Case Facts

(1) Orchid Charity is tax-exempt under Section 501(c)(3) and classified as a public

charity described in Section 509(a)(2).

(2) Mr. Hosta, Orchid’s President, has exclusive signature authority over Orchid’s

checking account

(3) Orchid is on a calendar year and timely filed its Forms 990 each year.

(4) It was selected for examination for its 2020 tax year. Review of the Form 990

shows the following:

a. The Treasurer’s brother was paid compensation of $50,000.

b. An independent contractor was paid $25,000 for professional services.

c. An outstanding loan to Mr. Hosta of $10,000 from 2010.

(5) Mr. Hosta used Orchid’s checking account to make purchases and cash

withdrawals totaling $41,000 during the 2020 tax year.

a. $10,000 was paid to his son’s private school for tuition

b. $25,000 was paid for cruise tickets for him and his wife

c. $2,000 was paid for genealogical testing for him and immediate family

members

d. $4,000 dollars was withdrawn by him with no explanation

e. Mr. Hosta claims the purchases and cash withdrawals were compensation

and repayment of a loan.

f. Neither Orchid nor Mr. Hosta were able to supply any reasonable business

purpose for the purchases and withdrawals. The amounts weren’t reported as compensation on either Form W-2 or Form 1099 and they weren’t included on the organization’s Forms 941, Employer’s Quarterly Federal Tax Return. Mr. Hosta didn’t report them on his personal income tax return. Promissory notes payable weren’t executed. Nor were any interest payments made.

g. The examiner determined these transactions should be treated as excess

benefit transactions. The transactions are between an ATEO and a disqualified person. In addition, they appear to be of a personal nature and weren’t clearly treated as compensation. Orchid has no documentation to support that these were valid business expenses or that they, in any way, further its exempt purposes. Therefore, all elements of an excess benefit transaction have been met.

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(6) Orchid’s books and records reflect a loan to Mr. Hosta in the amount of $10,000.

a. The loan appeared on the books on June 15, 2010, and the loan amount has

remained unchanged.

b. The $10,000 is still reported as a loan receivable on the Form 990.

c. No payments, interest or principal, have been received on the loan.

d. The examiner asked for a loan agreement or other documentation reflecting

the terms between Orchid and Mr. Hosta. Both stated that it was an oral agreement but have no explanation as to why principal or interest repayments haven’t been made.

e. The examiner determined the loan should be treated as an excess benefit

transaction. The organization has included this loan on the books as a receivable. However, the alleged loan has no other standard characteristics of a loan conducted at arm’s length such as periodic principal and interest payments or a written loan document explaining terms.

(7) As shown on the return, Orchid paid the treasurer’s brother $50,000 in

compensation.

a. Per discussions with Orchid and written documentation of employment terms,

the brother has significant duties and works 8 hours per day four days a week.

b. Before setting his compensation, the organization considered amounts paid

for comparable work by other similarly situated organizations.

c. The compensation has been reported on a W-2, 990 and 941 each year as

well as on the brother’s personal income tax return.

d. Based on the facts, the examiner determined the payments to the brother are

reasonable compensation and not an excess benefit. An exempt organization is treated as clearly indicating its intent to treat an economic benefit as compensation if it provides written substantiation that is contemporaneous with the transfer of the particular benefit. In this case, Orchid has provided sufficient written substantiation for the compensation paid.

(8) Orchid purchased a used car for $5,000 in 2020 from a body shop owned by the

former vice president.

a. The written purchase agreement details the year, make, model and condition

of the vehicle.

b. The fair market value price is around $6,000.

c. When the examiner reviewed operations, it appeared that the car is used

frequently for exempt activities and isn’t used for personal reasons.

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d. The purchase was recorded on EO’s books and Form 990.

e. The examiner determined this wasn’t an excess benefit transaction because

the car was purchased at arm’s length and was used by the organization for exempt activities.