A 501(c)(3) organization exists to serve the public. Three related rules keep it that way: the ban on private inurement, the limit on private benefit, and the excess benefit excise taxes in Section 4958 of the Internal Revenue Code. None of them stops you from paying a fair salary or signing a fair lease with someone you know. They stop people from using the organization as a source of personal gain.
Inurement and private benefit are not the same thing
Private inurement is the narrower rule. The IRS describes it as letting the organization's income or assets accrue to an insider, meaning a person with a personal or private interest in its activities, such as an officer, director or key employee. Paying an insider unreasonable compensation is the classic example. The IRS states that any amount of inurement may be grounds for loss of tax-exempt status. There is no "small enough to ignore" amount.
Private benefit reaches further. It covers benefits to anyone, insiders or outsiders, individuals or companies. The Treasury regulations require a 501(c)(3) to serve "a public rather than a private interest" and not be operated for designated individuals, the founder's family or persons they control. Some private benefit is unavoidable: a scholarship benefits the student, and a vendor earns a profit. That is fine when the benefit is incidental to the public purpose. It becomes a problem when it is more than incidental.
The regulations give examples. A museum that exhibits only a group of local artists' work and passes 90% of every sale to them serves the artists' private interests, even though the artists are not insiders. An educational group that only teaches a program owned by its president's for-profit company serves that company, whether or not the royalties are reasonable.
Who is a disqualified person
Section 4958 applies to public charities, 501(c)(4) social welfare organizations and 501(c)(29) organizations. It does not apply to private foundations, which have their own self-dealing rules (see public charity vs. private foundation).
A disqualified person is anyone who was in a position to exercise substantial influence over the organization at any time in the five years before the transaction. That automatically includes:
- voting members of the board;
- presidents, CEOs and chief operating officers;
- treasurers and chief financial officers;
- family members of those people, including spouses, ancestors, children, grandchildren, brothers and sisters, and certain of their spouses; and
- 35% controlled entities, such as a company in which those people own more than 35% of the voting power.
Others can be disqualified persons depending on the facts. The IRS lists factors such as founding the organization, being a substantial contributor, having pay based on revenue from activities you control, or managing a substantial part of the operation. An employee who holds none of those roles, is not a family member or substantial contributor, and earns less than the highly compensated amount ($160,000 for 2025 in the Form 990 instructions) is not treated as a disqualified person.
What an excess benefit transaction is
An excess benefit transaction happens when the organization gives a disqualified person an economic benefit worth more than what the organization gets back, including services performed. Common forms are salary above market rate, a lease or sale of property at a price that favors the insider, a loan on unusually generous terms, or personal expenses paid with organization funds. The IRS notes that embezzlement by a disqualified person is also an excess benefit transaction.
Benefits must be clearly intended as pay. A benefit counts as compensation only if the organization showed its intent at the time, for example through a signed employment contract or by reporting it on an original Form W-2, Form 1099 or Form 990. A car allowance that no one documented can be treated as an excess benefit in full, even if total pay would otherwise be reasonable.
Initial contracts are an exception. Fixed payments under a binding written contract with someone who was not a disqualified person before signing it are not tested under Section 4958. A material change to the contract later can turn it into a new contract that is tested.
The intermediate sanctions
These taxes are known as intermediate sanctions because they let the IRS penalize the people involved without revoking the organization's exemption.
| Tax | Who pays | Rate |
|---|---|---|
| Initial tax | The disqualified person | 25% of the excess benefit |
| Additional tax if not corrected in the taxable period | The disqualified person | 200% of the excess benefit |
| Manager tax | Any officer, director or trustee who knowingly participated, unless not willful and due to reasonable cause | 10% of the excess benefit, capped at $20,000 per transaction for all managers combined |
Correction means undoing the excess benefit: the disqualified person repays the excess plus interest at no less than the applicable federal rate, so the organization ends up no worse off. The taxes are reported and paid on Form 4720, and the organization reports the transaction on Schedule L of Form 990 or Form 990-EZ.
A youth soccer league rents its office from a board member. A comparable space nearby rents for $2,000 a month, but the league pays the board member $3,000 a month. Over one year the excess benefit is $1,000 × 12 = $12,000.
- Initial tax on the board member: 25% × $12,000 = $3,000.
- If the board member does not repay the $12,000 plus interest in time: an additional 200% × $12,000 = $24,000.
- A treasurer who knowingly approved the lease: 10% × $12,000 = $1,200.
The rebuttable presumption of reasonableness
The best protection is a process. If your board follows three steps, pay or a property transfer is presumed reasonable, and the IRS can overcome that presumption only with enough contrary evidence to rebut the data your board relied on.
- Approval by people without a conflict. The board or an authorized committee approves the arrangement, and no member voting on it has a conflict of interest. A written conflict of interest policy makes this step routine.
- Reliance on comparability data. Before deciding, the board obtains and relies on appropriate data, such as salaries at similar organizations or an independent appraisal. Organizations with gross receipts under $1 million have a safe harbor: data on pay at three comparable organizations in the same or similar communities for similar services is enough.
- Concurrent documentation. The minutes record the terms and date, who was present and who voted, the data used and how it was obtained, and how any conflicted member was handled. The record must be prepared before the later of the next board meeting or 60 days after the final action, and approved within a reasonable time after that.
If you cannot complete every step, do as many as you can. Our guides on paying founders and staff and nonprofit recordkeeping show what that looks like in practice.
When the organization's exemption is at risk
Section 4958 does not replace the inurement ban. The IRS says that in most cases the excise taxes will be imposed instead of revocation, but it weighs factors such as the size and scope of the excess benefit compared with the organization's ongoing exempt activities, whether there were multiple transactions, whether safeguards were in place, and whether the benefit was corrected or correction was pursued in good faith. A board that adopts safeguards and acts quickly is in a much stronger position. The board duties guide covers the oversight that prevents these problems in the first place.
Frequently asked questions
Can a founder be paid a salary by the nonprofit?
Yes. Reasonable compensation for services actually performed is not inurement. The founder is usually a disqualified person, so the pay should be set by board members without a conflict, using comparability data, and documented in the minutes.
Is a board member's business allowed to sell to the nonprofit?
Yes, if the price and terms are no better for the board member than a fair market deal. The board member should step out of the discussion and vote, and the board should record the comparison it relied on.
Does the 200% tax apply automatically?
No. The 200% additional tax applies only if the excess benefit is not corrected within the taxable period, which ends when the IRS mails a notice of deficiency or assesses the 25% tax, whichever comes first.
Are board members personally liable?
The manager tax falls on officers, directors and trustees who knowingly participated, unless their participation was not willful and was due to reasonable cause. It is 10% of the excess benefit, capped at $20,000 per transaction for all managers combined, and they are jointly and severally liable for it.
Sources
- IRS: Instructions for Form 990 (2025), Appendix G, Section 4958 Excess Benefit Transactions. irs.gov
- IRS: Publication 4221-PC, Compliance Guide for 501(c)(3) Public Charities (Rev. 3-2018). irs.gov
- Legal Information Institute: 26 U.S. Code § 4958, Taxes on excess benefit transactions. law.cornell.edu
- eCFR: 26 CFR 1.501(c)(3)-1, Organizations organized and operated for religious, charitable, scientific... purposes. ecfr.gov
- eCFR: 26 CFR 53.4958-6, Rebuttable presumption that a transaction is not an excess benefit transaction. ecfr.gov
IRS forms, fees and inflation-adjusted amounts change. We review this page when the IRS publishes new instructions.
501Nonprofit.com is a private company, not the IRS. This page is general information, not legal or tax advice for your organization. Example organizations and figures are hypothetical.
