 FR 9565, 3 CFR, 1959–
1963 Comp., p. 389.
§ 71.1
[Amended]
2. The incorporation by reference in
14 CFR 71.1 of Federal Aviation
Administration Order 7400.9M,
Airspace Designations and Reporting
Points, dated August 30, 2004, and
effective September 16, 2004, is to be
amended as follows:
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53599
Paragraph 6005 Class E airspace extending
upward from 700 or more feet above the
surface of the earth.
*
*
*
*
*
AAL AK E5 Nikolai, AK [New]
Nikolai Airport, AK
(Lat. 63°01′07″ N., long. 154°21′30″ W.)
That airspace extending upward from 700
feet (ft.) above the surface within a 6.4
nautical mile (NM) radius of the Nikolai
Airport.
*
*
*
*
*
Issued in Anchorage, AK, on August 30,
2005.
Joseph Rollins,
Acting Director, Alaska Flight Services Area
Office.
[FR Doc. 05–17839 Filed 9–8–05; 8:45 am]
BILLING CODE 4910–13–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 53
[REG–111257–05]
RIN 1545–BE37
Standards for Recognition of TaxExempt Status if Private Benefit Exists
or If an Applicable Tax-Exempt
Organization Has Engaged in Excess
Benefit Transaction(s)
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking.
AGENCY:
SUMMARY: This document contains
proposed regulations that clarify the
substantive requirements for tax
exemption under section 501(c)(3) of the
Internal Revenue Code (Code). This
document also contains provisions that
clarify the relationship between the
substantive requirements for tax
exemption under section 501(c)(3) and
the imposition of section 4958 excise
taxes.
DATES: Written comments and requests
for a public hearing must be received by
December 8, 2005.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–111257–05), room
5203, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand
delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to: CC:PA:LPD:PR (REG–111257–05),
Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue,
NW., Washington, DC. Alternatively,
taxpayers may submit comments
electronically via the IRS Internet site at
https://www.irs.gov/regs or the Federal
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Federal Register / Vol. 70, No. 174 / Friday, September 9, 2005 / Proposed Rules
eRulemaking Portal at https://
www.regulations.gov (IRS–REG–
111257–05). A public hearing may be
scheduled if requested.
FOR FURTHER INFORMATION CONTACT:
Concerning the regulations, Galina
Kolomietz, (202) 622–4441; Concerning
submission of comments and requests
for a public hearing, Richard Hurst,
(202) 622–7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. Section 501(c)(3) and the Regulations
Thereunder
To be described in section 501(c)(3),
an organization must be organized and
operated exclusively for religious,
charitable, scientific, or educational
purposes. In addition, no part of the net
earnings of the organization may inure
to the benefit of any private shareholder
or individual, no substantial part of the
organization’s activities may include
attempts to influence legislation, and
the organization may not intervene in
political campaigns.
Existing regulations under section
501(c)(3) were adopted in substantially
their present form in 1959. In explaining
and clarifying the statutory
requirements, these regulations provide
that, to be described in section 501(c)(3),
an organization must be both organized
and operated for exempt purposes. An
organization is not operated exclusively
for exempt purposes and, thus, is not
described in section 501(c)(3), if any of
its net earnings inure to the benefit of
a private shareholder or individual.
§ 1.501(c)(3)–1(c)(2). The regulations
define private shareholder or individual
as referring to persons having a personal
and private interest in the activities of
the organization. § 1.501(a)–1(c).
In addition, an organization is not
organized or operated for one or more of
the exempt purposes enumerated in
§ 1.501(c)(3)–1(d)(1)(i) and, thus, is not
described in section 501(c)(3), if it is
organized or operated for the benefit of
private interests such as designated
individuals, the creator or his family,
shareholders of the organization, or
persons controlled, directly or
indirectly, by such interests.
§ 1.501(c)(3)–1(d)(1)(ii).
These proposed regulations amend
the regulations under section 501(c)(3),
adding several examples to illustrate the
requirement in § 1.501(c)(3)–1(d)(1)(ii)
that an organization serve a public
rather than a private interest. The
examples illustrate that prohibited
private benefits may involve noneconomic benefits as well as economic
benefits. In addition, prohibited private
benefit may arise regardless of whether
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payments made to private interests are
reasonable or excessive. The examples
reflect current law.
B. Section 4958 and the Regulations
Thereunder
Section 4958 was added to the Code
by the Taxpayer Bill of Rights 2, Public
Law 104–168 (110 Stat. 1452, July 30,
1996). Section 4958 imposes certain
excise taxes on transactions that provide
excess economic benefits to disqualified
persons with respect to public charities
and social welfare organizations
described in sections 501(c)(3) and
501(c)(4), respectively. These
organizations are collectively referred to
as applicable tax-exempt organizations.
Section 4958(e). An excess benefit is the
amount by which the value of an
economic benefit provided by an
applicable tax-exempt organization
directly or indirectly to or for the use of
a disqualified person exceeds the value
of the consideration (including the
performance of services) received for
providing such benefit. § 53.4958–1(b).
A disqualified person is defined as a
person who is in a position to exercise
substantial influence over the affairs of
an applicable tax-exempt organization.
Section 4958(f)(1). Section 4958(a)
imposes the liability for excise taxes on
disqualified persons who receive an
excess benefit from, and on certain
organization managers who knowingly
participate in, an excess benefit
transaction. Section 4958 imposes no
corresponding sanctions on exempt
organizations. The section 4958 excise
taxes generally apply to excess benefit
transactions occurring on or after
September 14, 1995.
On August 4, 1998, a notice of
proposed rulemaking (REG–246256–96)
clarifying certain definitions and rules
contained in section 4958 was
published in the Federal Register (63
FR 41486). Those 1998 proposed
regulations were revised in response to
written and oral comments and replaced
by temporary and proposed regulations
on January 10, 2001 (TD 8920, 66 FR
2144, and REG–246256–96, 66 FR 2173).
Final regulations under section 4958
were published on January 23, 2002 (TD
8978, 67 FR 3076).
C. History of the Relationship Between
Section 4958 Taxes and Tax-Exempt
Status
Section 501(c)(3) and the
longstanding regulations thereunder
establish certain tests that an
organization must meet to qualify for
tax-exempt status. § 1.501(c)(3)–1(a)(1).
Section 4958, by its terms, does not
address the tax-exempt status of
applicable tax-exempt organizations, but
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instead imposes excise tax liability on
disqualified persons and certain
organization managers.
In the 1996 House Report on section
4958, Congress briefly addressed the
relationship between section 4958 and
tax-exempt status. Specifically, the
Report stated that these ‘‘intermediate
sanctions for excess benefit transactions
may be imposed by the IRS in lieu of (or
in addition to) revocation of the
organization’s tax-exempt status.’’ H.
Rep. No. 104–506, 104th Cong., 2d
Sess., at 59 (1996) (emphasis added).
The Report also stated, in a footnote,
that, in general, revocation of taxexempt status, with or without the
imposition of excise taxes, would occur
only if an organization no longer
operates as a charitable organization. H.
Rep. No. 104–506, 104th Cong., 2d
Sess., at 59, note 15.
In keeping with the differences
between section 501(c)(3) and section
4958, the Treasury Department and the
IRS consistently have taken the position
that the imposition of excise taxes under
section 4958 does not foreclose
revocation of tax-exempt status in
appropriate cases. The 1998 proposed
regulations under section 4958 stated
that ‘‘[t]he excise taxes imposed by
section 4958 do not affect the
substantive statutory standards for tax
exemption under section 501(c)(3) or
(4).’’ Proposed § 53.4958–7(a), (63 FR
41,505). Both the 2001 temporary and
the 2002 final regulations stated that—
Section 4958 does not affect the
substantive standards for tax exemption
under section 501(c)(3) or (4), including the
requirements that the organization be
organized and operated exclusively for
exempt purposes, and that no part of its net
earnings inure to the benefit of any private
shareholder or individual. Thus, regardless of
whether a particular transaction is subject to
excise taxes under section 4958, existing
principles and rules may be implicated, such
as the limitation on private benefit. (26 CFR
53.4958–8(a)).
The preamble to the 1998 proposed
regulations under section 4958 stated
that the IRS will exercise its
administrative discretion in enforcing
the requirements of sections 4958,
501(c)(3), and 501(c)(4). The preamble
to the 1998 proposed regulations listed
the following four factors the IRS will
consider in determining whether an
applicable tax-exempt organization
described in section 501(c)(3) continues
to be described in section 501(c)(3) in
cases in which section 4958 excise taxes
are also imposed: (1) Whether the
organization has been involved in
repeated excess benefit transactions; (2)
the size and the scope of the excess
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benefit transactions; (3) whether, after
concluding that it has been party to an
excess benefit transaction, the
organization has implemented
safeguards to prevent future
recurrences; and (4) whether there was
compliance with other applicable laws.
(63 FR 41,488 through 41,489).
The preamble to the 2001 temporary
regulations stated that the IRS intends to
publish guidance regarding the factors it
will consider as it gains more
experience in administering section
4958. The preamble to the 2002 final
regulations stated that, until such
guidance is published, the IRS will
consider all relevant facts and
circumstances in the administration of
section 4958 cases. These proposed
regulations amend the regulations under
section 501(c)(3) to provide guidance on
certain factors that the IRS will consider
in determining whether an applicable
tax-exempt organization described in
section 501(c)(3) that engages in one or
more excess benefit transactions
continues to be described in section
501(c)(3).
D. Section 4958 and Application for
Recognition of Tax-Exempt Status
Under Section 501(c)(3)
Section 4958 and the regulations
thereunder do not apply to
organizations that are not applicable
tax-exempt organizations as defined
therein. These proposed regulations
amend the regulations under section
4958 to clarify that the IRS has
discretion to refuse to issue a ruling
recognizing exemption under section
501(c)(3) to any applicant whose
purpose or activities violate any
provision of section 501(c)(3), including
the inurement prohibition and the
limitation on private benefit, even
though such violation could serve as
grounds for imposing section 4958
excise taxes if the applicant’s taxexempt status were recognized.
E. Proposed Effective Date
These regulations are proposed to be
applicable on the date of publication in
the Federal Register of a Treasury
Decision adopting them as final
regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a
significant regulatory action as defined
in Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to this notice of proposed rulemaking,
and because this notice of proposed
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rulemaking does not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, this notice
of proposed rulemaking will be
submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its
impact on business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations,
consideration will be given to any
comments (a signed original and eight
(8) copies) that are submitted timely to
the IRS. The IRS and the Treasury
Department specifically request
comments on the clarity of the proposed
rule and how it may be made easier to
understand. All comments will be
available for public inspection and
copying.
A public hearing may be scheduled if
requested in writing by a person who
timely submits written comments. If a
public hearing is scheduled, notice of
the date, time, and place will be
published in the Federal Register.
Drafting Information
The principal authors of these
regulations are Galina Kolomietz and
Phyllis Haney, Office of Division
Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities).
However, other personnel from the IRS
and the Treasury Department
participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 53
Excise taxes, Foundations,
Investments, Lobbying, Reporting and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 53
are proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read, in part, as
follows:
Authority: 26 U.S.C. 7805 * * *.
Par. 2. In § 1.501(c)(3)–1, paragraph
(d)(1)(iii) is redesignated as paragraph
(d)(1)(iv).
Par. 3. In § 1.501(c)(3)–1, paragraphs
(d)(1)(iii) and (g) are added to read as
follows:
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53601
§ 1.501(c)(3)–(1) Organizations organized
and operated for religious, charitable,
scientific, testing for public safety, literary,
or educational purposes, or for the
prevention of cruelty to children or animals.
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*
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(d) * * *
(1) * * *
(iii) Examples. The following
examples illustrate the requirement of
paragraph (d)(1)(ii) of this section that
an organization serve a public rather
than a private interest:
Example 1. (i) O is an educational
organization the purpose of which is to study
history and immigration. The focus of O’s
historical studies is the genealogy of one
family, tracing the descent of its present
members. O actively solicits for membership
only individuals who are members of that
one family. O’s research is directed toward
publishing a history of that family that will
document the pedigrees of family members.
A major objective of O’s research is to
identify and locate living descendants of that
family to enable those descendants to become
acquainted with each other.
(ii) O’s educational activities primarily
serve the private interests of members of a
single family rather than a public interest.
Therefore, O is operated for the benefit of
private interests in violation of the restriction
on private benefit in § 1.501(c)(3)–1(d)(1)(ii).
Based on these facts and circumstances, O is
not operated exclusively for exempt purposes
and, therefore, is not described in section
501(c)(3).
Example 2. (i) O is an art museum. O’s sole
activity is exhibiting art created by a group
of unknown but promising local artists. O is
governed by a board of trustees unrelated to
the artists whose work O exhibits. All of the
art exhibited is offered for sale at prices set
by the artist. Each artist whose work is
exhibited has a consignment arrangement
with O. Under this arrangement, when art is
sold, the museum retains 10 percent of the
selling price to cover the costs of operating
the museum and gives the artist 90 percent.
(ii) The artists in this situation directly
benefit from the exhibition and sale of their
art. As a result, the sole activity of O serves
the private interests of these artists. Because
O gives 90 percent of the proceeds from its
sole activity to the individual artists, the
direct benefits to the artists are substantial
and O’s provision of these benefits to the
artists is more than incidental to its other
purposes and activities. This arrangement
causes O to be operated for the benefit of
private interests in violation of the restriction
on private benefit in § 1.501(c)(3)–1(d)(1)(ii).
Based on these facts and circumstances, O is
not operated exclusively for exempt purposes
and, therefore, is not described in section
501(c)(3).
Example 3. (i) O is an educational
organization the purpose of which is to train
individuals in a program developed by P, O’s
president. All of the rights to the program are
owned by Company K, a for-profit
corporation owned by P. Prior to the
existence of O, the teaching of the program
was conducted by Company K. O licenses,
from Company K, the right to use a reference
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to the program in O’s name and the right to
teach the program, in exchange for specified
royalty payments. Under the license
agreement, Company K provides O with the
services of trainers and with course materials
on the program. O may develop and
copyright new course materials on the
program but all such materials must be
assigned to Company K without
consideration if the license agreement is
terminated. Company K sets the tuition for
the seminars and lectures on the program
conducted by O. O has agreed not to become
involved in any activity resembling the
program or its implementation for 2 years
after the termination of O’s license
agreement.
(ii) O’s sole activity is conducting seminars
and lectures on the program. This
arrangement causes O to be operated for the
benefit of P and Company K in violation of
the restriction on private benefit in
§ 1.501(c)(3)–1(d)(1)(ii), regardless of whether
the royalty payments from O to Company K
for the right to teach the program are
reasonable. Based on these facts and
circumstances, O is not operated exclusively
for exempt purposes and, therefore, is not
described in section 501(c)(3).
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*
(g) Interaction with section 4958—(1)
Application process. An organization
that applies for recognition of
exemption under section 501(a) as an
organization described in section
501(c)(3) must establish its eligibility
under this section. The Commissioner
may deny an application for exemption
for failure to establish any of this
section’s requirements for exemption.
Section 4958 does not apply to
transactions with an organization that
has failed to establish that it satisfies all
of the requirements for exemption under
section 501(c)(3). See § 53.4958–2 of this
chapter.
(2) Substantive requirements for
exemption still apply to applicable taxexempt organizations described in
section 501(c)(3)—(i) In general.
Regardless of whether a particular
transaction is subject to excise taxes
under section 4958, the substantive
requirements for tax exemption under
section 501(c)(3) still apply to an
applicable tax-exempt organization (as
defined in section 4958(e) and
§ 53.4958–2 of this chapter) described in
section 501(c)(3) whose disqualified
persons or organization managers are
subject to excise taxes under section
4958. Accordingly, an organization may
no longer meet the requirements for taxexempt status under section 501(c)(3)
because the organization fails to satisfy
the requirements of paragraph (b), (c) or
(d) of this section. See § 53.4958–8(a) of
this chapter.
(ii) Determining whether revocation of
tax-exempt status is appropriate when
section 4958 excise taxes also apply. In
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determining whether to continue to
recognize the tax-exempt status of an
applicable tax-exempt organization (as
defined in section 4958(e) and
§ 53.4958–2 of this chapter) described in
section 501(c)(3) that engages in one or
more excess benefit transactions (as
defined in section 4958(c) and
§ 53.4958–4 of this chapter) that violate
the prohibition on inurement under this
section, the Commissioner will consider
all relevant facts and circumstances,
including, but not limited to, the
following—
(A) The size and scope of the
organization’s regular and ongoing
activities that further exempt purposes
before and after the excess benefit
transaction or transactions occurred;
(B) The size and scope of the excess
benefit transaction or transactions
(collectively, if more than one) in
relation to the size and scope of the
organization’s regular and ongoing
activities that further exempt purposes;
(C) Whether the organization has been
involved in repeated excess benefit
transactions;
(D) Whether the organization has
implemented safeguards that are
reasonably calculated to prevent future
violations; and
(E) Whether the excess benefit
transaction has been corrected (within
the meaning of section 4958(f)(6) and
§ 53.4958–7 of this chapter), or the
organization has made good faith efforts
to seek correction from the disqualified
persons who benefited from the excess
benefit transaction.
(iii) All factors will be considered in
combination with each other.
Depending on the particular situation,
the Commissioner may assign greater or
lesser weight to some factors than to
others. The factors listed in paragraphs
(g)(2)(ii)(D) and (E) of this section will
weigh more strongly in favor of
continuing to recognize exemption
where the organization discovers the
excess benefit transaction or
transactions and takes action before the
Commissioner discovers the excess
benefit transaction or transactions.
Further, with respect to the factor listed
in paragraph (g)(2)(ii)(E) of this section,
correction after the excess benefit
transaction or transactions are
discovered by the Commissioner, by
itself, is never a sufficient basis for
continuing to recognize exemption.
(iv) Examples. The following
examples illustrate the principles of
paragraph (g)(2)(ii) of this section. For
purposes of each example, assume that
O is an applicable tax-exempt
organization (as defined in section
4958(e) and § 53.4958–2 of this chapter)
described in section 501(c)(3) for all
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relevant periods. The examples are as
follows:
Example 1. (i) O was created as a museum
for the purpose of exhibiting art to the
general public. In Years 1 and 2, O engages
in fundraising and in selecting, leasing, and
preparing an appropriate facility for a
museum. In Year 3, a new board of trustees
is elected. All of the new trustees are local
art dealers. Beginning in Year 3 and
continuing to the present, O uses almost all
of its revenues to purchase art solely from its
trustees at prices that exceed fair market
value. O exhibits and offers for sale all of the
art it purchases. O’s Form 1023, ‘‘Application
for Recognition of Exemption,’’ did not
disclose the possibility that O’s trustees
would be selling art to O.
(ii) O’s purchases of art from its trustees at
more than fair market value constitute excess
benefit transactions between an applicable
tax-exempt organization and disqualified
persons under section 4958. Therefore, these
transactions are subject to the appropriate
excise taxes provided in that section. In
addition, O’s purchases of art from its
trustees at more than fair market value
violate the proscription against inurement
under section 501(c)(3) and § 1.501(c)(3)–
1(c)(2).
(iii) The application of the factors in
§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as
follows. Beginning in Year 3, O does not
engage in any regular and ongoing activities
that further exempt purposes because almost
all of O’s activities consist of purchasing art
from its trustees and exhibiting and offering
for sale all of the art it purchases. The size
and scope of the excess benefit transactions
collectively are significant in relation to the
size and scope of any of O’s ongoing
activities that further exempt purposes. O has
been involved in repeated excess benefit
transactions, namely, purchases of art from
its trustees at more than fair market value. O
has not implemented safeguards that are
reasonably calculated to prevent such
improper purchases in the future. The excess
benefit transactions have not been corrected,
nor has O made good faith efforts to seek
correction from the disqualified persons who
benefited from the excess benefit transactions
(the trustees). The trustees continue to
control O’s Board. Based on the application
of the factors to these facts, O is no longer
described in section 501(c)(3) effective in
Year 3.
Example 2. (i) The facts are the same as in
Example 1, except that in Year 4, O’s entire
board of trustees resigns, and O no longer
offers all exhibited art for sale. The former
board is replaced with members of the
community who are not in the business of
buying or selling art and who have skills and
experience running educational programs
and institutions. O promptly discontinues
the practice of purchasing art from current or
former trustees, adopts a written conflicts of
interest policy, adopts written art valuation
guidelines, hires legal counsel to recover the
excess amounts O had paid its former
trustees, and implements a new program of
educational activities.
(ii) O’s purchases of art from its former
trustees at more than fair market value
constitute excess benefit transactions
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between an applicable tax-exempt
organization and disqualified persons under
section 4958. Therefore, these transactions
are subject to the appropriate excise taxes
provided in that section. In addition, O’s
purchases of art from its trustees at more than
fair market value violate the proscription
against inurement under section 501(c)(3)
and § 1.501(c)(3)–1(c)(2).
(iii) The application of the factors in
§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as
follows. In Year 3, O does not engage in any
regular and ongoing activities that further
exempt purposes. However, in Year 4, O
elects a new board of trustees comprised of
individuals who have skills and experience
running educational programs and
implements a new program of educational
activities. As a result of these actions,
beginning in Year 4, O engages in regular and
ongoing activities that further exempt
purposes. The size and scope of the excess
benefit transactions that occurred in Year 3,
taken collectively, are significant in relation
to the size and scope of O’s regular and
ongoing exempt function activities that were
conducted in Year 3. Beginning in Year 4,
however, as O’s exempt function activities
are established and grow, the size and scope
of the excess benefit transactions that
occurred in Year 3 become less and less
significant as compared to the size and extent
of O’s regular and ongoing exempt function
activities that began in Year 4 and continued
thereafter. O was involved in repeated excess
benefit transactions in Year 3. However, by
discontinuing its practice of purchasing art
from its current and former trustees, by
replacing its former board with independent
members of the community, and by adopting
a conflicts of interest policy and art valuation
guidelines, O has implemented safeguards
that are reasonably calculated to prevent
future violations. In addition, O has made a
good faith effort to seek correction from the
disqualified persons who benefited from the
excess benefit transactions (its former
trustees). Based on the application of the
factors to these facts, O continues to meet the
requirements for tax exemption under section
501(c)(3).
Example 3. (i) O conducts educational
programs for the benefit of the general public.
Since its formation, O has employed its
founder, C, as its Chief Executive Officer.
Beginning in Year 5 of O’s operations and
continuing to the present, C caused O to
divert significant portions of O’s funds to pay
C’s personal expenses. The diversions by C
significantly reduced the funds available to
conduct O’s ongoing educational programs.
The board of trustees never authorized C to
cause O to pay C’s personal expenses from
O’s funds. Certain members of the board were
aware that O was paying C’s personal
expenses. However, the board did not
terminate C’s employment and did not take
any action to seek repayment from C or to
prevent C from continuing to divert O’s funds
to pay C’s personal expenses. C claimed that
O’s payments of C’s personal expenses
represented loans from O to C. However, no
contemporaneous loan documentation exists,
and C never made any payments of principal
or interest.
(ii) The diversions of O’s funds to pay C’s
personal expenses constituted excess benefit
VerDate Aug<18>2005
15:12 Sep 08, 2005
Jkt 205001
transactions between an applicable taxexempt organization and a disqualified
person under section 4958. Therefore, these
transactions are subject to the appropriate
excise taxes provided in that section. In
addition, these transactions violate the
proscription against inurement under section
501(c)(3) and § 1.501(c)(3)–1(c)(2).
(iii) The application of the factors in
§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as
follows. O has engaged in regular and
ongoing activities that further exempt
purposes both before and after the excess
benefit transactions occurred. However, the
size and scope of the excess benefit
transactions engaged in by O beginning in
Year 5, collectively, are significant in relation
to the size and scope of O’s activities that
further exempt purposes. Moreover, O has
been involved in repeated excess benefit
transactions. O has not implemented any
safeguards that are reasonably calculated to
prevent future diversions. The excess benefit
transactions have not been corrected, nor has
O made good faith efforts to seek correction
from C, the disqualified person who
benefited from the excess benefit
transactions. Based on the application of the
factors to these facts, O is no longer described
in section 501(c)(3) effective in Year 5.
Example 4. (i) O conducts activities that
further exempt purposes. O employs C as its
Chief Executive Officer. C, on behalf of O,
entered into a contract with Company K to
construct an addition to O’s existing
building. The addition to O’s building is a
significant undertaking in relation to O’s
other activities. C owns all of the voting stock
of Company K. Under the contract, O paid
Company K an amount that substantially
exceeded the fair market value of the services
Company K provided. When O’s board of
trustees approved the contract with Company
K, the board did not perform due diligence
that could have made it aware that the
contract price for Company K’s services was
excessive. Subsequently, but before the IRS
commences an examination of O, O’s board
of trustees determines that the contract price
was excessive. Thus, O concludes that an
excess benefit transaction has occurred. After
the board makes this determination, it
promptly removes C as Chief Executive
Officer, terminates C’s employment with O,
and hires legal counsel to recover the excess
payments to Company K. In addition, O
promptly adopts a conflicts of interest policy
and significant new contract review
procedures designed to prevent future
recurrences of this problem.
(ii) The purchase of services by O from
Company K at more than fair market value
constitutes an excess benefit transaction
between an applicable tax-exempt
organization and disqualified persons under
section 4958. Therefore, this transaction is
subject to the appropriate excise taxes
provided in that section. In addition, this
transaction violates the proscription against
inurement under section 501(c)(3) and
§ 1.501(c)(3)–1(c)(2).
(iii) The application of the factors in
§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as
follows. O has engaged in regular and
ongoing activities that further exempt
purposes both before and after the excess
PO 00000
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Fmt 4702
Sfmt 4702
53603
benefit transaction occurred. Although the
size and scope of the excess benefit
transaction were significant in relation to the
size and scope of O’s activities that further
exempt purposes, the transaction with
Company K was a one-time occurrence. By
adopting a conflicts of interest policy and
significant new contract review procedures
and by terminating C, O has implemented
safeguards that are reasonably calculated to
prevent future violations. Moreover, O took
corrective actions before the IRS commenced
an examination of O. In addition, O has made
a good faith effort to seek correction from
Company K, the disqualified person who
benefited from the excess benefit transaction.
Based on the application of the factors to
these facts, O continues to be described in
section 501(c)(3).
Example 5. (i) O is a large organization
with substantial assets and revenues. O
conducts activities that further exempt
purposes. O employs C as its Chief Financial
Officer. During Year 1, O pays $2,500 of C’s
personal expenses. O does not make these
payments under an accountable plan under
§ 53.4958–4(a)(4) of this chapter. In addition,
O does not report any of these payments on
C’s Form W–2, ‘‘Wage and Tax Statement,’’
or on a Form 1099–MISC, ‘‘Miscellaneous
Income,’’ for C for Year 1, and O does not
report these payments as compensation on its
Form 990, ‘‘Return of Organization Exempt
From Income Tax,’’ for Year 1. Moreover,
none of these payments can be disregarded
under section 4958 as nontaxable fringe
benefits and none consisted of fixed
payments under an initial contract under
§ 53.4958–4(a)(3) of this chapter. C does not
report the $2,500 of payments as income on
his individual federal income tax return for
Year 1. O does not repeat this reporting
omission in subsequent years and, instead,
reports all payments of C’s personal expenses
not made under an accountable plan as
income to C.
(ii) O’s payment in Year 1 of $2,500 of C’s
personal expenses constitutes an excess
benefit transaction between an applicable
tax-exempt organization and a disqualified
person under section 4958. Therefore, this
transaction is subject to the appropriate
excise taxes provided in that section. In
addition, this transaction violates the
proscription against inurement in section
501(c)(3) and § 1.501(c)(3)–1(c)(2).
(iii) The application of the factors in
§ 1.501(c)(3)–1(g)(2)(ii) to these facts is as
follows. O engages in regular and ongoing
activities that further exempt purposes. The
payment of $2,500 of C’s personal expenses
represented only a de minimis portion of O’s
assets and revenues; thus, the size and scope
of the excess benefit transaction were not
significant in relation to the size and scope
of O’s activities that further exempt purposes.
The reporting omission that resulted in the
excess benefit transaction in Year 1 is not
repeated in subsequent years. Based on the
application of the factors to these facts, O
continues to be described in section
501(c)(3).
(3) Effective date. The rules in
paragraph (g) of this section will apply
with respect to excess benefit
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transactions occurring after the date of
publication in the Federal Register of a
Treasury Decision adopting these rules
as final regulations.
PART 53—FOUNDATION AND SIMILAR
EXCISE TAXES
Par. 3. The authority citation for part
53 continues to read, in part, as follows:
Authority: 26 U.S.C. 7805.
§ 53.4958–2 Definition of applicable taxexempt organization.
Example 1. O is a nonprofit corporation
formed under state law. O filed its
application for recognition of exemption
under section 501(c)(3) within the time
prescribed under section 508(a). In its
application, O described its plans for
purchasing property from some of its
directors at prices that would exceed fair
market value. After reviewing the
application, the IRS determined that because
of the proposed property purchase
transactions, O failed to establish that it met
the requirements for an organization
described in section 501(c)(3). Accordingly,
the IRS denied O’s application. While O’s
application was pending, O engaged in the
purchase transactions described in its
application at prices that exceeded the fair
market value of the property. Although these
transactions would constitute excess benefit
transactions under section 4958, because the
IRS never recognized O as an organization
described in section 501(c)(3), O was never
an applicable tax-exempt organization under
section 4958. Therefore, these transactions
are not subject to the excise taxes provided
in section 4958.
Example 2. O is a nonprofit corporation
formed under state law. O files its
application for recognition of exemption
under section 501(c)(3) within the time
prescribed under section 508(a). The IRS
issues a favorable determination letter in
Year 1 that recognizes O as an organization
described in section 501(c)(3). Subsequently,
in Year 5 of O’s operations, O engages in
certain transactions that constitute excess
benefit transactions under section 4958 and
violate the proscription against inurement
under section 501(c)(3) and § 1.501(c)(3)–
1(c)(2). The IRS examines the Form 990,
‘‘Return of Organization Exempt From
Income Tax’’, that O filed for Year 5. After
considering all the relevant facts and
circumstances in accordance with
§ 1.501(c)(3)–1(g), the IRS concludes that O is
no longer described in section 501(c)(3)
effective in Year 5. The IRS does not examine
the Forms 990 that O filed for its first four
years of operations and, accordingly, does
not revoke O’s exempt status for those years.
Although O’s tax-exempt status is revoked
Jkt 205001
*
*
*
*
BILLING CODE 4830–01–P
(a) * * *
(6) Examples. The following examples
illustrate the principles of this section,
which defines an applicable tax-exempt
organization for purposes of section
4958:
15:12 Sep 08, 2005
*
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
[FR Doc. 05–17858 Filed 9–8–05; 8:45 am]
Par. 4. In § 53.4958–2, paragraph
(a)(6) is added to read as follows:
VerDate Aug<18>2005
effective in Year 5, under the lookback rules
in § 53.4958–2(a)(1) and § 53.4958–3(a)(1) of
this chapter, for a period of five years prior
to the excess benefit transactions that
occurred in Year 5, O was an applicable taxexempt organization and O’s directors were
disqualified persons as to O. Therefore, the
transactions between O and its directors
during Year 5 are subject to the appropriate
excise taxes provided in section 4958.
DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
(1) Web Site: https://dms.dot.gov.
(2) Mail: Docket Management Facility,
U.S. Department of Transportation, 400
Seventh Street SW., Washington, DC
20590–0001.
(3) Fax: 202–493–2251.
(4) Delivery: Room PL–401 on the
Plaza level of the Nassif Building, 400
Seventh Street SW., Washington, DC,
between 9 a.m. and 5 p.m., Monday
through Friday, except Federal holidays.
The telephone number is 202–366–
9329.
(5) Federal eRulemaking Portal:
https://www.regulations.gov.
FOR FURTHER INFORMATION CONTACT:
Roger Wiebusch, Bridge Administration
Branch, telephone 314 539–3900, ext.
2378.
SUPPLEMENTARY INFORMATION:
33 CFR Part 117
Request for Comments
[USCG–2005–22362; Formerly CGD08–05–
046]
RIN 1625–AA09
Drawbridge Operation Regulation; Gulf
Intracoastal Waterway, West Larose,
LA
Coast Guard, DHS.
Notice of proposed rulemaking;
change of address and docket number
for comments.
AGENCY:
ACTION:
SUMMARY: On September 2, 2005, the
Coast Guard published a notice and
requested comments on a proposed
change to regulations governing the
operation of the SR 1 (West Larose)
vertical lift bridge across the Gulf
Intracoastal Waterway, mile 35.6 west of
Harvey Lock, at Larose, Louisiana. The
proposed rule would change the
bridge’s schedule so that it would
remain closed to navigation at various
times on weekdays during the school
year to facilitate the safe, efficient
movement of staff, students and other
residents within the parish. That notice
was issued August 26, 2005, before
Hurricane Katrina struck New Orleans
and caused that city to be flooded. We
have changed the address and docket
number where comments on the
proposed rule should be sent because of
flood conditions in New Orleans.
DATES: Comments and related material
must reach the Coast Guard on or before
November 1, 2005.
ADDRESSES: You may submit comments
identified by Coast Guard docket
number USCG–2005–22362 to the
Docket Management Facility at the U.S.
Department of Transportation. To avoid
duplication, please use only one of the
following methods:
PO 00000
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Sfmt 4702
We encourage you to participate in
this rulemaking by submitting
comments and related material. If you
do so, please include your name and
address, identify the docket number for
this rulemaking (USCG–2005–22362),
indicate the specific section of this
document to which each comment
applies, and give the reason for each
comment. Please submit all comments
and related material in an unbound
format, no larger than 81⁄2 by 11 inches,
suitable for copying. If you would like
to know they reached us, please enclose
a stamped, self-addressed postcard or
envelope. We will consider all
comments and material received during
the comment period. We may change
this proposed rule in view of them.
Change of Address and Docket
The notice of proposed rulemaking
published September 2, 2005 (70 FR
52343) entitled, ‘‘Drawbridge Operation
Regulation; Gulf Intracoastal Waterway,
West Larose, LA’’, listed an address in
New Orleans, LA, as the place to send
your comments on the proposed rule.
That rulemaking notice was issued
August 26, 2005, before Hurricane
Katrina struck New Orleans and flooded
that city. We have changed the location
for receiving comments because of flood
conditions in New Orleans. If you wish
to comment on the proposed rule, send
your comment to the Docket
Management Facility in Washington,
DC, by one of the means indicated in the
ADDRESSES section above in this notice.
With this change of address, we have
also changed the docket number to
USCG–2005–22362. Please use this new
docket number.
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Agencies
[Federal Register Volume 70, Number 174 (Friday, September 9, 2005)]
[Proposed Rules]
[Pages 53599-53604]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-17858]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 53
[REG-111257-05]
RIN 1545-BE37
Standards for Recognition of Tax-Exempt Status if Private Benefit
Exists or If an Applicable Tax-Exempt Organization Has Engaged in
Excess Benefit Transaction(s)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations that clarify the
substantive requirements for tax exemption under section 501(c)(3) of
the Internal Revenue Code (Code). This document also contains
provisions that clarify the relationship between the substantive
requirements for tax exemption under section 501(c)(3) and the
imposition of section 4958 excise taxes.
DATES: Written comments and requests for a public hearing must be
received by December 8, 2005.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-111257-05), room
5203, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
111257-05), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the IRS Internet site at https://
www.irs.gov/regs or the Federal
[[Page 53600]]
eRulemaking Portal at https://www.regulations.gov (IRS-REG-111257-05). A
public hearing may be scheduled if requested.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Galina
Kolomietz, (202) 622-4441; Concerning submission of comments and
requests for a public hearing, Richard Hurst, (202) 622-7180 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. Section 501(c)(3) and the Regulations Thereunder
To be described in section 501(c)(3), an organization must be
organized and operated exclusively for religious, charitable,
scientific, or educational purposes. In addition, no part of the net
earnings of the organization may inure to the benefit of any private
shareholder or individual, no substantial part of the organization's
activities may include attempts to influence legislation, and the
organization may not intervene in political campaigns.
Existing regulations under section 501(c)(3) were adopted in
substantially their present form in 1959. In explaining and clarifying
the statutory requirements, these regulations provide that, to be
described in section 501(c)(3), an organization must be both organized
and operated for exempt purposes. An organization is not operated
exclusively for exempt purposes and, thus, is not described in section
501(c)(3), if any of its net earnings inure to the benefit of a private
shareholder or individual. Sec. 1.501(c)(3)-1(c)(2). The regulations
define private shareholder or individual as referring to persons having
a personal and private interest in the activities of the organization.
Sec. 1.501(a)-1(c).
In addition, an organization is not organized or operated for one
or more of the exempt purposes enumerated in Sec. 1.501(c)(3)-
1(d)(1)(i) and, thus, is not described in section 501(c)(3), if it is
organized or operated for the benefit of private interests such as
designated individuals, the creator or his family, shareholders of the
organization, or persons controlled, directly or indirectly, by such
interests. Sec. 1.501(c)(3)-1(d)(1)(ii).
These proposed regulations amend the regulations under section
501(c)(3), adding several examples to illustrate the requirement in
Sec. 1.501(c)(3)-1(d)(1)(ii) that an organization serve a public
rather than a private interest. The examples illustrate that prohibited
private benefits may involve non-economic benefits as well as economic
benefits. In addition, prohibited private benefit may arise regardless
of whether payments made to private interests are reasonable or
excessive. The examples reflect current law.
B. Section 4958 and the Regulations Thereunder
Section 4958 was added to the Code by the Taxpayer Bill of Rights
2, Public Law 104-168 (110 Stat. 1452, July 30, 1996). Section 4958
imposes certain excise taxes on transactions that provide excess
economic benefits to disqualified persons with respect to public
charities and social welfare organizations described in sections
501(c)(3) and 501(c)(4), respectively. These organizations are
collectively referred to as applicable tax-exempt organizations.
Section 4958(e). An excess benefit is the amount by which the value of
an economic benefit provided by an applicable tax-exempt organization
directly or indirectly to or for the use of a disqualified person
exceeds the value of the consideration (including the performance of
services) received for providing such benefit. Sec. 53.4958-1(b). A
disqualified person is defined as a person who is in a position to
exercise substantial influence over the affairs of an applicable tax-
exempt organization. Section 4958(f)(1). Section 4958(a) imposes the
liability for excise taxes on disqualified persons who receive an
excess benefit from, and on certain organization managers who knowingly
participate in, an excess benefit transaction. Section 4958 imposes no
corresponding sanctions on exempt organizations. The section 4958
excise taxes generally apply to excess benefit transactions occurring
on or after September 14, 1995.
On August 4, 1998, a notice of proposed rulemaking (REG-246256-96)
clarifying certain definitions and rules contained in section 4958 was
published in the Federal Register (63 FR 41486). Those 1998 proposed
regulations were revised in response to written and oral comments and
replaced by temporary and proposed regulations on January 10, 2001 (TD
8920, 66 FR 2144, and REG-246256-96, 66 FR 2173). Final regulations
under section 4958 were published on January 23, 2002 (TD 8978, 67 FR
3076).
C. History of the Relationship Between Section 4958 Taxes and Tax-
Exempt Status
Section 501(c)(3) and the longstanding regulations thereunder
establish certain tests that an organization must meet to qualify for
tax-exempt status. Sec. 1.501(c)(3)-1(a)(1). Section 4958, by its
terms, does not address the tax-exempt status of applicable tax-exempt
organizations, but instead imposes excise tax liability on disqualified
persons and certain organization managers.
In the 1996 House Report on section 4958, Congress briefly
addressed the relationship between section 4958 and tax-exempt status.
Specifically, the Report stated that these ``intermediate sanctions for
excess benefit transactions may be imposed by the IRS in lieu of (or in
addition to) revocation of the organization's tax-exempt status.'' H.
Rep. No. 104-506, 104th Cong., 2d Sess., at 59 (1996) (emphasis added).
The Report also stated, in a footnote, that, in general, revocation of
tax-exempt status, with or without the imposition of excise taxes,
would occur only if an organization no longer operates as a charitable
organization. H. Rep. No. 104-506, 104th Cong., 2d Sess., at 59, note
15.
In keeping with the differences between section 501(c)(3) and
section 4958, the Treasury Department and the IRS consistently have
taken the position that the imposition of excise taxes under section
4958 does not foreclose revocation of tax-exempt status in appropriate
cases. The 1998 proposed regulations under section 4958 stated that
``[t]he excise taxes imposed by section 4958 do not affect the
substantive statutory standards for tax exemption under section
501(c)(3) or (4).'' Proposed Sec. 53.4958-7(a), (63 FR 41,505). Both
the 2001 temporary and the 2002 final regulations stated that--
Section 4958 does not affect the substantive standards for tax
exemption under section 501(c)(3) or (4), including the requirements
that the organization be organized and operated exclusively for
exempt purposes, and that no part of its net earnings inure to the
benefit of any private shareholder or individual. Thus, regardless
of whether a particular transaction is subject to excise taxes under
section 4958, existing principles and rules may be implicated, such
as the limitation on private benefit. (26 CFR 53.4958-8(a)).
The preamble to the 1998 proposed regulations under section 4958
stated that the IRS will exercise its administrative discretion in
enforcing the requirements of sections 4958, 501(c)(3), and 501(c)(4).
The preamble to the 1998 proposed regulations listed the following four
factors the IRS will consider in determining whether an applicable tax-
exempt organization described in section 501(c)(3) continues to be
described in section 501(c)(3) in cases in which section 4958 excise
taxes are also imposed: (1) Whether the organization has been involved
in repeated excess benefit transactions; (2) the size and the scope of
the excess
[[Page 53601]]
benefit transactions; (3) whether, after concluding that it has been
party to an excess benefit transaction, the organization has
implemented safeguards to prevent future recurrences; and (4) whether
there was compliance with other applicable laws. (63 FR 41,488 through
41,489).
The preamble to the 2001 temporary regulations stated that the IRS
intends to publish guidance regarding the factors it will consider as
it gains more experience in administering section 4958. The preamble to
the 2002 final regulations stated that, until such guidance is
published, the IRS will consider all relevant facts and circumstances
in the administration of section 4958 cases. These proposed regulations
amend the regulations under section 501(c)(3) to provide guidance on
certain factors that the IRS will consider in determining whether an
applicable tax-exempt organization described in section 501(c)(3) that
engages in one or more excess benefit transactions continues to be
described in section 501(c)(3).
D. Section 4958 and Application for Recognition of Tax-Exempt Status
Under Section 501(c)(3)
Section 4958 and the regulations thereunder do not apply to
organizations that are not applicable tax-exempt organizations as
defined therein. These proposed regulations amend the regulations under
section 4958 to clarify that the IRS has discretion to refuse to issue
a ruling recognizing exemption under section 501(c)(3) to any applicant
whose purpose or activities violate any provision of section 501(c)(3),
including the inurement prohibition and the limitation on private
benefit, even though such violation could serve as grounds for imposing
section 4958 excise taxes if the applicant's tax-exempt status were
recognized.
E. Proposed Effective Date
These regulations are proposed to be applicable on the date of
publication in the Federal Register of a Treasury Decision adopting
them as final regulations.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to this notice of proposed
rulemaking, and because this notice of proposed rulemaking does not
impose a collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments (a signed original and
eight (8) copies) that are submitted timely to the IRS. The IRS and the
Treasury Department specifically request comments on the clarity of the
proposed rule and how it may be made easier to understand. All comments
will be available for public inspection and copying.
A public hearing may be scheduled if requested in writing by a
person who timely submits written comments. If a public hearing is
scheduled, notice of the date, time, and place will be published in the
Federal Register.
Drafting Information
The principal authors of these regulations are Galina Kolomietz and
Phyllis Haney, Office of Division Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities). However, other personnel from the IRS
and the Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 53
Excise taxes, Foundations, Investments, Lobbying, Reporting and
recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 53 are proposed to be amended as
follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read,
in part, as follows:
Authority: 26 U.S.C. 7805 * * *.
Par. 2. In Sec. 1.501(c)(3)-1, paragraph (d)(1)(iii) is
redesignated as paragraph (d)(1)(iv).
Par. 3. In Sec. 1.501(c)(3)-1, paragraphs (d)(1)(iii) and (g) are
added to read as follows:
Sec. 1.501(c)(3)-(1) Organizations organized and operated for
religious, charitable, scientific, testing for public safety, literary,
or educational purposes, or for the prevention of cruelty to children
or animals.
* * * * *
(d) * * *
(1) * * *
(iii) Examples. The following examples illustrate the requirement
of paragraph (d)(1)(ii) of this section that an organization serve a
public rather than a private interest:
Example 1. (i) O is an educational organization the purpose of
which is to study history and immigration. The focus of O's
historical studies is the genealogy of one family, tracing the
descent of its present members. O actively solicits for membership
only individuals who are members of that one family. O's research is
directed toward publishing a history of that family that will
document the pedigrees of family members. A major objective of O's
research is to identify and locate living descendants of that family
to enable those descendants to become acquainted with each other.
(ii) O's educational activities primarily serve the private
interests of members of a single family rather than a public
interest. Therefore, O is operated for the benefit of private
interests in violation of the restriction on private benefit in
Sec. 1.501(c)(3)-1(d)(1)(ii). Based on these facts and
circumstances, O is not operated exclusively for exempt purposes
and, therefore, is not described in section 501(c)(3).
Example 2. (i) O is an art museum. O's sole activity is
exhibiting art created by a group of unknown but promising local
artists. O is governed by a board of trustees unrelated to the
artists whose work O exhibits. All of the art exhibited is offered
for sale at prices set by the artist. Each artist whose work is
exhibited has a consignment arrangement with O. Under this
arrangement, when art is sold, the museum retains 10 percent of the
selling price to cover the costs of operating the museum and gives
the artist 90 percent.
(ii) The artists in this situation directly benefit from the
exhibition and sale of their art. As a result, the sole activity of
O serves the private interests of these artists. Because O gives 90
percent of the proceeds from its sole activity to the individual
artists, the direct benefits to the artists are substantial and O's
provision of these benefits to the artists is more than incidental
to its other purposes and activities. This arrangement causes O to
be operated for the benefit of private interests in violation of the
restriction on private benefit in Sec. 1.501(c)(3)-1(d)(1)(ii).
Based on these facts and circumstances, O is not operated
exclusively for exempt purposes and, therefore, is not described in
section 501(c)(3).
Example 3. (i) O is an educational organization the purpose of
which is to train individuals in a program developed by P, O's
president. All of the rights to the program are owned by Company K,
a for-profit corporation owned by P. Prior to the existence of O,
the teaching of the program was conducted by Company K. O licenses,
from Company K, the right to use a reference
[[Page 53602]]
to the program in O's name and the right to teach the program, in
exchange for specified royalty payments. Under the license
agreement, Company K provides O with the services of trainers and
with course materials on the program. O may develop and copyright
new course materials on the program but all such materials must be
assigned to Company K without consideration if the license agreement
is terminated. Company K sets the tuition for the seminars and
lectures on the program conducted by O. O has agreed not to become
involved in any activity resembling the program or its
implementation for 2 years after the termination of O's license
agreement.
(ii) O's sole activity is conducting seminars and lectures on
the program. This arrangement causes O to be operated for the
benefit of P and Company K in violation of the restriction on
private benefit in Sec. 1.501(c)(3)-1(d)(1)(ii), regardless of
whether the royalty payments from O to Company K for the right to
teach the program are reasonable. Based on these facts and
circumstances, O is not operated exclusively for exempt purposes
and, therefore, is not described in section 501(c)(3).
* * * * *
(g) Interaction with section 4958--(1) Application process. An
organization that applies for recognition of exemption under section
501(a) as an organization described in section 501(c)(3) must establish
its eligibility under this section. The Commissioner may deny an
application for exemption for failure to establish any of this
section's requirements for exemption. Section 4958 does not apply to
transactions with an organization that has failed to establish that it
satisfies all of the requirements for exemption under section
501(c)(3). See Sec. 53.4958-2 of this chapter.
(2) Substantive requirements for exemption still apply to
applicable tax-exempt organizations described in section 501(c)(3)--(i)
In general. Regardless of whether a particular transaction is subject
to excise taxes under section 4958, the substantive requirements for
tax exemption under section 501(c)(3) still apply to an applicable tax-
exempt organization (as defined in section 4958(e) and Sec. 53.4958-2
of this chapter) described in section 501(c)(3) whose disqualified
persons or organization managers are subject to excise taxes under
section 4958. Accordingly, an organization may no longer meet the
requirements for tax-exempt status under section 501(c)(3) because the
organization fails to satisfy the requirements of paragraph (b), (c) or
(d) of this section. See Sec. 53.4958-8(a) of this chapter.
(ii) Determining whether revocation of tax-exempt status is
appropriate when section 4958 excise taxes also apply. In determining
whether to continue to recognize the tax-exempt status of an applicable
tax-exempt organization (as defined in section 4958(e) and Sec.
53.4958-2 of this chapter) described in section 501(c)(3) that engages
in one or more excess benefit transactions (as defined in section
4958(c) and Sec. 53.4958-4 of this chapter) that violate the
prohibition on inurement under this section, the Commissioner will
consider all relevant facts and circumstances, including, but not
limited to, the following--
(A) The size and scope of the organization's regular and ongoing
activities that further exempt purposes before and after the excess
benefit transaction or transactions occurred;
(B) The size and scope of the excess benefit transaction or
transactions (collectively, if more than one) in relation to the size
and scope of the organization's regular and ongoing activities that
further exempt purposes;
(C) Whether the organization has been involved in repeated excess
benefit transactions;
(D) Whether the organization has implemented safeguards that are
reasonably calculated to prevent future violations; and
(E) Whether the excess benefit transaction has been corrected
(within the meaning of section 4958(f)(6) and Sec. 53.4958-7 of this
chapter), or the organization has made good faith efforts to seek
correction from the disqualified persons who benefited from the excess
benefit transaction.
(iii) All factors will be considered in combination with each
other. Depending on the particular situation, the Commissioner may
assign greater or lesser weight to some factors than to others. The
factors listed in paragraphs (g)(2)(ii)(D) and (E) of this section will
weigh more strongly in favor of continuing to recognize exemption where
the organization discovers the excess benefit transaction or
transactions and takes action before the Commissioner discovers the
excess benefit transaction or transactions. Further, with respect to
the factor listed in paragraph (g)(2)(ii)(E) of this section,
correction after the excess benefit transaction or transactions are
discovered by the Commissioner, by itself, is never a sufficient basis
for continuing to recognize exemption.
(iv) Examples. The following examples illustrate the principles of
paragraph (g)(2)(ii) of this section. For purposes of each example,
assume that O is an applicable tax-exempt organization (as defined in
section 4958(e) and Sec. 53.4958-2 of this chapter) described in
section 501(c)(3) for all relevant periods. The examples are as
follows:
Example 1. (i) O was created as a museum for the purpose of
exhibiting art to the general public. In Years 1 and 2, O engages in
fundraising and in selecting, leasing, and preparing an appropriate
facility for a museum. In Year 3, a new board of trustees is
elected. All of the new trustees are local art dealers. Beginning in
Year 3 and continuing to the present, O uses almost all of its
revenues to purchase art solely from its trustees at prices that
exceed fair market value. O exhibits and offers for sale all of the
art it purchases. O's Form 1023, ``Application for Recognition of
Exemption,'' did not disclose the possibility that O's trustees
would be selling art to O.
(ii) O's purchases of art from its trustees at more than fair
market value constitute excess benefit transactions between an
applicable tax-exempt organization and disqualified persons under
section 4958. Therefore, these transactions are subject to the
appropriate excise taxes provided in that section. In addition, O's
purchases of art from its trustees at more than fair market value
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. Beginning in Year 3, O
does not engage in any regular and ongoing activities that further
exempt purposes because almost all of O's activities consist of
purchasing art from its trustees and exhibiting and offering for
sale all of the art it purchases. The size and scope of the excess
benefit transactions collectively are significant in relation to the
size and scope of any of O's ongoing activities that further exempt
purposes. O has been involved in repeated excess benefit
transactions, namely, purchases of art from its trustees at more
than fair market value. O has not implemented safeguards that are
reasonably calculated to prevent such improper purchases in the
future. The excess benefit transactions have not been corrected, nor
has O made good faith efforts to seek correction from the
disqualified persons who benefited from the excess benefit
transactions (the trustees). The trustees continue to control O's
Board. Based on the application of the factors to these facts, O is
no longer described in section 501(c)(3) effective in Year 3.
Example 2. (i) The facts are the same as in Example 1, except
that in Year 4, O's entire board of trustees resigns, and O no
longer offers all exhibited art for sale. The former board is
replaced with members of the community who are not in the business
of buying or selling art and who have skills and experience running
educational programs and institutions. O promptly discontinues the
practice of purchasing art from current or former trustees, adopts a
written conflicts of interest policy, adopts written art valuation
guidelines, hires legal counsel to recover the excess amounts O had
paid its former trustees, and implements a new program of
educational activities.
(ii) O's purchases of art from its former trustees at more than
fair market value constitute excess benefit transactions
[[Page 53603]]
between an applicable tax-exempt organization and disqualified
persons under section 4958. Therefore, these transactions are
subject to the appropriate excise taxes provided in that section. In
addition, O's purchases of art from its trustees at more than fair
market value violate the proscription against inurement under
section 501(c)(3) and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. In Year 3, O does not
engage in any regular and ongoing activities that further exempt
purposes. However, in Year 4, O elects a new board of trustees
comprised of individuals who have skills and experience running
educational programs and implements a new program of educational
activities. As a result of these actions, beginning in Year 4, O
engages in regular and ongoing activities that further exempt
purposes. The size and scope of the excess benefit transactions that
occurred in Year 3, taken collectively, are significant in relation
to the size and scope of O's regular and ongoing exempt function
activities that were conducted in Year 3. Beginning in Year 4,
however, as O's exempt function activities are established and grow,
the size and scope of the excess benefit transactions that occurred
in Year 3 become less and less significant as compared to the size
and extent of O's regular and ongoing exempt function activities
that began in Year 4 and continued thereafter. O was involved in
repeated excess benefit transactions in Year 3. However, by
discontinuing its practice of purchasing art from its current and
former trustees, by replacing its former board with independent
members of the community, and by adopting a conflicts of interest
policy and art valuation guidelines, O has implemented safeguards
that are reasonably calculated to prevent future violations. In
addition, O has made a good faith effort to seek correction from the
disqualified persons who benefited from the excess benefit
transactions (its former trustees). Based on the application of the
factors to these facts, O continues to meet the requirements for tax
exemption under section 501(c)(3).
Example 3. (i) O conducts educational programs for the benefit
of the general public. Since its formation, O has employed its
founder, C, as its Chief Executive Officer. Beginning in Year 5 of
O's operations and continuing to the present, C caused O to divert
significant portions of O's funds to pay C's personal expenses. The
diversions by C significantly reduced the funds available to conduct
O's ongoing educational programs. The board of trustees never
authorized C to cause O to pay C's personal expenses from O's funds.
Certain members of the board were aware that O was paying C's
personal expenses. However, the board did not terminate C's
employment and did not take any action to seek repayment from C or
to prevent C from continuing to divert O's funds to pay C's personal
expenses. C claimed that O's payments of C's personal expenses
represented loans from O to C. However, no contemporaneous loan
documentation exists, and C never made any payments of principal or
interest.
(ii) The diversions of O's funds to pay C's personal expenses
constituted excess benefit transactions between an applicable tax-
exempt organization and a disqualified person under section 4958.
Therefore, these transactions are subject to the appropriate excise
taxes provided in that section. In addition, these transactions
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O has engaged in regular
and ongoing activities that further exempt purposes both before and
after the excess benefit transactions occurred. However, the size
and scope of the excess benefit transactions engaged in by O
beginning in Year 5, collectively, are significant in relation to
the size and scope of O's activities that further exempt purposes.
Moreover, O has been involved in repeated excess benefit
transactions. O has not implemented any safeguards that are
reasonably calculated to prevent future diversions. The excess
benefit transactions have not been corrected, nor has O made good
faith efforts to seek correction from C, the disqualified person who
benefited from the excess benefit transactions. Based on the
application of the factors to these facts, O is no longer described
in section 501(c)(3) effective in Year 5.
Example 4. (i) O conducts activities that further exempt
purposes. O employs C as its Chief Executive Officer. C, on behalf
of O, entered into a contract with Company K to construct an
addition to O's existing building. The addition to O's building is a
significant undertaking in relation to O's other activities. C owns
all of the voting stock of Company K. Under the contract, O paid
Company K an amount that substantially exceeded the fair market
value of the services Company K provided. When O's board of trustees
approved the contract with Company K, the board did not perform due
diligence that could have made it aware that the contract price for
Company K's services was excessive. Subsequently, but before the IRS
commences an examination of O, O's board of trustees determines that
the contract price was excessive. Thus, O concludes that an excess
benefit transaction has occurred. After the board makes this
determination, it promptly removes C as Chief Executive Officer,
terminates C's employment with O, and hires legal counsel to recover
the excess payments to Company K. In addition, O promptly adopts a
conflicts of interest policy and significant new contract review
procedures designed to prevent future recurrences of this problem.
(ii) The purchase of services by O from Company K at more than
fair market value constitutes an excess benefit transaction between
an applicable tax-exempt organization and disqualified persons under
section 4958. Therefore, this transaction is subject to the
appropriate excise taxes provided in that section. In addition, this
transaction violates the proscription against inurement under
section 501(c)(3) and Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O has engaged in regular
and ongoing activities that further exempt purposes both before and
after the excess benefit transaction occurred. Although the size and
scope of the excess benefit transaction were significant in relation
to the size and scope of O's activities that further exempt
purposes, the transaction with Company K was a one-time occurrence.
By adopting a conflicts of interest policy and significant new
contract review procedures and by terminating C, O has implemented
safeguards that are reasonably calculated to prevent future
violations. Moreover, O took corrective actions before the IRS
commenced an examination of O. In addition, O has made a good faith
effort to seek correction from Company K, the disqualified person
who benefited from the excess benefit transaction. Based on the
application of the factors to these facts, O continues to be
described in section 501(c)(3).
Example 5. (i) O is a large organization with substantial assets
and revenues. O conducts activities that further exempt purposes. O
employs C as its Chief Financial Officer. During Year 1, O pays
$2,500 of C's personal expenses. O does not make these payments
under an accountable plan under Sec. 53.4958-4(a)(4) of this
chapter. In addition, O does not report any of these payments on C's
Form W-2, ``Wage and Tax Statement,'' or on a Form 1099-MISC,
``Miscellaneous Income,'' for C for Year 1, and O does not report
these payments as compensation on its Form 990, ``Return of
Organization Exempt From Income Tax,'' for Year 1. Moreover, none of
these payments can be disregarded under section 4958 as nontaxable
fringe benefits and none consisted of fixed payments under an
initial contract under Sec. 53.4958-4(a)(3) of this chapter. C does
not report the $2,500 of payments as income on his individual
federal income tax return for Year 1. O does not repeat this
reporting omission in subsequent years and, instead, reports all
payments of C's personal expenses not made under an accountable plan
as income to C.
(ii) O's payment in Year 1 of $2,500 of C's personal expenses
constitutes an excess benefit transaction between an applicable tax-
exempt organization and a disqualified person under section 4958.
Therefore, this transaction is subject to the appropriate excise
taxes provided in that section. In addition, this transaction
violates the proscription against inurement in section 501(c)(3) and
Sec. 1.501(c)(3)-1(c)(2).
(iii) The application of the factors in Sec. 1.501(c)(3)-
1(g)(2)(ii) to these facts is as follows. O engages in regular and
ongoing activities that further exempt purposes. The payment of
$2,500 of C's personal expenses represented only a de minimis
portion of O's assets and revenues; thus, the size and scope of the
excess benefit transaction were not significant in relation to the
size and scope of O's activities that further exempt purposes. The
reporting omission that resulted in the excess benefit transaction
in Year 1 is not repeated in subsequent years. Based on the
application of the factors to these facts, O continues to be
described in section 501(c)(3).
(3) Effective date. The rules in paragraph (g) of this section will
apply with respect to excess benefit
[[Page 53604]]
transactions occurring after the date of publication in the Federal
Register of a Treasury Decision adopting these rules as final
regulations.
PART 53--FOUNDATION AND SIMILAR EXCISE TAXES
Par. 3. The authority citation for part 53 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805.
Par. 4. In Sec. 53.4958-2, paragraph (a)(6) is added to read as
follows:
Sec. 53.4958-2 Definition of applicable tax-exempt organization.
(a) * * *
(6) Examples. The following examples illustrate the principles of
this section, which defines an applicable tax-exempt organization for
purposes of section 4958:
Example 1. O is a nonprofit corporation formed under state law.
O filed its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). In its
application, O described its plans for purchasing property from some
of its directors at prices that would exceed fair market value.
After reviewing the application, the IRS determined that because of
the proposed property purchase transactions, O failed to establish
that it met the requirements for an organization described in
section 501(c)(3). Accordingly, the IRS denied O's application.
While O's application was pending, O engaged in the purchase
transactions described in its application at prices that exceeded
the fair market value of the property. Although these transactions
would constitute excess benefit transactions under section 4958,
because the IRS never recognized O as an organization described in
section 501(c)(3), O was never an applicable tax-exempt organization
under section 4958. Therefore, these transactions are not subject to
the excise taxes provided in section 4958.
Example 2. O is a nonprofit corporation formed under state law.
O files its application for recognition of exemption under section
501(c)(3) within the time prescribed under section 508(a). The IRS
issues a favorable determination letter in Year 1 that recognizes O
as an organization described in section 501(c)(3). Subsequently, in
Year 5 of O's operations, O engages in certain transactions that
constitute excess benefit transactions under section 4958 and
violate the proscription against inurement under section 501(c)(3)
and Sec. 1.501(c)(3)-1(c)(2). The IRS examines the Form 990,
``Return of Organization Exempt From Income Tax'', that O filed for
Year 5. After considering all the relevant facts and circumstances
in accordance with Sec. 1.501(c)(3)-1(g), the IRS concludes that O
is no longer described in section 501(c)(3) effective in Year 5. The
IRS does not examine the Forms 990 that O filed for its first four
years of operations and, accordingly, does not revoke O's exempt
status for those years. Although O's tax-exempt status is revoked
effective in Year 5, under the lookback rules in Sec. 53.4958-
2(a)(1) and Sec. 53.4958-3(a)(1) of this chapter, for a period of
five years prior to the excess benefit transactions that occurred in
Year 5, O was an applicable tax-exempt organization and O's
directors were disqualified persons as to O. Therefore, the
transactions between O and its directors during Year 5 are subject
to the appropriate excise taxes provided in section 4958.
* * * * *
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 05-17858 Filed 9-8-05; 8:45 am]
BILLING CODE 4830-01-P