When Nonprofit Insiders Get Too Much (Excess Benefit Transactions)

Public charities are entrusted with stewarding resources for the public good. To protect charitable assets from improper insider use, the IRS enforces intermediate sanctions under Internal Revenue Code §4958, which impose excise taxes on excess benefit transactions. An excess benefit transaction occurs when a disqualified person (an insider with substantial influence) receives more economic benefit from the charity than what they provide in return.

Understanding how these rules work helps boards and nonprofit leaders prevent costly mistakes.

Who Is a “Disqualified Person”?

A disqualified person is typically someone with the ability to influence organizational decisions, such as:

• Board members
• Officers (CEO, CFO, Executive Director, etc.)
• Key employees
• Founders
• Substantial contributors
• Family members of the above
• Entities owned by any of these individuals

If any of these insiders receive a benefit beyond fair market value, the IRS may impose excise taxes.

Excise Taxes Imposed

When an excess benefit occurs, the IRS may assess:

• 25% excise tax on the disqualified person for the excess amount.
• 200% excise tax on the disqualified person if the excess benefit is not corrected within the taxable period.
  • The taxable period starts on the date the transaction occurs and ends on the earlier of (i) the date the IRS issues a statutory notice of deficiency, or (ii) the date the §4958 taxes are assessed.
  • The IRS may abate the 200% tax if the disqualified person corrects the transaction within a 90‑day correction period following the close of the taxable period.
  • If a partial correction is made, the 200% tax applies only to the uncorrected portion.
• 10% excise tax on organization managers who knowingly approved the transaction (capped per transaction), unless their participation was not willful and was due to reasonable cause.
• Common Examples of Excess Benefit Transactions

Below are the most frequent—and often overlooked—scenarios in which public charities unintentionally trigger excess benefit penalties.

1. Overcompensation of Executives

Compensation must be reasonable and supported by comparability data.

 Examples

• Paying an executive director significantly above market ranges for similar regional nonprofits
• Providing a housing or vehicle allowance not approved as part of a documented compensation package
• Awarding retroactive “catch‑up pay” without proper board approval
• Paying a bonus without objective performance metrics

Insufficient documentation alone can push compensation into “unreasonable” territory.

2. Undervalued Sale or Lease of Property

If a public charity allows an insider to buy, use, or rent its property below fair market value, the discount is considered an excess benefit.

 Examples

• Renting space to a board member for nominal rent
• Selling a charity‑owned vehicle for far less than market value
• Allowing insiders to use a nonprofit event venue at steep discounts
• Granting below‑market lease terms to a business owned by an officer

The difference between fair market value and what the insider pays is the excess benefit.

3. Overpayment for Goods or Services

This happens when a charity pays more than what a similar organization would pay for the same goods or services.

Examples

• Hiring a board member’s consulting firm at above‑market rates
• Paying a related party significantly more for routine services like landscaping, cleaning, or IT support
• Purchasing supplies exclusively from a business owned by an insider at inflated prices

Even if the services are legitimate, the overpayment itself is an excess benefit.

Personal Use of Charity Assets

Nonprofit resources must be used only for charitable purposes unless the user reimburses the organization at fair market value.

 Examples

• Using a nonprofit vehicle for personal trips
• Charging personal expenses to the nonprofit’s credit card
• Living in a nonprofit‑owned residence without paying full rent
• Using nonprofit staff time for personal errands

Repeated “small” uses can add up to a major excess benefit.

Loans to Insiders — A Major Red Flag

Loans from a public charity to a disqualified person are generally presumed to be private benefits, even when the loan includes interest. A loan creates an excess benefit unless the charity can prove all of the following:

1. The interest is fair market rate
2. The loan is properly secured
3. There is a written promissory note with a realistic repayment schedule
4. The loan furthers the charity’s exempt purpose
5. Repayment is reasonably expected

Examples

• Interest but no collateral: $75,000 to the executive director at 6% interest with no collateral = Excess benefit
• Market interest but no charitable purpose: $20,000 to a board member for personal medical bills = Private benefit + excess benefit
• Poor documentation: $10,000 at 5% with no written note = Entire loan treated as excess benefit
• Below‑market or forgivable: $100,000 at 1% forgivable on hitting goals = Excess benefit

6. Weak or Missing Documentation

The IRS relies heavily on documentation. When it’s lacking, the agency assumes the worst.

 Examples

• Reimbursements with no receipts
• Vague expense submissions (e.g., “program expenses — $2,500”)
• Meals, travel, or entertainment without a documented business purpose
• Retroactive approvals of compensation or perks

If the charity cannot show a benefit was fair and reasonable, the IRS may classify the entire amount as an excess benefit.

How Charities Can Prevent Excess Benefit Transactions

• Use independent compensation studies (document comparability)
• Keep detailed minutes, contracts, and appraisals
• Require insiders to recuse themselves from decisions involving their compensation or benefits
• Adopt and enforce a conflict‑of‑interest policy
• Review all related‑party transactions for reasonableness
• Avoid loans to insiders entirely

Good documentation is your best defense.

Excess benefit transactions can occur even when intentions are good. By understanding high‑risk areas, especially loans, personal use of assets, and related‑party transactions, nonprofits can protect their missions, avoid severe IRS penalties, and uphold public trust.