Part I. Rulings — Internal Revenue Bulletin 2008-18

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 62.—Adjusted Gross Income Defined

26 CFR 1.62–2: Reimbursements and other expense allowance arrangements.

A revenue ruling addresses which party is subject to the section 274(n) limitation when a trucking company leases truck drivers from a leasing company and the leasing company reimburses the drivers for meal and incidental expenses they incur in the course of performing services. See Rev. Rul. 2008-23, page 852.

Section 274.—Disallowance of Certain Entertainment, etc., Expenses

26 CFR 1.274–2: Disallowance of deductions for certain expenses for entertainment, amusement, recreation, or travel. (Also §§ 62, 1.62–2.)

Employee leasing arrangements. This ruling addresses which party is subject to the Code section 274(n) limitation when a trucking company leases truck drivers from a leasing company and the leasing company reimburses the drivers for meal and incidental expenses they incur in the course of performing services.

Rev. Rul. 2008–23

ISSUE

If a Client leases employees from a Leasing Company, and the Leasing Company reimburses the employees for meal and incidental expenses (M&IE) they incur in the course of performing services, which party’s deduction for reimbursement of the M&IE is subject to the limitation under § 274(n) of the Internal Revenue Code?

FACTS

Leasing Company and Client, who are unrelated parties, enter into a written em

ployee leasing contract under which Leasing Company leases drivers to Client to haul products in exchange for Client’s periodic payments to Leasing Company. The employee leasing contract provides that Leasing Company will calculate Client’s periodic payments to cover Leasing Company’s expenditures (wages due to drivers, payments of the M&IE to drivers under a reimbursement arrangement between Leasing Company and the drivers, and other expenses) plus a profit.

Each driver (Driver) performs services as an employee in the trucking industry. Driver incurs M&IE while traveling overnight away from home in connection with Driver’s employment. In addition to receiving wages, Driver receives a separately stated reimbursement at the M&IE rate from Leasing Company. All the reimbursements paid to Driver are paid under a “reimbursement or other expense allowance arrangement,” within the meaning of § 274(e)(3), between Leasing Company and Driver.

Neither Leasing Company nor Client deducts the M&IE amounts as compensation on its originally filed income tax return, nor does either treat the M&IE amounts as wages for purposes of withholding under Chapter 24. The employee leasing contract does not address which party reimburses the drivers’ M&IE for purposes of applying the § 274(n) limitation. In each situation described below, either Leasing Company or Client may be the Driver’s employer under the usual common law rules applicable to determining the employer-employee relationship. See § 31.3121(d)–1 of the Employment Tax Regulations.

Situation 1 . Driver adequately accounts to Leasing Company for the M&IE to satisfy the substantiation requirements of § 274(d) pursuant to an annually updated revenue procedure, Rev. Proc. 2007–63, 2007–42 I.R.B. 809 (or any successor). After calculating Driver’s wages and any M&IE payments that may be due, Leasing Company sends Client a billing invoice for a periodic payment due. The invoice is for a lump-sum and does not itemize for the amount of any M&IE reimbursement. Client pays Leasing Company the

lump-sum periodic payment. Upon receiving Client’s periodic payment, Leasing Company pays both Driver’s wages and M&IE reimbursement.

Situation 2 . Driver adequately accounts to Leasing Company for the M&IE to satisfy the substantiation requirements of § 274(d) pursuant to Rev. Proc. 2007–63 (or any successor). After Driver accounts to Leasing Company for M&IE, Leasing Company calculates Driver’s wages and any M&IE payments that may be due. Leasing Company sends Client a billing invoice for a periodic payment due. The invoice is for a lump-sum and does not itemize for the amount of any M&IE reimbursement. Client pays Leasing Company the lump-sum periodic payment. Upon receiving Client’s periodic payment, Leasing Company pays both Driver’s wages and M&IE reimbursement. Immediately after Leasing Company pays Driver, Leasing Company sends Client a statement indicating the amount paid to Driver as a reimbursement of Driver’s M&IE. Leasing Company also accounts for that amount by delivering to Client a copy of all of the substantiation that Driver had originally submitted to Leasing Company. Client accepts the substantiation submitted by Leasing Company and acknowledges that the portion of its periodic payment equal to the amount that Leasing Company paid to reimburse Driver’s M&IE is paid under a reimbursement arrangement with Leasing Company and is subject to the § 274(n) limitation.

Situation 3. Driver is paid an allowance at the applicable M&IE rate by Leasing Company, but substantiates the expenses to Client. Client then immediately delivers to Leasing Company a copy of all of the information that Driver had originally submitted to Client to substantiate Driver’s expenses, and Client informs Driver that it has done so. Leasing Company accepts the substantiation. Driver adequately accounts for the M&IE to satisfy the substantiation requirements of § 274(d) pursuant to Rev. Proc. 2007–63 (or any successor).

After receiving Driver’s substantiation, Leasing Company calculates Driver’s wages and any M&IE reimbursements that may be due. Leasing Company sends

2008–18 I.R.B. 852 May 5, 2008

allowance arrangement” in § 274(e)(3) has the same meaning it has “in section 62(2)(A), but without regard to whether the taxpayer is the employee of a person for whom services are performed.” T.D. 6659, 1963–2 C.B. 113. The subsequent addition of § 62(c) in 1988 and its accompanying regulations did not change the meaning of “reimbursement or other expense allowance arrangement” for purposes of § 274(e)(3). Thus, the application of § 274(e)(3) does not require the existence of an accountable plan within the meaning of § 62(c) and the regulations under that section.

Section 274(n)(1) limits certain deductions allowable under § 162. If an employee or independent contractor incurs M&IE in connection with the performance of services for another person and is not reimbursed, § 274(n) limits any § 162(a)(2) deduction claimed by the employee or independent contractor. If an employee accounts for the expenses under § 274(d) to the payor, is reimbursed under a reimbursement or other expense allowance arrangement, and the payment is not treated both as additional compensation and as wages for income tax withholding purposes, then under § 274(e)(3)(A), the employee is not subject to § 274(n). See § 274(n)(2)(A) and § 1.274–2(f)(2)(iv)( a ). The party initially making the reimbursement (“initial payor”) bears the expenses, and § 274(n) limits that party’s § 162(a)(2) deduction, unless that party also satisfies § 274(e)(3)(B). Sections 1.274–2(f)(2)(iv)( b ) and 1.274–5(f)(4)(iii). If the initial payor, in connection with its performance of services for a third party, is reimbursed under a reimbursement or other expense allowance arrangement with the third party, and the initial payor accounts to the third party in the same manner that the employee accounted for the expenses to the initial payor, then the initial payor satisfies § 274(e)(3)(B). Section 1.274–2(f)(2)(iv)( c )( 1 ). In that case, the third party bears the expenses, and § 274(n) limits the § 162(a)(2) deduction that the third party claims for those expenses.

In Transport Labor Contract/Leasing, Inc. v. Commissioner, 461 F.3d 1030 (8 ^th

Cir. 2006), rev’g 123 T.C. 154 (2004) ( TLC ), the question was the application of § 274(n) for taxable years ending in

Client a billing invoice for a periodic payment due. The invoice is for a lump-sum and does not itemize for the amount of any M&IE reimbursement. Client pays Leasing Company the lump-sum periodic payment. Upon receiving Client’s periodic payment, Leasing Company pays both Driver’s wages and M&IE reimbursement. Immediately after Leasing Company pays Driver, Leasing Company sends Client a statement indicating the amount paid to Driver as a reimbursement of Driver’s M&IE. Leasing Company also accounts to Client by referring to the substantiation Client had received from Driver and had submitted (via a copy) to Leasing Company. Client accepts the substantiation submitted by Leasing Company and acknowledges that the portion of its periodic payment equal to the amount that Leasing Company paid to reimburse Driver’s M&IE is paid under a reimbursement arrangement with Leasing Company and is subject to the § 274(n) limitation.

LAW

Section 162(a)(2) allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including traveling expenses (such as M&IE) while away from home in the pursuit of a trade or business.

In general, § 274(d)(1) provides that no deduction is allowed under § 162 to a taxpayer for traveling expenses (including M&IE) unless the taxpayer substantiates the expenses. If the taxpayer is an employee and is reimbursed for M&IE by a payor (whether the employer, the employer’s agent, or a third party), the employee satisfies § 274(d) by accounting to the payor with adequate records substantiating the amount of the expense, the time and place of the expense, and the business purpose of the expense. Section 1.274–5(f)(4)(i) (last sentence) and (f)(4)(iii) of the Income Tax Regulations. With some exceptions, an employee who adequately accounts for the M&IE is not again required to substantiate the expenses. Section 1.274–5T(f)(5) of the temporary Income Tax Regulations. If the payor and employee use the annually updated revenue procedure to substantiate the expenses, the M&IE amount (to the extent reimbursed and substantiated) is

treated as an expense for food or beverages and is subject to § 274(n). See section 6.05 of Rev. Proc. 2007–63. If the taxpayer is an independent contractor and receives a payment for M&IE under a reimbursement or other expense allowance arrangement from a client, § 274(d) requires that the independent contractor account to the client with adequate records, or other sufficient evidence corroborating the independent contractor’s own statement, substantiating the amount of the expense, the time and place of the expense, and the business purpose of the expense. Section 1.274–5T(h)(3). Unlike an employee, however, an independent contractor must maintain a copy of the records, or other sufficient evidence, to substantiate the expenses. Section 274(d); § 1.274–5T(h)(2).

Section 274(n)(1) generally limits the amount allowed as a deduction for any expense for food or beverages to 50 percent of the expense, although § 274(n)(3) generally imposes a lesser limitation on deductions for truck drivers’ expenses. However, § 274(n)(2) excepts expenses described in § 274(e)(3) from the limitation imposed by § 274(n)(1).

Section 274(e)(3) expenses are those paid or incurred by a taxpayer in connection with the performance of services for another person (whether or not that other person is the taxpayer’s employer) under a reimbursement or other expense allowance arrangement with that other person. If the payment is made to an employee, the § 274(e)(3)(A) exception applies to the employee only to the extent the employer does not report the payment as compensation to the employee on the employer’s originally filed income tax return and as wages to the employee for purposes of withholding under Chapter 24. Section 1.274–2(f)(2)(iv)( b ). If the payment is made to an independent contractor, the § 274(e)(3)(B) exception applies to the independent contractor to the extent the independent contractor accounts for the expenses to the payor in a manner satisfying § 274(d). Section 1.274–2(f)(2)(iv)( c ).

For purposes of § 274(e)(3), a “reimbursement or other expense allowance arrangement” includes, but is not limited to, an “accountable plan” as that term is defined for purposes of § 62(c). See § 1.62–2(c)(1). Since 1963, § 1.274–2(f)(2)(iv)( a ) has provided that the term “reimbursement or other expense

May 5, 2008 853 2008–18 I.R.B.

knowledges that the portion of its periodic payment equal to the amount that Leasing Company paid to reimburse Driver’s M&IE is paid under a reimbursement arrangement and is subject to the § 274(n) limitation. Leasing Company meets the requirements of § 274(e)(3)(B) because (1) under the employee leasing contract and as indicated by their course of dealing, Leasing Company can prove that it has established a reimbursement or other expense allowance arrangement with Client within the meaning of § 274(e)(3), and (2) Leasing Company accounts to Client by delivering a copy of the substantiation that Driver had provided to Leasing Company ( i.e., in a manner satisfying § 274(d)). Therefore, Leasing Company is not subject to § 274(n), Client bears the expense of the M&IE, and § 274(n) limits Client’s § 162(a)(2) deduction for the M&IE, regardless of whether Leasing Company or Client is Driver’s employer under the usual common law rules.

Situation 3 . Leasing Company has a copy of the information Driver originally submitted to Client to account for Driver’s M&IE. Leasing Company, as payor of the substantiated M&IE reimbursement to Driver, must determine if its deduction of the expenses under § 162(a) is subject to the § 274(n) limitation. Immediately after Leasing Company pays Driver, Leasing Company sends Client a statement indicating the amount paid to Driver that was a reimbursement of Driver’s M&IE. Leasing Company also accounts to Client by referring to the substantiation Client had received from Driver and had submitted (via a copy) to Leasing Company. Client accepts the substantiation submitted by Leasing Company, and acknowledges that the portion of its periodic payment equal to the amount that Leasing Company paid to reimburse Driver’s M&IE is paid under a reimbursement arrangement and is subject to the § 274(n) limitation. Leasing Company meets the requirements of § 274(e)(3)(B) because (1) under the employee leasing contract and as indicated by their course of dealing, Leasing Company can prove that it has established a reimbursement or other expense allowance arrangement with Client within the meaning of § 274(e)(3), and (2) Leasing Company accounts to Client by referring to the substantiation that Driver originally submitted to Client ( i.e., in a manner satisfying

1993 through 1996 to an employee leasing arrangement that provided for the payment to employees of per diem allowances for M&IE. The Court of Appeals for the Eighth Circuit found that the trucking company clients, not the leasing company (TLC), actually bore the per diem expenses under the reimbursement arrangement between the parties. The appellate court held that TLC qualified for the exception in § 274(e)(3)(B) and, therefore, that TLC’s § 162(a)(2) deduction for the per diem expenses was not limited by § 274(n).

The appellate court reversed the Tax Court, which had held that § 274(n) limited TLC’s § 162(a)(2) deduction because TLC was the drivers’ common law employer. Under the Tax Court’s analysis, the § 274(n) limitation necessarily applies to the employees’ common law employer. Compare Beech Trucking Co. v. Commis- sioner, 118 T.C. 428, 443 (2002) (relying on common law employer factor and identity of party ultimately bearing the expense to determine incidence of § 274(n) limitation). The appellate court opined that the Tax Court had erroneously failed to examine whether TLC qualified for the exception in § 274(e)(3)(B).

In TLC, the Court of Appeals for the Eighth Circuit determined that TLC’s § 162 deduction ultimately was not limited by § 274(n) because TLC was not the party that ultimately bore the per diem expenses. The appellate court concluded that status as a common law employer is not dispositive in the § 274(n) analysis, but did not explicitly reject that status as a relevant factor. The Internal Revenue Service acquiesces in the result in TLC and agrees with the appellate court’s opinion that the § 274(n) limitation should apply to the party that ultimately bears the per diem expenses. However, the Internal Revenue Service does not agree with the opinion to the extent that it could be read to imply that status as a common law employer is relevant to the § 274(n) analysis.

ANALYSIS

In each situation below, Driver is an employee who incurs M&IE in connection with the performance of services for another person, receives a reimbursement at the M&IE rate, and accounts for the reimbursement under a “reimbursement or other expense allowance arrangement”

within the meaning of § 274(e)(3). Neither Leasing Company nor Client deducts the M&IE amounts as compensation paid to Driver on its originally filed income tax return, nor treats the M&IE amounts as wages paid to Driver for purposes of withholding under Chapter 24. Therefore, under § 274(e)(3)(A), Driver is not subject to § 274(n).

Situation 1 . Leasing Company, as payor of the substantiated M&IE reimbursement to Driver, must determine if its deduction of the expenses under § 162(a) is subject to the § 274(n) limitation. Although Leasing Company pays the M&IE of each driver in connection with its performance of services for Client, Leasing Company has provided Client only an invoice for a lump-sum periodic payment due. Therefore, Leasing Company does not satisfy § 274(e)(3)(B) because it has not accounted to Client in a manner satisfying § 274(d) and does not have a reimbursement or other expense allowance arrangement with Client. Under these circumstances, Leasing Company bears the expense of the M&IE, and § 274(n) limits Leasing Company’s § 162(a)(2) deduction for the M&IE, regardless of whether Leasing Company or Client is Driver’s employer under the usual common law rules. Even if Leasing Company had provided an itemized invoice to Client designating a portion of the periodic payment as a reimbursement of Driver’s M&IE, Leasing Company still does not satisfy § 274(e)(3)(B) because it has not accounted to Client in a manner satisfying § 274(d) and does not have a reimbursement or other expense allowance arrangement with Client.

Situation 2 . Leasing Company, as payor of the substantiated M&IE reimbursement to Driver, must determine if its deduction of the expenses under § 162(a) is subject to the § 274(n) limitation. Leasing Company has the information Driver originally submitted to account for Driver’s M&IE. Immediately after Leasing Company pays Driver, Leasing Company sends Client a statement indicating the amount paid to Driver that was a reimbursement of Driver’s M&IE. Leasing Company also accounts to Client by delivering to Client a copy of the substantiation that Driver had originally provided to Leasing Company. Client accepts the substantiation submitted by Leasing Company and ac

2008–18 I.R.B. 854 May 5, 2008

§ 274(d)). Therefore, Leasing Company is not subject to § 274(n), Client bears the expense of the M&IE, and § 274(n) limits Client’s § 162(a)(2) deduction for the M&IE, regardless of whether Leasing Company or Client is Driver’s employer under the usual common law rules.

HOLDINGS

(1) In Situation 1, Leasing Company’s deduction for reimbursement of the M&IE to Driver is subject to the § 274(n) limitation.

(2) In Situation 2, Client’s deduction for reimbursement of the M&IE to Leasing Company is subject to the § 274(n) limitation.

(3) In Situation 3, Client’s deduction for reimbursement of the M&IE to Leasing Company is subject to the § 274(n) limitation.

DRAFTING INFORMATION

The principal author of this revenue ruling is Jeffrey T. Rodrick of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this revenue ruling, contact Mr. Rodrick at (202) 622–4930 (not a toll-free call).

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 467.—Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 482.—Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 501.—Exemption From Tax on Corporations, Certain Trusts, etc.

26 CFR 1.501(c)(3)–1: Organizations organized and operated for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals.

T.D. 9390

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 53

Standards for Recognition of Tax-Exempt Status if Private Benefit Exists or if an Applicable Tax-Exempt Organization Has Engaged in Excess Benefit Transaction(s)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations that clarify the substantive requirements for tax exemption under section 501(c)(3) of the Internal Revenue Code (Code). This document also contains provisions that clarify the relationship between the substantive requirements for tax exemption under section 501(c)(3) and the imposition of section 4958 excise taxes on excess benefit transactions. These regulations affect organizations described in section 501(c)(3) of the Code and organizations applying for exemption as organizations described in section 501(c)(3) of the Code.

DATES: Effective Date: These regulations are effective March 28, 2008.

FOR FURTHER INFORMATION CONTACT: Galina Kolomietz, (202) 622–7971 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On September 9, 2005, a notice of proposed rulemaking (REG–111257–05, 2005–2 C.B. 759) clarifying the substantive requirements for tax exemption under section 501(c)(3) of the Code, and the relationship between the substantive requirements for tax exemption under section 501(c)(3) and the imposition of section 4958 excise taxes was published in the Federal Register (70 FR 53599). The IRS received several written comments responding to this notice. After consideration of all comments received, the proposed regulations under sections 501(c)(3) and 4958 are revised and published in final form. The major areas of comments and revisions are discussed in the following preamble. See §601.601(d)(2)(ii)( b )).

Explanation and Summary of Comments

Private Benefit

The proposed regulations added several examples to illustrate the requirement in §1.501(c)(3)–1(d)(1)(ii) that an organization serve a public rather than a private interest. The purpose of the examples is

May 5, 2008 855 2008–18 I.R.B.

in the proposed regulations, which looked to “whether the organization has been involved in repeated excess benefit transactions.” In response to this comment, the third factor of the proposed regulations is revised to substitute the term “multiple” for the word “repeated.” The term “multiple” refers to both (1) repeated instances of the same (or substantially similar) excess benefit transaction, regardless of whether the transaction involves the same or different persons; and (2) the presence of more than one excess benefit transaction, regardless of whether the transactions are the same or substantially similar and regardless of whether they involve the same or different persons.

Another comment requested guidance regarding when the IRS would consider the presence of a single excess benefit transaction to jeopardize an organization’s tax-exempt status. Because such a determination would depend on the facts and circumstances, the final regulations do not adopt the comment.

c. Due diligence and safeguards

One comment requested that evidence that an organization’s board of directors conducted appropriate due diligence or followed certain safeguards in connection with the excess benefit transaction be treated as a factor weighing in favor of continuing to recognize exemption. The IRS and the Treasury Department agree that the organization’s reliance on objectively reasonable internal controls and procedures, such as the procedures for establishing a rebuttable presumption of reasonableness, in approving a transaction that is later determined to be an excess benefit transaction, should be treated as a factor weighing in favor of continuing to recognize exemption. Accordingly, the fourth factor under the proposed regulations is revised to make clear that implementation by an organization of safeguards that are reasonably calculated to prevent excess benefit transactions will be treated as a factor weighing in favor of continuing to recognize exemption regardless of whether such safeguards are implemented in direct response to the excess benefit transaction(s) at issue or as a general matter of corporate governance or fiscal management. Thus, an organization may be treated as having implemented safe

to illustrate that prohibited private benefit may involve non-economic benefits as well as economic benefits and that prohibited private benefit may arise regardless of whether payments made to private interests are reasonable or excessive.

One comment suggested that, rather than add three isolated examples on private benefit to the regulations, the IRS consider a broader revision of the regulations under section 501(c)(3) to provide a more detailed discussion of the underlying principles of the private benefit doctrine. In particular, this comment suggested that the regulations address the relative quantity of private benefit that could preclude exemption. The IRS and the Treasury Department are not revising the existing regulations under section 501(c)(3) at this time. The new examples in the proposed regulations clarify the principles of the private benefit doctrine under current law. In §1.501(c)(3)–1(d)(1)(iii), Example 1 illustrates that private benefit may involve non-economic benefits. Example 2 illustrates that private benefit is inconsistent with tax-exempt status under section 501(c)(3) if it is substantial and not merely incidental to the accomplishment of the organization’s exempt purposes. Example 3 illustrates that private benefit may exist even though the transaction is at fair market value. Moreover, these examples are intended to illustrate the principle that private benefit remains an independent basis for revocation even if it does not involve economic benefit or raise fair market value issues. Accordingly, these examples are adopted in final form without revision.

Revocation Standards

The proposed regulations provided guidance on certain factors that the IRS will consider in determining whether an applicable tax-exempt organization described in section 501(c)(3) that engages in one or more excess benefit transactions continues to be described in section 501(c)(3). The comments received in response to the proposed regulations are discussed below. Overall, the commentators reacted favorably to the factors set forth in the proposed regulations. The factors described in the proposed regulations are finalized without major revisions. The application of the factors is refined by the

addition of a new example to the final regulations.

a. Interaction with determination of existence of excess benefit transaction

Two comments suggested that the final regulations clarify the interaction between the determination of the organization’s taxexempt status and the determination of the existence of an excess benefit transaction. One of these comments specifically requested that the final regulations state that the IRS will not take any action to remove an organization’s tax exemption on excess benefit transaction grounds while the IRS’s determination of the existence of an excess benefit transaction is itself being contested in court. The final regulations do not adopt this comment. The determination of an organization’s tax-exempt status and the determination of the existence of an excess benefit transaction are separate determinations, involving distinct parties, different legal elements, and separate processes, even though they may relate to the same facts.

b. Clarification of terms

Two comments voiced the need to clarify the terms “significant” and “ de min- imis ” as they are used in the proposed regulations. One of these comments suggested adding an example of a safe harbor based on specific amounts the IRS would consider clearly insignificant, perhaps as a percentage of overall expenditures. Because the determination of whether an activity or an amount is “significant” or “ de minimis ” depends on the facts and circumstances, the final regulations do not adopt this comment.

One comment suggested adding examples combining potential de minimis values with other abating or negative factors and/or examples containing values that are not de miminis . The final regulations contain a new example that illustrates the application of the revocation factors to an excess benefit transaction that is neither significant in comparison to the size and scope of the organization’s exempt activities nor de minimis .

One comment requested clarification of the term “repeated” as used in Example 3 of §1.501(c)(3)–1(g) of the proposed regulations. The term was used in that example to correspond to the third factor

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not in the context of an automatic excess benefit transaction, the new example in the final regulations involves an excess benefit transaction that is not de minimis .

e. Removal of disqualified person

One comment suggested that the regulations address whether and under what circumstances removal of a disqualified person may be necessary to avoid revocation. The new example added by these final regulations illustrates that removal of a disqualified person is not a necessary condition for continued exemption. In the example, the organization implemented safeguards designed to prevent future excess benefit transactions involving the same disqualified persons.

f. Best practices

One comment described specific actions that boards of applicable tax-exempt organizations should be required to take to improve governance and to prevent excess benefit transactions at their organizations. This comment was not adopted because the purpose of these regulations is to set forth an analytical framework for determining whether to revoke tax-exempt status if an organization engages in one or more excess benefit transactions.

Special Analyses

It has been determined that this regulation is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation, and because this regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal authors of these regulations are Galina Kolomietz and Phyllis Haney, Office of Division Counsel/Associate Chief Counsel (Tax

guards reasonably calculated to prevent excess benefit transactions even though the organization is contesting the existence of the excess benefit transaction(s) at issue. An example is added to illustrate how implementation of safeguards, including preexisting safeguards, will be taken into account in determining whether to continue to recognize an organization’s tax-exempt status.

One comment suggested that an organization’s good faith attempt to establish a rebuttable presumption of reasonableness within the meaning of §53.4958–6 be treated as a factor weighing in favor of continuing to recognize exemption. Another comment suggested that a good faith attempt by an organization’s board of directors to determine fair market value be treated as a factor precluding revocation even if the IRS disagrees with the board’s fair market value analysis. The fourth factor, as revised in these final regulations, takes into account whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions. This factor takes safeguards into account, regardless of whether they were implemented before or after an excess benefit transaction occurred. The comments raise the question of how this factor will apply where steps have been taken to avoid an excess benefit transaction, but nonetheless have failed to prevent the excess benefit transaction. The weight afforded to this particular circumstance will depend upon the specific facts and circumstances.

d. Requests for additional examples

Two comments suggested adding to the proposed regulations an example specifically addressing reasonable compensation. In response to these comments, the new example added by these final regulations addresses reasonable compensation.

One comment suggested that the regulations include examples involving health care organizations. The IRS and the Treasury Department note that the application of sections 501(c)(3) and 4958 to health care organizations is not unique. The examples in these regulations, although not specifically involving health care organizations, apply to health care organizations in the same manner as they apply

to other organizations described in section 501(c)(3). One comment criticized the examples in the proposed regulations as too “blackand-white” and suggested that the regulations be supplemented with examples that discuss less clear facts. Specifically, this comment requested guidance on situations involving more than de minimis amounts in which an applicable tax-exempt organization does not seek correction from the disqualified person involved. The new example added by these final regulations illustrates that, in some situations, even in the absence of correction of non- de min- imis excess benefit transactions, an organization may retain its tax-exempt status if the other factors, in combination, warrant continued exemption. Under the fifth factor, the IRS will take into account the organization’s good faith with respect to correction. Accordingly, the reasons behind the organization’s failure to seek correction will be examined.

One comment suggested adding an example that would illustrate what factors, in addition to post-audit correction, would be sufficient to avoid revocation. The example that has been added illustrates a case where factors other than correction support continued exemption. The IRS and the Treasury Department may consider publication of future guidance on the application of the factors based on other specific fact patterns that the IRS encounters in the course of tax administration.

One comment requested adding an example discussing the effect of “automatic excess benefit transactions” that are not de minimis on the organization’s tax-exempt status. The term “automatic excess benefit transaction” refers to a transaction in which a disqualified person provides services to an organization and receives economic benefits from the organization that are not substantiated, contemporaneously and in writing, as compensation within the meaning of §53.4958–4(c). After the enactment of the Pension Protection Act of 2006, Public Law 109–280 (120 Stat. 780 (2006)), the term “automatic excess benefit transaction” also refers to any grant, loan, compensation or other similar payment from a donor advised fund to a donor or donor advisor with respect to such fund and from a supporting organization to any of its disqualified persons. See section 4958(c)(2) and (3). Although

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Exempt and Government Entities). However, other personnel from the IRS and the Treasury Department participated in their development.

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Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 53 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.501(c)(3)–1 is revised by:

Redesignating paragraph (d)(1)(iii) as paragraph (d)(1)(iv) and adding a new paragraph (d)(1)(iii).
Redesignating paragraph (f) as paragraph (g) and adding a new paragraph (f).

The additions read as follows:

§1.501(c)(3)–1 Organizations organized and operated for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals .

- - - (d) - - (1) - - (iii) Examples . The following examples illustrate the requirement of paragraph (d)(1)(ii) of this section that an organization serve a public rather than a private interest:

Example 1 . (i) O is an educational organization the purpose of which is to study history and immigration. O’s educational activities include sponsoring lectures and publishing a journal. The focus of O’s historical studies is the genealogy of one family, tracing the descent of its present members. O actively solicits for membership only individuals who are members of that one family. O’s research is directed toward publishing a history of that family that will document the pedigrees of family members. A major objective of O’s research is to identify and locate living descendants of that family to enable those descendants to become acquainted with each other.

(ii) O’s educational activities primarily serve the private interests of members of a single family rather than a public interest. Therefore, O is operated for the benefit of private interests in violation of the restriction on private benefit in paragraph (d)(1)(ii) of this section. Based on these facts and circumstances, O is not operated exclusively for exempt purposes and, therefore, is not described in section 501(c)(3).

Example 2 . (i) O is an art museum. O’s principal activity is exhibiting art created by a group of

unknown but promising local artists. O’s activity, including organized tours of its art collection, promotes the arts. O is governed by a board of trustees unrelated to the artists whose work O exhibits. All of the art exhibited is offered for sale at prices set by the artist. Each artist whose work is exhibited has a consignment arrangement with O. Under this arrangement, when art is sold, the museum retains 10 percent of the selling price to cover the costs of operating the museum and gives the artist 90 percent.

(ii) The artists in this situation directly benefit from the exhibition and sale of their art. As a result, the principal activity of O serves the private interests of these artists. Because O gives 90 percent of the proceeds from its sole activity to the individual artists, the direct benefits to the artists are substantial and O’s provision of these benefits to the artists is more than incidental to its other purposes and activities. This arrangement causes O to be operated for the benefit of private interests in violation of the restriction on private benefit in paragraph (d)(1)(ii) of this section. Based on these facts and circumstances, O is not operated exclusively for exempt purposes and, therefore, is not described in section 501(c)(3).

Example 3 . (i) O is an educational organization the purpose of which is to train individuals in a program developed by P, O’s president. The program is of interest to academics and professionals, representatives of whom serve on an advisory panel to O. All of the rights to the program are owned by Company K, a for-profit corporation owned by P. Prior to the existence of O, the teaching of the program was conducted by Company K. O licenses, from Company K, the right to conduct seminars and lectures on the program and to use the name of the program as part of O’s name, in exchange for specified royalty payments. Under the license agreement, Company K provides O with the services of trainers and with course materials on the program. O may develop and copyright new course materials on the program but all such materials must be assigned to Company K without consideration if and when the license agreement is terminated. Company K sets the tuition for the seminars and lectures on the program conducted by O. O has agreed not to become involved in any activity resembling the program or its implementation for 2 years after the termination of O’s license agreement.

(ii) O’s sole activity is conducting seminars and lectures on the program. This arrangement causes O to be operated for the benefit of P and Company K in violation of the restriction on private benefit in paragraph (d)(1)(ii) of this section, regardless of whether the royalty payments from O to Company K for the right to teach the program are reasonable. Based on these facts and circumstances, O is not operated exclusively for exempt purposes and, therefore, is not described in section 501(c)(3).

- - - (f) Interaction with section 4958 —(1) Application process . An organization that applies for recognition of exemption under section 501(a) as an organization described in section 501(c)(3) must establish its eligibility under this section. The Commissioner may deny an application for exemption for failure to establish any of section 501(c)(3)’s requirements for exemp

tion. Section 4958 does not apply to transactions with an organization that has failed to establish that it satisfies all of the requirements for exemption under section 501(c)(3). See §53.4958–2. (2) Substantive requirements for ex- emption still apply to applicable tax-ex- empt organizations described in section 501(c)(3) —(i) In general . Regardless of whether a particular transaction is subject to excise taxes under section 4958, the substantive requirements for tax exemption under section 501(c)(3) still apply to an applicable tax-exempt organization (as defined in section 4958(e) and §53.4958–2) described in section 501(c)(3) whose disqualified persons or organization managers are subject to excise taxes under section 4958. Accordingly, an organization will no longer meet the requirements for tax-exempt status under section 501(c)(3) if the organization fails to satisfy the requirements of paragraph (b), (c) or (d) of this section. See §53.4958–8(a).

(ii) Determination of whether revoca- tion of tax-exempt status is appropriate when section 4958 excise taxes also ap- ply . In determining whether to continue to recognize the tax-exempt status of an applicable tax-exempt organization (as defined in section 4958(e) and §53.4958–2) described in section 501(c)(3) that engages in one or more excess benefit transactions (as defined in section 4958(c) and §53.4958–4) that violate the prohibition on inurement under section 501(c)(3), the Commissioner will consider all relevant facts and circumstances, including, but not limited to, the following—

(A) The size and scope of the organization’s regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred;

(B) The size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization’s regular and ongoing activities that further exempt purposes;

(D) Whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and

2008–18 I.R.B. 858 May 5, 2008

(E) Whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6) and §53.4958–7), or the organization has made good faith efforts to seek correction from the disqualified person(s) who benefited from the excess benefit transaction.

(iii) All factors will be considered in combination with each other. Depending on the particular situation, the Commissioner may assign greater or lesser weight to some factors than to others. The factors listed in paragraphs (f)(2)(ii)(D) and (E) of this section will weigh more heavily in favor of continuing to recognize exemption where the organization discovers the excess benefit transaction or transactions and takes action before the Commissioner discovers the excess benefit transaction or transactions. Further, with respect to the factor listed in paragraph (f)(2)(ii)(E) of this section, correction after the excess benefit transaction or transactions are discovered by the Commissioner, by itself, is never a sufficient basis for continuing to recognize exemption.

(iv) Examples . The following examples illustrate the principles of paragraph (f)(2)(ii) of this section. For purposes of each example, assume that O is an applicable tax-exempt organization (as defined in section 4958(e) and §53.4958–2) described in section 501(c)(3). The examples read as follows:

Example 1 . (i) O was created as a museum for the purpose of exhibiting art to the general public. In Years 1 and 2, O engages in fundraising and in selecting, leasing, and preparing an appropriate facility for a museum. In Year 3, a new board of trustees is elected. All of the new trustees are local art dealers. Beginning in Year 3 and continuing to the present, O uses a substantial portion of its revenues to purchase art solely from its trustees at prices that exceed fair market value. O exhibits and offers for sale all of the art it purchases. O’s Form 1023, “ Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” did not disclose the possibility that O would purchase art from its trustees.

(ii) O’s purchases of art from its trustees at more than fair market value constitute excess benefit transactions between an applicable tax-exempt organization and disqualified persons under section 4958. Therefore, these transactions are subject to the applicable excise taxes provided in that section. In addition, O’s purchases of art from its trustees at more than fair market value violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section.

(iii) The application of the factors in paragraph (f)(2)(ii) of this section to these facts is as follows. Beginning in Year 3, O does not engage primarily in regular and ongoing activities that further exempt

purposes because a substantial portion of O’s activities consists of purchasing art from its trustees and dealing in such art in a manner similar to a commercial art gallery. The size and scope of the excess benefit transactions collectively are significant in relation to the size and scope of any of O’s ongoing activities that further exempt purposes. O has been involved in multiple excess benefit transactions, namely, purchases of art from its trustees at more than fair market value. O has not implemented safeguards that are reasonably calculated to prevent such improper purchases in the future. The excess benefit transactions have not been corrected, nor has O made good faith efforts to seek correction from the disqualified persons who benefited from the excess benefit transactions (the trustees). The trustees continue to control O’s Board. Based on the application of the factors to these facts, O is no longer described in section 501(c)(3) effective in Year 3. Example 2 . (i) The facts are the same as in Ex- ample 1, except that in Year 4, O’s entire board of trustees resigns, and O no longer offers all exhibited art for sale. The former board is replaced with members of the community who are not in the business of buying or selling art and who have skills and experience running charitable and educational programs and institutions. O promptly discontinues the practice of purchasing art from current or former trustees, adopts a written conflicts of interest policy, adopts written art valuation guidelines, hires legal counsel to recover the excess amounts O had paid its former trustees, and implements a new program of activities to further the public’s appreciation of the arts.

(ii) O’s purchases of art from its former trustees at more than fair market value constitute excess benefit transactions between an applicable tax-exempt organization and disqualified persons under section 4958. Therefore, these transactions are subject to the applicable excise taxes provided in that section. In addition, O’s purchases of art from its trustees at more than fair market value violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section.

(iii) The application of the factors in paragraph (f)(2)(ii) of this section to these facts is as follows. In Year 3, O does not engage primarily in regular and ongoing activities that further exempt purposes. However, in Year 4, O elects a new board of trustees comprised of individuals who have skills and experience running charitable and educational programs and implements a new program of activities to further the public’s appreciation of the arts. As a result of these actions, beginning in Year 4, O engages in regular and ongoing activities that further exempt purposes. The size and scope of the excess benefit transactions that occurred in Year 3, taken collectively, are significant in relation to the size and scope of O’s regular and ongoing exempt function activities that were conducted in Year 3. Beginning in Year 4, however, as O’s exempt function activities grow, the size and scope of the excess benefit transactions that occurred in Year 3 become less and less significant as compared to the size and scope of O’s regular and ongoing exempt function activities. O was involved in multiple excess benefit transactions in Year 3. However, by discontinuing its practice of purchasing art from its current and former trustees, by replacing its former board with independent members of the community, and by adopting a conflicts of interest policy and art

valuation guidelines, O has implemented safeguards that are reasonably calculated to prevent future violations. In addition, O has made a good faith effort to seek correction from the disqualified persons who benefited from the excess benefit transactions (its former trustees). Based on the application of the factors to these facts, O continues to meet the requirements for tax exemption under section 501(c)(3).

Example 3 . (i) O conducts educational programs for the benefit of the general public. Since its formation, O has employed its founder, C, as its Chief Executive Officer. Beginning in Year 5 of O’s operations and continuing to the present, C caused O to divert significant portions of O’s funds to pay C’s personal expenses. The diversions by C significantly reduced the funds available to conduct O’s ongoing educational programs. The board of trustees never authorized C to cause O to pay C’s personal expenses from O’s funds. Certain members of the board were aware that O was paying C’s personal expenses. However, the board did not terminate C’s employment and did not take any action to seek repayment from C or to prevent C from continuing to divert O’s funds to pay C’s personal expenses. C claimed that O’s payments of C’s personal expenses represented loans from O to C. However, no contemporaneous loan documentation exists, and C never made any payments of principal or interest.

(ii) The diversions of O’s funds to pay C’s personal expenses constitute excess benefit transactions between an applicable tax-exempt organization and a disqualified person under section 4958. Therefore, these transactions are subject to the applicable excise taxes provided in that section. In addition, these transactions violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section.

Example 4 . (i) O conducts activities that further exempt purposes. O uses several buildings in the conduct of its exempt activities. In Year 1, O sold one of the buildings to Company K for an amount that was substantially below fair market value. The sale was a significant event in relation to O’s other activities. C, O’s Chief Executive Officer, owns all of the voting stock of Company K. When O’s board of trustees approved the transaction with Company K, the board did not perform due diligence that could have made it aware that the price paid by Company K to acquire the building was below fair market value. Subsequently, but before the IRS commences an examination of O, O’s board of trustees determines that

May 5, 2008 859 2008–18 I.R.B.

Company K paid less than the fair market value for the building. Thus, O concludes that an excess benefit transaction occurred. After the board makes this determination, it promptly removes C as Chief Executive Officer, terminates C’s employment with O, and hires legal counsel to recover the excess benefit from Company K. In addition, O promptly adopts a conflicts of interest policy and new contract review procedures designed to prevent future recurrences of this problem.

(ii) The sale of the building by O to Company K at less than fair market value constitutes an excess benefit transaction between an applicable tax-exempt organization and a disqualified person under section 4958 in Year 1. Therefore, this transaction is subject to the applicable excise taxes provided in that section. In addition, this transaction violates the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section .

Example 5 . (i) O is a large organization with substantial assets and revenues. O conducts activities that further its exempt purposes. O employs C as its Chief Financial Officer. During Year 1, O pays $2,500 of C’s personal expenses. O does not make these payments pursuant to an accountable plan, as described in §53.4958–4(a)(4)(ii). In addition, O does not report any of these payments on C’s Form W–2, “ Wage and Tax Statement,” or on a Form 1099–MISC, “ Miscellaneous Income,” for C for Year 1, and O does not report these payments as compensation on its Form 990, “ Return of Organization Exempt From Income Tax,” for Year 1. Moreover, none of these payments can be disregarded as nontaxable fringe benefits under §53.4958–4(c)(2) and none consisted of fixed payments under an initial contract under §53.4958–4(a)(3). C does not report the $2,500 of payments as income on his individual Federal income tax return for Year 1. O does not repeat this reporting omission in subsequent years and, instead, reports all payments of C’s personal expenses not made under an accountable plan as income to C.

(ii) O’s payment in Year 1 of $2,500 of C’s personal expenses constitutes an excess benefit transaction between an applicable tax-exempt organization and a disqualified person under section 4958. Therefore, this transaction is subject to the applicable excise taxes provided in that section. In addition, this transaction violates the proscription against in

urement in section 501(c)(3) and paragraph (c)(2) of this section.

(iii) The application of the factors in paragraph (f)(2)(ii) of this section to these facts is as follows. O engages in regular and ongoing activities that further exempt purposes. The payment of $2,500 of C’s personal expenses represented only a de minimis portion of O’s assets and revenues; thus, the size and scope of the excess benefit transaction were not significant in relation to the size and scope of O’s activities that further exempt purposes. The reporting omission that resulted in the excess benefit transaction in Year 1 occurred only once and is not repeated in subsequent years. Based on the application of the factors to these facts, O continues to be described in section 501(c)(3).

Example 6. (i) O is a large organization with substantial assets and revenues. O furthers its exempt purposes by providing social services to the population of a specific geographic area. O has a sizeable workforce of employees and volunteers to conduct its work. In Year 1, O’s board of directors adopted written procedures for setting executive compensation at O. O’s executive compensation procedures were modeled on the procedures for establishing a rebuttable presumption of reasonableness under §53.4958–6. In accordance with these procedures, the board appointed a compensation committee to gather data on compensation levels paid by similarly situated organizations for functionally comparable positions. The members of the compensation committee were disinterested within the meaning of §53.4958–6(c)(1)(iii). Based on its research, the compensation committee recommended a range of reasonable compensation for several of O’s existing top executives (the Top Executives). On the basis of the committee’s recommendations, the board approved new compensation packages for the Top Executives and timely documented the basis for its decision in board minutes. The board members were all disinterested within the meaning of §53.4958–6(c)(1)(iii). The Top Executives were not involved in setting their own compensation. In Year 1, even though payroll expenses represented a significant portion of O’s total operating expenses, the total compensation paid to O’s Top Executives represented only an insubstantial portion of O’s total payroll expenses. During a subsequent examination, the IRS found that the compensation committee relied exclusively on compensation data from organizations that perform similar social services to O. The IRS concluded, however, that the organizations were not similarly situated because they served substantially larger geographic regions with more diverse populations and were larger than O in terms of annual revenues, total operating budget, number of employees, and number of beneficiaries served. Accordingly, the IRS concluded that the compensation committee did not rely on “appropriate data as to comparability” within the meaning of §53.4958–6(c)(2) and, thus, failed to establish the rebuttable presumption of reasonableness under §53.4958–6. Taking O’s size and the nature of the geographic area and population it serves into account, the IRS concluded that the Top Executives’ compensation packages for Year 1 were excessive. As a result of the examination, O’s board added new members to the compensation committee who have

expertise in compensation matters and also amended its written procedures to require the compensation committee to evaluate a number of specific factors, including size, geographic area, and population covered by the organization, in assessing the comparability of compensation data. O’s board renegotiated the Top Executives’ contracts in accordance with the recommendations of the newly constituted compensation committee on a going forward basis. To avoid potential liability for damages under state contract law, O did not seek to void the Top Executives’ employment contracts retroactively to Year 1 and did not seek correction of the excess benefit amounts from the Top Executives. O did not terminate any of the Top Executives.

(ii) O’s payments of excessive compensation to the Top Executives in Year 1 constituted excess benefit transactions between an applicable tax-exempt organization and disqualified persons under section 4958. Therefore, these payments are subject to the applicable excise taxes provided under that section, including second-tier taxes if there is no correction by the disqualified persons. In addition, these payments violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section.

(iii) The application of the factors in paragraph (f)(2)(ii) of this section to these facts is as follows. O has engaged in regular and ongoing activities that further exempt purposes both before and after the excess benefit transactions occurred. The size and scope of the excess benefit transactions, in the aggregate, were not significant in relation to the size and scope of O’s activities that further exempt purposes. O engaged in multiple excess benefit transactions. Nevertheless, prior to entering into these excess benefit transactions, O had implemented written procedures for setting the compensation of its top management that were reasonably calculated to prevent the occurrence of excess benefit transactions. O followed these written procedures in setting the compensation of the Top Executives for Year 1. Despite the board’s failure to rely on appropriate comparability data, the fact that O implemented and followed these written procedures in setting the compensation of the Top Executives for Year 1 is a factor favoring continued exemption. The fact that O amended its written procedures to ensure the use of appropriate comparability data and renegotiated the Top Executives’ compensation packages on a going forward basis are also factors favoring continued exemption, even though O did not void the Top Executives’ existing contracts and did not seek correction from the Top Executives. Based on the application of the factors to these facts, O continues to be described in section 501(c)(3).

(3) Applicability . The rules in paragraph (f) of this section will apply with respect to excess benefit transactions occurring after March 28, 2008.

PART 53—FOUNDATION AND SIMILAR EXCISE TAXES

Par. 3. The authority citation for part 53 continues to read, in part, as follows:

2008–18 I.R.B. 860 May 5, 2008

Authority: 26 U.S.C. 7805 * * * Par. 4. In §53.4958–2, paragraph (a)(6) is added to read as follows:

§53.4958–2 Definition of applicable tax-exempt organization .

(a) - * (6) Examples . The following examples illustrate the principles of this section, which defines an applicable tax-exempt organization for purposes of section 4958:

Example 1 . O is a nonprofit corporation formed under state law. O filed its application for recognition of exemption under section 501(c)(3) within the time prescribed under section 508(a). In its application, O described its plans for purchasing property from some of its directors at prices that would exceed fair market value. After reviewing the application, the IRS determined that because of the proposed property purchase transactions, O failed to establish that it met the requirements for an organization described in section 501(c)(3). Accordingly, the IRS denied O’s application. While O’s application was pending, O engaged in the purchase transactions described in its application at prices that exceeded the fair market values of the properties. Although these transactions would constitute excess benefit transactions under section 4958, because the IRS never recognized O as an organization described in section 501(c)(3), O was never an applicable tax-exempt organization under section 4958. Therefore, these transactions are not subject to the excise taxes provided in section 4958. Example 2 . O is a nonprofit corporation formed under state law. O files its application for recognition of exemption under section 501(c)(3) within the time prescribed under section 508(a). The IRS issues a favorable determination letter in Year 1 that recognizes O as an organization described in section 501(c)(3). Subsequently, in Year 5 of O’s operations, O engages in certain transactions that constitute excess benefit transactions under section 4958 and violate the proscription against inurement under section 501(c)(3) and §1.501(c)(3)–1(c)(2). The IRS examines the Form 990, “ Return of Organization Exempt From Income Tax ”, that O filed for Year 5. After considering all the relevant facts and circumstances in accordance with §1.501(c)(3)–1(f), the IRS concludes that O is no longer described in section 501(c)(3) effective in Year 5. The IRS does not examine the Forms 990 that O filed for its first four years of operations and, accordingly, does not revoke O’s ex

empt status for those years. Although O’s tax-exempt status is revoked effective in Year 5, under the lookback rules in paragraph (a)(1) of this section and §53.4958–3(a)(1) of this chapter, during the five-year period prior to the excess benefit transactions that occurred in Year 5, O was an applicable tax-exempt organization and O’s directors were disqualified persons as to O. Therefore, the transactions between O and its directors during Year 5 are subject to the applicable excise taxes provided in section 4958.

Linda E. Stiff, Deputy Commissioner for Services and Enforcement.

Approved March 19, 2008.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on March 27, 2008, 8:45 a.m., and published in the issue of the Federal Register for March 28, 2008, 73 F.R. 16519)

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 1274.—Determi- nation of Issue Price in the Case of Certain Debt Instru- ments Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for May 2008.

Rev. Rul. 2008–24

This revenue ruling provides various prescribed rates for federal income tax purposes for May 2008 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

May 5, 2008 861 2008–18 I.R.B.

REV. RUL. 2008–24 TABLE 1

Applicable Federal Rates (AFR) for May 2008

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term

AFR 1.64% 1.63% 1.63% 1.62% 110% AFR 1.80% 1.79% 1.79% 1.78% 120% AFR 1.97% 1.96% 1.96% 1.95% 130% AFR 2.13% 2.12% 2.11% 2.11%

Mid-term

AFR 2.74% 2.72% 2.71% 2.70% 110% AFR 3.01% 2.99% 2.98% 2.97% 120% AFR 3.29% 3.26% 3.25% 3.24% 130% AFR 3.57% 3.54% 3.52% 3.51% 150% AFR 4.12% 4.08% 4.06% 4.05% 175% AFR 4.82% 4.76% 4.73% 4.71%

Long-term

AFR 4.21% 4.17% 4.15% 4.13% 110% AFR 4.64% 4.59% 4.56% 4.55% 120% AFR 5.06% 5.00% 4.97% 4.95% 130% AFR 5.49% 5.42% 5.38% 5.36%

REV. RUL. 2008–24 TABLE 2

Adjusted AFR for May 2008

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted 2.07% 2.06% 2.05% 2.05% AFR

Mid-term adjusted AFR 3.17% 3.15% 3.14% 3.13%

Long-term adjusted 4.71% 4.66% 4.63% 4.62% AFR

REV. RUL. 2008–24 TABLE 3

Rates Under Section 382 for May 2008

Adjusted federal long-term rate for the current month 4.71%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 4.71%

REV. RUL. 2008–24 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for May 2008

Appropriate percentage for the 70% present value low-income housing credit 7.80%

Appropriate percentage for the 30% present value low-income housing credit 3.34%

2008–18 I.R.B. 862 May 5, 2008

REV. RUL. 2008–24 TABLE 5

Rate Under Section 7520 for May 2008

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 3.2%

20, 2006. Section 406 of the Act amends section 7623, concerning the payment of awards to whistleblowers, and establishes a Whistleblower Office within the IRS that has responsibility for the administration of a whistleblower program. The Whistleblower Office, in connection with administering a whistleblower program, will analyze information provided by a whistleblower, and either investigate the matter itself or assign it to the appropriate IRS office for investigation. In analyzing information provided by a whistleblower, or investigating a matter, the Whistleblower Office may determine that it requires the assistance of the whistleblower, or the legal representative of the whistleblower. The legislative history of section 406 of the Act states that “[t]o the extent the disclosure of returns or return information is required [for the whistleblower or his or her legal representative] to render such assistance, the disclosure must be pursuant to an IRS tax administration contract.” Joint Committee on Taxation, Technical Explanation of H.R. 6408, The “Tax Relief and Health Care Act of 2006,” as Introduced in the House on December 7, 2006, at 89 (JCX–50–06), December 7, 2006. The legislative history further states that “[i]t is expected that such disclosures will be infrequent and will be made only when the assigned task cannot be properly or timely completed without the return information to be disclosed.” Id.

Under section 6103(a), returns and return information are confidential unless the Internal Revenue Code (Code) authorizes disclosure. Section 6103(n) is the authority by which returns and return information may be disclosed pursuant to a tax administration contract. Section 6103(n) authorizes, pursuant to regulations prescribed by the Secretary, returns and return information to be disclosed to any person, including any person described in section 7513(a), for purposes of tax administration, to the extent necessary in connection with: (1) the processing, storage, transmission, and reproduction of returns and return information; (2) the

Section 1288.—Treatment of Original Issue Discount on Tax-Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 6103.—Confi- dentiality and Disclosure of Returns and Return Information

26 CFR 301.6103(n)–2T: Disclosure of return infor- mation in connection with written contracts among the IRS, whistleblowers, and legal representatives of whistleblowers (temporary).

T.D. 9389

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 301

Disclosure of Return Information in Connection With Written Contracts Among the IRS, Whistleblowers, and Legal Representatives of Whistleblowers

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to the disclosure of return information, pursuant to section 6103(n) of the Internal Revenue Code (Code), by an officer or employee of the Treasury Department, to a whistleblower and, if applicable, the legal representative of the whistleblower, to the extent necessary in connection with a written contract among the IRS, the whistleblower and, if applicable, the legal representative

of the whistleblower, for services relating to the detection of violations of the internal revenue laws or related statutes. The temporary regulations will affect officers and employees of the Treasury Department who disclose return information to whistleblowers, or their legal representatives, in connection with written contracts among the IRS, whistleblowers and, if applicable, their legal representatives, for services relating to the detection of violations of the internal revenue laws or related statutes. The temporary regulations will also affect any whistleblower, or legal representative of a whistleblower, who receives return information in connection with a written contract among the IRS, the whistleblower and, if applicable, the legal representative of the whistleblower, for services relating to the detection of violations of the internal revenue laws or related statutes. The text of the temporary regulations also serves as the text of the proposed regulations (REG–114942–07) set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin.

DATES: Effective Date: These temporary regulations are effective on March 25, 2008. Applicability Date: For dates of applicability, see §301.6103(n)–2T(f).

FOR FURTHER INFORMATION CONTACT: Helene R. Newsome, 202–622–7950 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Procedure and Administration Regulations (26 CFR part 301) under section 6103(n) relating to the disclosure of return information in connection with written contracts among the IRS, whistleblowers and, if applicable, their legal representatives.

The Tax Relief and Health Care Act of 2006, Public Law 109–432 (120 Stat. 2958), (the Act) was enacted on December

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of sections 7431(a)(2), 7213(a)(1), and 7213A(a)(1)(B).

Safeguards

The temporary regulations, at §301.6103(n)–2T(d)(1), provide that whistleblowers and their legal representatives who receive return information under these regulations must comply with all applicable conditions and requirements as the IRS may prescribe from time to time (prescribed requirements) for the purposes of protecting the confidentiality of the return information and preventing unauthorized disclosures and inspections of the return information ( e.g., requirements pertaining to computer security, physical security of return information, methods of destruction of return information).

The temporary regulations, at §301.6103(n)–2T(d)(2), provide that any written contract for services as described in §301.6103(n)–2T(a)(1) must provide that any whistleblower and, if applicable, the legal representative of a whistleblower, who has access to return information under these regulations shall comply with the prescribed requirements.

The temporary regulations, at §301.6103(n)–2T(d)(3), impose the requirement that whistleblowers, and their legal representatives who receive return information under these regulations, must agree in writing, before any disclosure of return information is made, to permit an inspection of their premises by the IRS relative to the maintenance of the return information disclosed to them under these regulations and, upon completion of services as described in the written contract with the IRS, to dispose of all return information by returning the return information, including any and all copies or notes made, to the IRS, or to the extent that it cannot be returned, by destroying the information in a manner consistent with security guidelines and other safeguards for protecting return information in guidance published by the IRS.

The temporary regulations, at §301.6103(n)–2T(d)(4), provide that if the IRS determines that any whistleblower, or the legal representative of a whistleblower, who has access to return information under these regulations, has failed to, or does not, satisfy the prescribed requirements, the IRS, using the procedures described in

programming, maintenance, repair, testing, and procurement of equipment; and (3) the providing of other services. These temporary regulations describe the circumstances, pursuant to section 6103(n), under which officers and employees of the Treasury Department may disclose return information to whistleblowers and, if applicable, their legal representatives, in connection with written contracts for services relating to the detection of violations of the internal revenue laws or related statutes.

Explanation of Provisions

General Rule

The temporary regulations, at §301.6103(n)–2T(a)(1), provide that an officer or employee of the Treasury Department may, pursuant to sections 6103(n) and 7623, disclose return information to a whistleblower and, if applicable, the legal representative of the whistleblower, to the extent necessary in connection with a written contract among the IRS, the whistleblower and, if applicable, the legal representative of the whistleblower, for services relating to the detection of violations of the internal revenue laws or related statutes. If a whistleblower has retained the services of a legal representative, then, in addition to the whistleblower, the whistleblower’s legal representative must be a party to the written contract with the IRS. These temporary regulations do not provide for the disclosure of returns to whistleblowers or their legal representatives.

The temporary regulations, at §301.6103(n)–2T(a)(2), provide that the Commissioner has the discretion to determine whether to enter into a written contract with the whistleblower and, if applicable, the legal representative of the whistleblower, for services as described in §301.6103(n)–2T(a)(1). The IRS expects to enter into these contracts only infrequently, and any contract that is entered into, and any disclosures made pursuant to this type of contract, will be carefully tailored to the specific facts of the case.

Limitations

The temporary regulations, at §301.6103(n)–2T(b)(1), set forth the condition that the disclosure of return

information in connection with a written contract for services described in §301.6103(n)–2T(a)(1) may be made only to the extent the IRS deems it necessary in connection with the reasonable or proper performance of the contract. In this regard, disclosures should relate to relevant taxable years and types of tax. The temporary regulations, at §301.6103–2T(b)(2), set forth the additional condition that if the IRS determines that the services of a whistleblower and, if applicable, the legal representative of the whistleblower as described in §301.6103(n)–2T(a)(1) can be performed reasonably or properly by disclosure of only parts or portions of return information, then only the parts or portions of the return information are to be disclosed.

The temporary regulations, at §301.6103(n)–2T(b)(3), provide that, upon written request by a whistleblower, or a legal representative of a whistleblower, with whom the IRS has entered into a written contract for services as described in §301.6103(n)–2T(a)(1), the Director of the Whistleblower Office, or designee of the Director, may inform the whistleblower and, if applicable, the legal representative of the whistleblower, of the status of the whistleblower’s claim for award under section 7623, including whether the claim is being evaluated for potential investigative action, or is pending due to an ongoing examination, appeal, collection action, or litigation. This information may be disclosed only if the Commissioner determines that the disclosure would not seriously impair Federal tax administration.

The temporary regulations, at §301.6103(n)–2T(b)(4), impose the condition that return information disclosed to a whistleblower and, if applicable, a legal representative of a whistleblower, may not be disclosed or otherwise used by the whistleblower or a legal representative of a whistleblower, except as expressly authorized by the IRS.

Penalties

The temporary regulations, at §301.6103(n)–2T(c), set forth the civil and criminal penalties to which whistleblowers and their legal representatives are subject for unauthorized inspection or disclosure of return information by operation

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the disclosure would not seriously impair Federal tax administration.

(4) Return information disclosed to a whistleblower and, if applicable, a legal representative of a whistleblower, under this section, shall not be disclosed or otherwise used by the whistleblower or a legal representative of a whistleblower, except as expressly authorized in writing by the Director of the Whistleblower Office.

(c) Penalties . Any whistleblower, or legal representative of a whistleblower, who receives return information under this section, is subject to the civil and criminal penalty provisions of sections 7431, 7213, and 7213A for the unauthorized inspection or disclosure of the return information.

(d) Safeguards . (1) Any whistleblower, or the legal representative of a whistleblower, who receives return information under this section, shall comply with all applicable conditions and requirements as the IRS may prescribe from time to time (prescribed requirements) for the purposes of protecting the confidentiality of the return information and preventing any disclosure or inspection of the return information in a manner not authorized by this section.

(2) Any written contract for services as described in paragraph (a)(1) of this section shall provide that any whistleblower and, if applicable, the legal representative of a whistleblower, who has access to return information under this section, shall comply with the prescribed requirements.

(3) Any whistleblower, or the legal representative of a whistleblower, who may receive return information under this section, shall agree in writing, before any disclosure of return information is made, to permit an inspection of his or her premises by the IRS relative to the maintenance of the return information disclosed under these regulations and, upon completion of services as described in the written contract with the IRS, to dispose of all return information by returning the return information, including any and all copies or notes made, to the IRS, or to the extent that it cannot be returned, by destroying the information in a manner consistent with security guidelines and other safeguards for protecting return information in guidance published by the IRS.

(4) If the IRS determines that any whistleblower, or the legal representative of a whistleblower, who has access

the regulations under section 6103(p)(7), may take any action it deems necessary to ensure that the prescribed requirements are or will be satisfied.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special Analyses section of the preamble to the cross-reference notice of proposed rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Helene R. Newsome, Office of the Associate Chief Counsel (Procedure & Administration).

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Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 is amended by adding an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 301.6103(n)–2T also issued under 26 U.S.C. 6103(n); * * *

Par. 2. Section 301.6103(n)–2T is added to read as follows:

§301.6103(n)–2T Disclosure of return information in connection with written contracts among the IRS, whistleblowers, and legal representatives of whistleblowers (temporary) .

(a) General rule . (1) Pursuant to the provisions of sections 6103(n) and 7623 of the Internal Revenue Code and subject

to the conditions of this section, an officer or employee of the Treasury Department is authorized to disclose return information (as defined in section 6103(b)(2)) to a whistleblower and, if applicable, the legal representative of the whistleblower, to the extent necessary in connection with a written contract among the Internal Revenue Service (IRS), the whistleblower and, if applicable, the legal representative of the whistleblower, for services relating to the detection of violations of the internal revenue laws or related statutes.

(2) The Commissioner shall have the discretion to determine whether to enter into a written contract pursuant to section 7623 with the whistleblower and, if applicable, the legal representative of the whistleblower for services described in paragraph (a)(1) of this section.

(b) Limitations . (1) Disclosure of return information in connection with a written contract for services described in paragraph (a)(1) of this section shall be made only to the extent the IRS deems it necessary in connection with the reasonable or proper performance of the contract. Disclosures may include, but are not limited to, disclosures to accomplish properly any purpose or activity of the nature described in section 6103(k)(6) and the regulations thereunder.

(2) If the IRS determines that the services of a whistleblower and, if applicable, the legal representative of the whistleblower, as described in paragraph (a)(1) of this section can be performed reasonably or properly by disclosure of only parts or portions of return information, then only the parts or portions of the return information shall be disclosed.

(3) Upon written request by a whistleblower, or a legal representative of a whistleblower, with whom the IRS has entered into a written contract for services as described in paragraph (a)(1) of this section, the Director of the Whistleblower Office, or designee of the Director, may inform the whistleblower and, if applicable, the legal representative of the whistleblower, of the status of the whistleblower’s claim for award under section 7623, including whether the claim is being evaluated for potential investigative action, or is pending due to an ongoing examination, appeal, collection action, or litigation. The information may be disclosed only if the Commissioner determines that

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Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on March 24, 2008, 8:45 a.m., and published in the issue of the Federal Register for March 25, 2008, 73 F.R. 15668)

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

Section 7872.—Treatment of Loans With Below-Market Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of May 2008. See Rev. Rul. 2008-24, page 861.

to return information under this section, has failed to, or does not, satisfy the prescribed requirements, the IRS, using the procedures described in the regulations under section 6103(p)(7), may take any action it deems necessary to ensure that the prescribed requirements are or will be satisfied, including—

(i) Suspension of further disclosures of return information by the IRS to the whistleblower and, if applicable, the legal representative of the whistleblower, until the IRS determines that the conditions and requirements have been or will be satisfied; and

(ii) Suspension or termination of any duty or obligation arising under a contract with the IRS.

(e) Definitions . For purposes of this section—

(1) The term Treasury Department includes the IRS and the Office of the Chief Counsel for the IRS.

(2) The term whistleblower means an individual who provides information to the IRS regarding violations of the tax laws or related statutes and submits a claim for an award under section 7623 with respect to the information.

(3) The term legal representative means any individual who is a member in good standing in the bar of the highest court of any state, possession, territory, commonwealth, or the District of Columbia, and who has a written power of attorney executed by the whistleblower.

(f) Effective/applicability date . This section is applicable on March 25, 2008.

(g) Expiration date . This section will expire on March 23, 2011.

Linda E. Stiff, Deputy Commissioner for Services and Enforcement.

Approved March 12, 2008.

2008–18 I.R.B. 866 May 5, 2008