What Nonprofit Leaders Need to Know About Excise Tax to Avoid Penalties

These days, nonprofit leaders face a great deal of responsibility. This is especially true when it comes to understanding the legal and tax requirements involved in running a tax-exempt organization.

Specifically, nonprofit leaders need to be well-versed in excise tax as it relates to nonprofits to avoid potential fines, penalties and other compliance issues down the road.

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.

What’s important to remember about excise taxes is that they are applicable even to tax-exempt nonprofit organizations.

Excise Taxes and Disqualified Persons

Also important for nonprofit leaders to be aware of 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.

Specifically, a disqualified person in a nonprofit is anybody who is in a position of influence within the organization during the nonprofit’s “look-back” period of five years. In some cases, disqualified persons may even extend to family members of nonprofit leaders—depending on the level of control of 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.

However, 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 hefty 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 take measures to avoid putting themselves and the organization in the situation of receiving excess benefits or pay their excise taxes on excess benefits in accordance with the law and avoid compliance issues that could put their organizations in jeopardy down the road.

The Bottom Line

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 professional to consult with.

Working with a professional empowers nonprofit leaders to focus more on running their organizations while spending less time worrying about compliance and taxes.

To learn more about LGT and how we can serve you, contact us here.