MEMORANDUM 98-39

September 14, 1998

I wanted to inform you of proposed regulations by the Internal Revenue Service concerning the "Taxpayer Bill of Rights 2." The proposed regulations, published in the August 4th Federal Register, concern excise taxes on "excess benefit transactions" under Section 4958 of the Internal Revenue Code. The regulations were posted on July 31, 1998, and written comments must be received by November 2, 1998.

As explained in the attached article "IRS Proposes Regulations on Pay for Top Officials of Private Colleges" by Kit Lively, printed in the August 14, 1998 Chronicle of Higher Education, the law calls for stiff penalties for officials who receive salaries or benefits considered "excessive" by the IRS, and for certain managers who knowingly approve such transactions (unless such participation was not willful and was due to reasonable cause). According to the proposed regulations, Section 4958 imposes excise taxes on "transactions that provide excess economic benefits to disqualified persons of public charities and social welfare organizations." "Disqualified persons" include "any person who was in a position to exercise substantial influence over the affairs of the organization at any time during the five-year period ending on the date of the transaction," starting on September 14, 1995. Thus, "disqualified persons" could include directors, executive officers, treasurers, and chief financial officers, among others. Section 53.4958-3(f), example six refers specifically to the law school dean of a large, tax-exempt university.

T is a large university and an applicable tax-exempt organization for purposes of section 4958. L is the dean of the College of Law of T, a major source of revenue for T. The College of Law is important to T's reputation for excellent teaching and high quality faculty scholarship. T relies on this reputation to attract students and contributions from alumni and foundations. L plays a key role in faculty hiring and has authority to control or determine a significant portion of T's capital expenditures and operating budget because of L's position in the College of Law. L's compensation is greater than the amount of compensation referenced for a highly compensated employee in section 414(q)(1)(B)(i) in the year benefits are provided. Because of the importance of the College of Law to T and L's managerial control over that segment of T, L is in a position to exercise substantial influence over the affairs of T. Therefore L is a disqualified person with respect to any transaction involving T that provides economic benefits to L directly or indirectly.

According to Section 53.4958-1(a) of the proposed regulations, if the IRS determines that an "excess benefit transaction" has occurred, section 4958(a)(1) imposes a tax "equal to 25 percent of the excess benefit" to be paid by the "disqualified person." Under Section 53.4958-2, if the transaction is not "corrected" within the "taxable period," Section 4958(b) imposes a "tax equal to 200 percent of the excess benefit." Organization managers who knowingly participate in such transactions are also liable for excess taxes equal to 10% of the excess benefit.

The AALS has no substantive expertise on this issue and thus is not in a position to offer advice or interpretation. We are however working with the American Council on Education (A.C.E.), which has obtained analyses of the proposed regulations. We are bringing the issue to your attention should you want to discuss the proposed regulations within your school and decide whether to send an institutional response.

Attachment [Not available on website.]

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