Stanford is subject to IRS regulations that prohibit private inurement, where university assets, income or facilities would be used in a way that unfairly or unreasonably benefits or results in profits to private individuals. A common type of private inurement is an excess benefit transaction (EBT), which involves the transfer of assets to a person or other entity in excess of the value received from that person or entity. Violation of this regulation results in sanctions from the IRS.
Section 4958 of the Internal Revenue Code contains provisions to tax EBTs when provided to a disqualified person (DP). A DP is any person who was in a position to exercise substantial influence over the affairs of the organization any time during the five-year period leading up to the EBT. DPs include:
- Members of the Board of Trustees
- Officers with responsibility for implementing the decisions of the Board and supervising the management of the organization
- Those who manage finances
- Significant donors
- Persons whose compensation depends on revenues from the area they control
- Those with the ability to control capital budgets, operating budgets or employee compensation
- Managers of discrete parts of the organization that represent substantial assets and revenues
Outside professional advisors or those receiving less than $80,000 annual compensation are not considered DPs.
The DP is subject to a 25 percent tax on the EBT and must return the entire value of the EBT to Stanford within a reasonable period after the EBT determination. If this is not done, an additional 200 percent tax on the EBT is levied. An additional 10 percent tax on the EBT is due from a manager who allowed the EBT to occur, up to $10,000 per occurrence. The 25 percent tax may be refunded by the IRS if the EBT is corrected quickly and there is a reasonable cause for the error.
Section 4958 also requires that compensation paid to a DP must be reasonable. Compensation includes cash, deferred compensation, bonuses, severance and fringe benefits.
Compensation is deemed reasonable by the law if it is approved by a Compensation Committee of the Board, composed entirely of individuals who have no conflict of interest. The Committee must have obtained and relied upon appropriate comparable data, and its decisions must be adequately documented. Such data may come from published sources or from private surveys done by competent analysts.
All aspects of the DP’s compensation must be reviewed and approved by the Compensation Committee in order to receive the “safe harbor” protection of Section 4958. If an item is not reviewed nor reported on the DP’s W-2 or University Form 990, it may be considered an automatic EBT and subject to the 25 percent tax.
Stanford managers should identify prospective DPs and verify with the Compensation Office in Human Resources that their compensation is being reviewed by the Compensation Committee of the Board of Trustees. Managers should be particularly careful when dealing with firms in which a member of the Board of Trustees, a significant donor, an officer or other DP has a material financial interest. Wherever possible, transactions should be based upon published fee structures available to a broad range of customers.
Disclaimer: Stanford University does not offer personal tax advice. Nothing on this website shall be construed as tax advice. Stanford recommends seeking professional tax counsel whenever necessary.