The term “disqualified person” is critical in the context of IRC §4958, “Taxes on excess benefit transactions”, which pertains to the imposition of excise taxes on excess benefit transactions involving certain tax-exempt organizations, including public charities and social welfare organizations. A “disqualified person” is defined as anyone who is in a position to exercise substantial influence over the affairs of the organization at any time during a five-year period ending on the date of the transaction in question.
Key categories of disqualified persons typically include:
The definition can also extend to family members of these individuals and entities they control. This is designed to prevent insiders from using their influence to benefit personally at the expense of the organization’s mission and tax-exempt status.
If a transaction providing an economic benefit to a disqualified person is deemed excessive compared to the value of the services or goods provided to the organization, it is classified as an “excess benefit transaction”. The consequences of such a transaction are severe. The disqualified person involved may be subject to an initial excise tax of 25% of the excess benefit. If the transaction is not corrected within a specified period, an additional tax of 200% of the excess benefit can be imposed.
If you create a charity that benefits yourself, and you are classified as a disqualified person (such as an officer, director, or substantial contributor), any transaction providing you with an excess benefit over what you provide in return can trigger significant penalties. This includes taxes on the excess benefit received, and in severe cases, it can lead to the revocation of the organization’s tax-exempt status. Therefore, creating a charity primarily for personal benefit is not only contrary to the spirit of charitable work but also exposes you to legal and financial risks under IRC §4958.
Furthermore, organizational managers who knowingly approve such transactions can also face excise taxes. These penalties underscore the importance of rigorous oversight and compliance mechanisms within charitable organizations to prevent the misuse of their resources.
For organizations, it is advisable to establish clear policies and procedures for determining compensation and other benefits, conduct regular reviews of transactions with potential disqualified persons, and maintain robust conflict of interest policies to safeguard against the risk of excess benefit transactions. This not only ensures compliance with IRC Section 4958 but also helps maintain public trust in the integrity of charitable organizations.