During a panel discussion at a recent governance conference, IRS officials named fringe benefits as the most common area for intermediate sanctions on exempt organizations. Intermediate sanctions include excise taxes assessed on disqualified persons and exempt organization managers to limit private inurement to disqualified persons. Excise taxes on excess benefits under the intermediate sanctions rules can be extreme, as they are designed to effectively punish private inurement without revoking an organization’s tax exemption. However, the IRS may still seek exemption revocation when excess benefit transactions arise after enforcing the intermediate sanctions rules.
Organizations must include fringe benefits in compensation to all employees, especially disqualified persons, i.e., those in a position to exercise substantial influence over the affairs of the organization at any time during the preceding five-year period. Fringe benefits not treated as income for chief executives may be deemed automatic excess benefit transactions. Automatic excess benefits arise when an economic benefit for an executive or disqualified person should be treated as compensation but is not, even in situations where total compensation would have been reasonable had the benefit been originally included in income.
There must be clear intent the benefit is compensation, with written contemporaneous substantiation that the value was intended as compensation. It is an excess benefit and subject to intermediate sanctions if not approved as compensation through the organization’s policies and treated as such in the books and records. Intent to treat the benefit as compensation is accomplished when the organization includes the benefit in the disqualified person’s income and the person reports such income on personal income tax returns. An organization also may establish intent after the fact by amending its Form 990 at any time before the IRS begins an examination of the organization or disqualified person. Failing to do so before the IRS challenges the transaction will likely result in an excess benefit treatment by the IRS.
The IRS may also identify excess benefit transactions associated with fringe benefits through efforts to identify uncollected employment taxes. The IRS National Research Program is conducting a three-year study focusing on uncollected employment taxes including taxes due to the omission of taxable fringe benefits, as well as other forms of compensation.
Another focus area in the employee compensation arena is reimbursable expenses reportable as taxable compensation. Failure by the employer to properly draft and maintain accountable plans and/or failure by the employee to properly substantiate reimbursed expenses could result in unintended taxable compensation to the employee. Employers should maintain accountable plans requiring substantiation of reimbursable expenses. Accountable plans are reimbursement or expense-allowance arrangements covering deductible expenses for federal purposes in which the employee must account for the expenses and return any excess allowance or reimbursement within a reasonable time period. The panel stressed expense reimbursements must be periodically reviewed by governing boards for compliance. Also, the panel pointed out, corporate credit card billing statements are not sufficient to meet the substantiation requirements of an accountable expense reimbursement plan; original receipts are necessary.
Common instances of fringe benefits that should be included as taxable wages for disqualified persons include personal use of equipment and facilities. Organizations should consider the following steps to make sure fringe benefit treatment is appropriate and to avoid excess benefit transaction treatment:
- A compensation committee, comprising governing board members not related to or controlled by the chief executives, should review reasonableness of compensation packages for the organization’s highest-ranking officers.
- Properly document all transactions.
- Determine applicable state laws for compliance.
Organizations should proceed cautiously when providing fringe benefits for disqualified persons and should properly document all transactions. It is important all reimbursable expenses include proper substantiation for reimbursement. Because the excise tax resulting from intermediate sanctions is imposed on both the disqualified person and any organization managers who approved the payment, proper reporting of employee fringe benefits to key executives is even more critical.
Contact your BKD advisor with any questions you have regarding taxability of fringe benefits or the intermediate sanctions rules.
Article reprinted with permission from BKD, LLP, www.bkd.com. All rights reserved.