Nonprofit leaders face great responsibility, especially when understanding the legal and tax requirements involved in managing a tax-exempt organization. Specifically, nonprofit leaders need to understand excise tax related to nonprofits to avoid potential fines, penalties, and other compliance issues.
Understanding Excise Tax for Nonprofits
What exactly is excise tax and how does it affect nonprofit organizations? Specifically, excise taxes are taxes imposed on goods, services, or activities as a means of ensuring that providers are adhering to certain standards. Tax-exempt organizations can be assessed excise tax on several types of transactions, including excess benefits.
Excise Taxes and Disqualified Persons
Important for nonprofit leaders to be aware when it comes to excise taxes is that so-called “disqualified persons” (also commonly referred to as “insiders”) can receive excess benefit transactions that ultimately exceed the amount of value they offer to the organization. When this occurs, the IRS imposes an excise tax of 25% on the excess benefit itself. Unfortunately, this 25% tax can add up very quickly and could end up getting nonprofit leaders into a lot of trouble from a compliance standpoint.
Who Is Considered a “Disqualified Person”?
To determine whether a nonprofit leader may be subjected to this 25% excise tax, it is important to figure out whether they are considered a “disqualified person” by the IRS. A disqualified person in a nonprofit is anybody who is in a position of influence within the organization during the nonprofit’s “look-back” five years. In some cases, disqualified persons may even extend to family members of nonprofit leaders—depending on the level of control or influence they may have over operations.
Potential Penalties for Excess Benefit Transactions
All too often, nonprofit leaders are unaware of these classifications and the excise taxes to which they may be subjected as a result. Unfortunately, when the 25% excise tax imposed on excess benefits isn’t paid by nonprofit leaders, an additional excise tax or penalty of 200% of the amount could be imposed by the IRS. The reason this penalty is so severe is to encourage nonprofit leaders to take this situation seriously and pay their initial excise taxes on all excess benefits when they fall into disqualified person status.
What is considered an excess benefit, anyway? The IRS defines excess benefits for insiders as any compensation collected from the nonprofit that exceeds the value of the services they render. This can come in the form of money, property, or any other type of asset.
How to Avoid Penalties and Other Compliance Issues
For nonprofit leaders who are facing the 200% excise tax as a result of oversight, the most important thing to do is to correct the mistake as promptly as possible. If the initial 25% excise tax can be paid within the same tax year that it was assessed, then the IRS will generally waive the 200% penalty without issue.
For nonprofit leaders who have already received notices of deficiency by the IRS, the problem may be more difficult to correct. This is where it may be helpful to reach out to the IRS directly as a means of setting up a payment plan or exploring other options.
Ultimately, the best way to avoid excise taxes and penalties is for nonprofit leaders to be aware of excise tax laws and their potential status as disqualified persons. This way, disqualified persons can pay their excise taxes on excess benefits under the law and avoid compliance issues that could put their organizations in jeopardy down the road.
Consult with a Financial Advisor for Further Guidance
Dealing with taxes as a nonprofit leader can be challenging, especially when there are so many different laws and regulations to keep up with. This is where it can be especially helpful to have an experienced financial advisor to consult with. Specifically, a financial advisor can provide guidance when it comes to tax requirements, disqualified person status, and other matters related to handling finances as a nonprofit leader. Likewise, working with a financial advisor empowers nonprofit leaders to focus more on running their organizations while spending less time worrying about compliance and taxes.
If you have any questions or would like additional information, please contact DMJPS.
April Westmoreland, CPA
April is a Senior Manager at DMJPS PLLC and has significant experience in assurance services. She has worked with a broad range of industries, with a specific focus on not-for-profit, government entities, and employee benefit plans. April provides a personal and systematic approach to her services which include compilations, reviews, and audits of financial statements.