International Journal of Not-for-Profit Law / vol. 18, no. 1, February 2016 / 78
WHAT NONPROFIT BOARD MEMBERS AND MANAGERS
DON’T KNOW CAN HURT THEM FINANCIALLY:
IRS FORM 990 AND THE INTERMEDIATE SANCTIONS ACT
EUGENE H. FRAM, ED.D1
Nonprofit 501(C)(3) charitable organizations and 501(C)(4) social welfare organizations
fall under two IRS regulations—the extended annual Form 990 and the Intermediate
Sanctions Act (Act). Form 990 requires answers to 38 corporate questions on corporate
governance operations. The Act covers prohibitions related to providing or seeking
excess benefits. Most board members know about the Form 990, but few know about its
board obligations; and few board members and managers know the Act exists. With the
IRS aggressively enforcing the Act to eliminate faux nonprofits, unwitting nonprofit
board directors and managers can become ensnared financially.
Two classes of nonprofit organizations, 501(C)(3) charitable organizations and 501(C)(4)
social welfare organizations, are covered by two IRS regulations not applicable to for-profit
corporations. One regulation requires the organization to file an IRS Form 990 each year, including
financial data plus answers to 38 questions related to corporate governance. Many board
members may be unaware of their obligations to be involved in preparation of the form each
year. If there were an audit involving the 38 board questions, further, board members might be
expected to know about any exceptions to be reported, such as conflicts of interest. For example,
any board member whose firm or employing firm has a business relationship with the nonprofit
must specify it as a conflict of interest on Form 990 and probably abstain from voting on related
issues. Also, if the report is late, the nonprofit must file an IRS form, and the board needs to be
advised of the situation.
If the organization ignores any of the requirements, it can lose its tax-exempt status—a
penalty already imposed on thousands of smaller nonprofits. In some instances, moreover, failure
to heed the requirements might leave nonprofit board members open to personal liability for
failing in their corporate duties for “due care.”
1 Eugene H. Fram is Professor Emeritus, Saunders College of Business, Rochester Institute of Technology,
and the author of the newly published Going for Impact: The Nonprofit Director’s Essential Guidebook. He can be
reached at 1 West Edith Ave – A103, Los Altos, California 94022, firstname.lastname@example.org, blog http://non-profitmanagement-dr-fram.com.
The suggestions presented in this article are based on field observations as a veteran for-profit and
nonprofit director and consultant. They should not be construed as offering legal advice.
Parts of this article contain revised and updated material from Eugene Fram & Elaine Spaull (2001)
“Expectations for Nonprofit Boards are Changing,” Nonprofit World, May/June, and reflect the expertise of Elaine
Spaull, Ph.D., J.D.
Another obligation to which nonprofits must adhere is the Intermediate Sanctions Act,
Internal Revenue Code section 4958 (the Act). The Act was passed by Congress in 1996 with
temporary rules of enforcement, but it was not robustly enforced until about 2002. Although they
can be financially ensnared by the 20-year-old Act, very few nonprofit board members and
managers seem to know it exists. In making conference presentations to nonprofit directors,
CEOs, and managers, in fact, I find that ignorance of the law is frightening.
From press coverage and elsewhere, board members and managers are generally aware
that their organizations can be in trouble if they pay unreasonable compensations. But they are
unaware of other sections of the Act that can lead to personal liability for board members, senior
managers, and even such tangential persons such as volunteers and vendors.
History of the Intermediate Sanctions Act.
Up to 1996, the IRS had only one tool to sanction nonprofit organizations that violated its
regulations: It could revoke the organization’s tax-exempt status, a difficult and costly legal
process. Without fraud or a lack of “due care,” the IRS was powerless to hold individual board
members or managers financially responsible.2 The need for the Act was prompted by several
scandals in which CEOs and/or board members of high-profile organizations used their positions
to unjustly enrich themselves.
To give the IRS a tool to target those responsible for such activity while allowing the
nonprofits to retain their tax-exempt status and continue serving clients, Congress passed the
Intermediate Sanctions Act. “The legislative history of section 4958 provides that intermediate
sanctions … may be imposed … in lieu of, or addition to, revocation of and organizations tax-exempt
status—H. Rep. No. 104-506.”3
Importance of Excess Benefits and Disqualified Persons
The key to the Act is what one part of the legislation calls an excess benefit. An excess
benefit can develop in ways other than paying above-market wages. The IRS may consider as
excess benefits the nonprofit’s above-market payment for an asset or its disadvantageous
financial arrangements with other organizations. A fundraising group that receives an
excessively generous travel budget from a nonprofit group can also be in violation of the Act.
Those giving and those seeking an excess benefit can both be liable.
The Act also specifies who may be liable under its provisions, identified with the curious
title of disqualified persons:
Disqualified persons include organization officers, board members and their relatives.
[More importantly] the disqualified persons category also can be extended to people not
on the staff or board if they are in a position to exercise substantial influence over the
organization’s affairs. For example, if a volunteer agrees to chair a program task force,
that person may be considered a disqualified person. Major donors also may fall into this
2 Even when charged by state regulators, one board refused to back down on an excess salary. See:
3 David A. Levitt (2009) “Excess Benefit Transactions Under Section 4958 and Revocation of Tax-Exempt
Status,” Practical Tax Lawyer, spring.
category, even if their only role is to provide resources. The legal reasoning is that such
people have the ability to exercise substantial influence over the organization.4
In simple terms, those receiving the benefit as well as board members and managers approving it
are all subject to the Act.5
In addition, if some benefits are not included in the recipient’s W-2, they are considered
an automatic excess benefit that must be reported on the public IRS Form 990. As of 2008, the
IRS has the power to revoke the organization’s tax-exempt status if it is found guilty of one or
more excess benefits transactions.6
Personal Tax Sanctions
The IRS levies penalties in an unusual way. They are added to the income tax bill of the
individuals found responsible:
For example, if a section 501(C)(3) organization were found to have paid $150,000 to a
disqualified person in a transaction for which $100,000 was fair market value, the
disqualified person would have to pay a tax of 25% of $50,000 or $12,500 to the IRS. In
addition the disqualified person would have to return the excess benefit of $50,000 to the
organization, or be subject to the 200 percent penalty tax ($100,000).7
Enforcement of IRS 4958
To assess the level of enforcement of the Act, I contacted four practicing attorneys, two
of whom specialize in actions related to the Intermediate Sanctions Act. Three cited only one
court case related to a merger situation in which section 4958 was a primary issue.8 All agreed
that the IRS is settling cases without litigation.
Two attorneys suggested that the IRS might be following a procedure common to
The agency identifies an action as a violation of a statute, sometimes with modest
The agency proposes a settlement. If the accused agrees, the case is resolved.
If the case is not resolved, the agency takes aggressive actions to obtain a settlement—
sometimes euphemistically called “rattling the cage.”
If there is no settlement, the agency submits the action for trial or concedes the case.
With so few court cases on record, those accused seem to be acquiescing in the charges. One
hopes that all of these are nonprofits that have been established for self-interest.
4 Eugene Fram & Elaine Spaull (2001) “Expectations for Nonprofit Boards are Changing,” Nonprofit
5 David A. Levitt (2012) “Automatic Excess Benefit Transactions,” Nonprofit Law Matters, Adler &
Colvin, March 22.
6 Levitt (2009).
7 Levitt (2009).
8 Carracci v. Commissioner, http://caselaw.findlaw.com/us-5th-circuit/1147472.html
International Journal of Not-for-Profit Law / vol. 18, no. 1, February 2016 / 81
Such a process, however, can easily ensnare well-meaning nonprofit directors, managers,
or even volunteers who unwittingly approve an excess benefit. In my opinion, nonprofit directors
with nontraditional backgrounds may face a particular risk. In some states, nonprofits such as
medical facilities are required to have current or former clients on their boards, which could
leave some low-income people facing significant tax liabilities. These persons can be placed in a
precarious situation, especially if their D&O policies do not cover losses levied under the Act.
A Hypothetical Case
Following is a statement from a D&O policy that does cover the Act:
Costs of Defense incurred by the Insured. Loss shall not include: (1) criminal or civil
fines or penalties imposed by law, or taxes (except for the 10% “excess benefit” tax
assessed by the Internal Revenue Service against any Insured Person pursuant to 26 USC
Section 4958 (a))
Would naïve volunteer board members who approve an excess benefit be covered under such a
D&O policy? It is highly possible that an inept CFO and/or external auditor might be at fault for
the IRS bringing an action.
The naïveté about the Act extends beyond untutored volunteer board members. I have
encountered certified public accountants and attorneys, including one representing a national
legal association, who had no idea the law existed. I have also encountered a competent CFO
who had unintentionally failed to add an excess vacation benefit to an employee’s income.
Fortunately, the auditing firm found the error. If it had not done so, the IRS could have deemed
the error an automatic excess benefit. Obtaining a claim rescission would have entailed
substantial legal costs and dedicated management time.
In sum, ignorance of the Intermediate Sanctions Act can be financially devastating to
well-meaning people. Nonprofit board education is needed in the area. In particular, all board
members ought to
Be alert: Every board member should know that the Act covers much more than paying
higher salaries and identifying disqualified persons. Well-meaning outsiders, such as
donors and revenue-sharing organizations, could be deemed part of an operating
partnership that might be ensnared by Section 4958.
Know about compensation and benefits: Nonprofits frequently delegate compensation
decisions regarding the executive director or CEO to the board chair or a few senior
board members. The entire board should review all salary schedules every year. If
questioned by the IRS, every board member should know the compensation of the three
or five highest-paid persons. All of this needs to be completed before a salary increase is
Make certain records are kept: If the organization is audited, it will need records of any
transaction being questioned. Board members who are unsure whether a transaction
might involve an excess benefit should ask the board to seek competent legal counsel.
The existence of an excess benefit may fall in a gray area. It could well be fact-based, in
light of practices of comparable organizations. But counsel could flag whether the
potential exists for the payment or benefit to be deemed an excess benefit. If the board
refuses to accept the view of counsel, board members who might perceive it to be an
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excess benefit should vote “no” on the transaction and make certain their votes are
clearly recorded in the meeting minutes in order to avoid liability. When in danger of
approving an excess benefit, it is not a good idea “to go along to get along,” a culture
that seems to pervade nonprofit boards.
Know about safe harbor provisions: The IRS says boards should take certain actions
before making any decision that might be construed as involving an excess benefit—for
example, using organization funds to support an executive director’s trip to Europe after
20 years of service. The board should first appoint a group of disinterested board
members or a formal board committee of disinterested persons to approve such a
transaction, and it should ensure that the group’s decision rests on comparable data
gathered by disinterested field experts. For the European trip, it would be best to
determine if such a reward were standard industry practice, in case the IRS questions the
Make certain all directors’ and officers’ D&O liability insurance policies cover excess benefit
tax sanctions. If not, they should seek coverage. Some policies may exclude
indemnity coverage where there is a violation of law.
Make certain that the annual conflict of interest statement signed by board members,
managers and other disqualified persons includes some reference to the Intermediate
Have counsel review appropriate bylaws, operating guidelines, principles or policies,
etc., to make certain that all compensation processes and other major transactions
comply with the Intermediate Sanctions Act.