Initial Contract Rule

(1) Section 4958 doesn’t apply to a "fixed payment" made to a person pursuant to an

"initial contract." See Treas. Reg. 53.4958-4(a)(3).

(2) A "fixed payment" is a cash amount or other property specified in the contract or

determined by a "fixed formula" specified in the contract, which is to be paid or transferred in exchange for the provision of specified services or property. See Treas. Reg. 53.4958-4(a)(3)(ii)(A).

a. A "fixed formula" may incorporate an amount that depends upon future

"specified events or contingencies," if no person has discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus).

b. A "specified event or contingency" may include the amount of revenues

generated by (or other objective measure of) one or more activities of the ATEO.

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c. A fixed payment doesn’t include any amount paid to a person under a

reimbursement or similar arrangement where any person has discretion regarding the amounts incurred or reimbursed.

(3) An "initial contract" is a binding written contract between an ATEO and a person

who wasn’t a disqualified person under Section 4958(f)(1) and Treas. Reg. 53.4958-3 immediately prior to entering into the contract. See Treas. Reg. 53.4958-4(a)(3)(iii).

(4) The initial contract exception doesn’t apply to any fixed payment made, under the

initial contract, during any taxable year if the person fails to substantially perform the person’s obligations under the initial contract during that year. See Treas. Reg. 53.4958-4(a)(3)(iv).

(5) New Contracts. A binding written contract providing that it may be terminated or

canceled by the ATEO (except for substantial non-performance) without the other party’s consent and without substantial penalty to the organization is treated as a new contract as of the earliest date that any termination or cancellation, if made, would be effective. See Treas. Reg. 53.4958-4(a)(3)(v).

a. If the parties make a "material change" to the contract, it’s treated as a new

contract as of the date the material change is effective.

b. A "material change" includes an extension or renewal of the contract (except

for an extension or renewal resulting from the person contracting with the ATEO unilaterally exercising an option expressly granted by the contract), or a more than incidental change to the amount payable under the contract.

c. The new contract is tested under Treas. Reg. 53.4958-4(a)(3)(iii) to

determine whether it’s an "initial contract" which meets the exception from Section 4958 under Treas. Reg. 53.4958-4(a)(3).