Excess Benefit Transaction Rules – When Is A Party A Disqualified Individual?


Tax exempt organizations such as hospitals, are subject to various rules that limit the benefits that they can provide to individuals who are in a position of control over the organization.  The “excess benefit” provisions set forth in IRC § 4958 and related Treasury Regulations require a tax exempt organization  to disclose excess benefit transactions on Form 990.

The Excess Benefit Transaction Rules have very specific elements and are sometimes not as broadly applicable as may be asserted by the exempt organization.  On requirement is that the applicable party meet the requirements to be considered to be a “disqualified individual.”  There is a very specific definition of when an individual is disqualified.  In reality, very few physicians are actually subject to the Excess Benefit Transaction Rules.

Generally, disqualified persons are limited to individuals who are in a position to exercise substantial influence over the affairs of the organization.  Even where an individual physician is considered to be a disqualified individual, application to the medical group itself requires a completely separate attribution analysis.  Even if an individual physician is a disqualified individual, his or her medical group may not be disqualified for tax purposes.

This entire analysis relates to whether an “excess benefit transaction” exists.  If an excess benefit transaction exists, the individual who received the benefit must repay the excess amount to the tax exempt organization or be subject to a significant excise tax and potentially other penalties.

IRC § 4958(c)(1)(A) defines an “excess benefit transaction” to mean

“any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

Clearly, the Excess Benefit Transaction Rules only apply to a very specific group of parties who meet the definition of being “disqualified persons.”  If there is no “disqualified person” involved in the transaction, there can be no excess benefit transaction.  Accordingly, the first step in analyzing any transaction for potential excess benefit is determining whether or not disqualified persons receive an economic benefit in the transaction.

IRC § 4958(c)(1)(A) defines a “disqualified person” to mean, with respect to any transaction as “any person or entity in a position (at the time of or within five years prior to the transaction) to exercise substantial influence over the affairs of the exempt organization, even if that power is not actually used.”  The statute, regulations, and various other material from the IRS describe more specific factors that are to be considered when making a determination of whether a party is a disqualified person.

Only physicians who are in a position to exercise substantial influence can properly be treated as disqualified individuals.   Certain individuals such as voting members of the Board of Directors and senior corporate leaderships are automatically considered to be disqualified individuals.   Others are subject to a “facts and circumstances” analysis to determine whether these parties have “substantial influence and control” over the affairs of the tax exempt organization.  The IRS has considered a series of factors to be relevant to this analysis and has published examples that apply to analysis of whether certain physicians are in a position to exercise substantial influence and control.  Some of the relevant factors may include:

  • The individual’s compensation is primarily based on revenues derived from activities (or a department or function) of the organization that the individual is said to control;


  • The individual manages a discrete segment or activity of the organization that represents a substantial portion of the organization’s activities, assets, income, or expenses;
  • The person owns a controlling interest in a corporation, partnership or trust that is a disqualified person.

The IRS has also provided some very useful examples of how the determination should be made with respect to physicians.

The factor for management of a discrete segment or activity is also illustrated by four examples, where the IRS described two department heads (a cardiologist and a law school dean) who are in a position to exercise substantial influence and two others (a radiologist and the chair of a small academic department in the college of arts and sciences) who are not. Key factors in determining whether the individuals in those examples would be disqualified persons are (1) importance of the department as a direct and indirect revenue source; (2) managerial control over the department such as through a key role in hiring and authority to determine a significant portion of its capital and operating budgets and to allocate compensation of department staff; and (3) incentive bonuses funded by a portion of organization revenues attributable to the department vs. lack of any revenue-based compensation related to activities he/she controls.

It is normal practice for a tax exempt organization to maintain a list of parties that it has determined, through proper analysis, to be disqualified persons within the meaning other Excess Benefit Transaction Rules.  Normally, individuals who are so identified are regularly  notified of this status by the tax exempt organization.


The issue of whether an individual is a disqualified person can come up in a number of contexts.  For example, a hospital may raise the issue in the context of negotiating a contract or joint venture.  A physician may be asked to repay amounts that have been previously paid as compensation or otherwise.  A hospital may need to consider whether to disclose a payment on its annual for 990.  Regardless of how this issue us raised, it is critical that the appropriate analysis be performed to determine whether the excess benefit rules even apply to the given situation.    Improperly classifying a transaction as an excess benefit transaction can carry as mush risk as failing to properly account for a transaction that meets the various requirements.

A final work of caution to tax exempt organizations.  The issue of private benefit and excess benefit should never be raised as a negotiating tool or to leverage payment from a physician or other individual.  This negotiation tact can go south very quickly and can actually create evidence that can be used against the organization .  These are serious matters and they should be treated as compliance issues rather than negotiating tools.