The Internal Revenue Service keeps a close eye on tax-exempt organizations to ensure that their exempt status is not abused. Under Internal Revenue Code section 4958, the IRS can impose a 25% excise tax on the unreasonable portion of any compensation received by a key employee. The IRS can also impose a 10% excise tax on an officer or director who permitted the excessive payment. These excise taxes are imposed upon the individuals, not on the charity.

The Code refers to this unreasonable compensation as an “excess benefit transaction” because the employee is getting a benefit (compensation) in excess of the value of services he provides in exchange.

Internal Revenue Code §4958(a) applies to payments made by organizations exempt from tax under §501(c)(3) or (4):

(1) On the disqualified person

“There is hereby imposed on each excess benefit transaction a tax equal to 25 percent of the excess benefit. The tax imposed by this paragraph shall be paid by any disqualified person…with respect to such transaction.”

(2) On the management

“…there is hereby imposed on the participation of any organization manager in the excess benefit transaction, knowing that it is such a transaction, a tax equal to 10 percent of the excess benefit, unless such participation is not willful and is due to reasonable cause. The tax…shall be paid by any organization manager who participated in the excess benefit transaction.”