Correcting an Excess Benefit Transaction

Correction standard

A disqualified person corrects an excess benefit transaction by reversing the excess benefit when possible and taking any further measures necessary to restore the organization’s financial position under the highest fiduciary standards.

Correction does not necessarily require cancellation of the underlying agreement. However, if the agreement is ongoing, its terms may need to be changed for future payments.

Practically, preparers should distinguish the correction of the prior excess benefit from any changes needed to prevent future payments under an ongoing contract from continuing on the same terms.

Cash correction amount and interest

The general correction method is a payment of cash or cash equivalents by the disqualified person to the applicable tax-exempt organization. The payment must equal the correction amount.

The correction amount consists of the excess benefit plus interest on that excess benefit.

The interest rate used in determining the correction amount cannot be below the applicable Federal rate.

Practically, paying only the original excess benefit is not sufficient when interest must be included. The correction calculation must add interest using a rate that is at least the applicable Federal rate.

Returning the transferred property

If the applicable tax-exempt organization agrees, the disqualified person may correct by returning the specific property that was transferred in the excess benefit transaction.

This alternative is limited to the particular property previously transferred. An anti-abuse rule bars arrangements that effectively transfer other property instead of cash or cash equivalents.

For correction purposes, the returned property is treated as cash or a cash equivalent at the lower of two fair-market-value measurements.

Practically, an increase in the property’s value after the transaction does not increase its recognized correction value above its fair market value on the transaction date. A decline in value results in use of the lower value on the return date.

• One measurement is the property’s fair market value on the date the organization receives it back.
• The other measurement is the property’s fair market value on the date of the excess benefit transaction.

Balancing payments after a property return

After applying the required valuation limit, the value credited for the returned property must be compared with the correction amount.

If the property return results in a payment below the correction amount, the disqualified person must pay the shortfall to the organization in cash.

If the property return results in a payment above the correction amount, the organization is permitted to pay the excess in cash to the disqualified person.

The two outcomes are not symmetrical: the disqualified person must cover a shortfall, while the organization may—but is not required to—pay an excess.