The IRS is increasing audit examinations of tax exempt organizations, specifically with regard to related party lending. They are looking for disqualified transactions to disqualified people who are personally involved with the not for profit or tax-exempt organization. This includes lending between the non-profit and any of its directors or staff, related party lending, especially if the loan document is not properly executed or followed. Beware because the penalties are severe!
If a taxpayer loans or borrows from a non-profit, a properly executed lending or borrowing document with proper interest and payment arrangements must be maintained. A properly executed lending or borrowing document must be properly enforced with accruals of interest and actual payments being made per the loan agreement. If the Internal Revenue Service determines that the debt instruments are not properly executed they can and will determine that a disqualifying transaction has occurred and impose an excise tax of 25% of the “excess benefit” for each disqualifying transaction. The disqualified person who benefited from the transaction is liable for the tax.
In other words, if someone were to borrow from a non-profit without properly documenting the loan or obeying the terms of the documented loan, the IRS can levy a tax on the disqualified person of 25% of the amount borrowed.
In addition to the 25% excise tax, if the individual does not repay the loan within the taxable period, the IRS can come back and slap another 200% excise tax on the loan amount. That means that an disqualified person could end up with excise taxes of 225% of their disqualified transaction.
Another catastrophe associated with taking money from a non-profit in a disqualified transaction is that every disqualified person is jointly and severally liable for all excise taxes resulting from disqualified transactions from a non-profit. For example, if one person takes $100 out of a non-profit to pay some personal expenses, and another takes out $100,000 in an undocumented loan, both disqualified people would be liable for the resulting 25% excise tax of $25,025. If they wait and don’t pay back the amount taken out of the non-profit, both individuals then become liable for the full excise tax of $225,225.
As always if you have questions regarding specific transactions pertaining to your non-profit, we are here to help.