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Second Thoughts

I thought the recent election results, and how they may change the direction of federal and state tax policy and future tax legislation, would be a good topic for this week’s post. However, the more I delved into it, the more I realized that I was not yet ready to present an objective or dispassionate assessment of the statutory and regulatory changes we may expect to see beginning in 2029,[i] assuming the country continues on its current, ill-chartered course.[ii]  

Having allowed this last comment to “escape the fence of my teeth,”[iii] this post will review the Tax Court’s recent consideration[iv] of what I thought was an interesting twist of a frequently encountered scenario; i.e., the disallowance of that portion of a taxpayer’s deduction for their distributive share of partnership loss in excess of the taxpayer’s adjusted basis of for their interest in the partnership.[v]

Continue Reading A Partner’s Tax Loss That Never Was
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NOL Carryovers – the Theory

Let’s take a short walk down memory lane . . . while we still can.

Generally speaking, the amount by which a business’s expenses for a tax year exceed its gross income for such year represent the business’s net operating loss (“NOL”) for the year. There are many reasons why this may occur. For example, a business just starting out may be slow to generate sales, while also paying or incurring significant start-up costs. Alternatively, a business may belong to a cyclical industry that depends upon the well-being of the economy as a whole; for example, a retail business that depends upon discretionary spending by consumers.

For years, the Code has recognized that a business’s income tax liability for a particular taxable year may not correlate to its overall or historic economic performance. Consider a business that operates at a loss for several years before finding or rediscovering its groove. In order to remain in operation, it borrows from third party lenders (often with the personal guarantee of its owners), or its owners make additional capital contributions. If the business is not permitted to somehow use its losses to “average out” the results of its high-performing and poor-performing years, it would be paying more tax than warranted based on its actual economic results.[i]

That’s the theory.  

The TCJA

Prior to the enactment of the Tax Cuts and Jobs Act (the “TCJA”)[ii] in 2017, this business would have been permitted to carry its NOL realized during a tax year back to the two immediately-preceding tax years for the purpose of reducing the business’s taxable income in such years. If, as a result of such reduction, it was determined that the business had overpaid its taxes in either of the carryback years, the business could have claimed a refund for the excess amount of tax paid. In the case of a business that had fallen on some hard times, this recovery of taxes paid in prior years often represented a badly needed infusion of funds.

To the extent the business had NOLs remaining after the two-year carryback, it was permitted to carry them forward for up to twenty years for the purpose of reducing its future taxable income, and the resulting income tax liability, for each of those years.  

As a result of the TCJA, the two-year carryback was repealed for an NOL arising in a taxable year beginning after 2017. However, instead of the twenty-year carryforward period, a business with such NOLs was permitted to carry them forward indefinitely until they were exhausted. That said, the TCJA also limited a business’s NOL deduction for a carryover year to 80 percent of its taxable income for such year (determined without regard to the NOL deduction).

The Pandemic

In response to the outbreak of the pandemic and the economic consequences of the measures taken by the government to contain it, Congress enacted the CARES Act in 2020.[iii] Among other things, this legislation modified or delayed the implementation of certain provisions of the TCJA.

It also gave businesses that were being adversely affected by the pandemic an opportunity to obtain additional funding. Specifically, this law provided that any NOL arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, could be carried back to the five taxable years preceding the taxable year of such loss. By reducing its taxable income – and its tax liability – for such earlier years, the business could recover some of the taxes paid for those years. The funds returned to the business could then be used to keep it afloat.

Which brings us to case of the taxpayers described below.[iv]

The Acquisition

Until 2018, Target Corp (“Target”) had served as the common parent of a group of affiliated corporations and, as such, was the group’s agent and assumed responsibility for filing a consolidated corporate tax return on behalf of the entire group for the 2015 through 2018 tax years.

In October 2018, Target was acquired by, and merged into, Acquirer Corp (“Acquirer”), with Acquirer as the surviving corporation. As a result, Acquirer became the “default successor” to Target and “the agent” for its consolidated group’s taxable years through 2018.  

The CARES Act

Acquirer’s status as agent by succession for the Target corporate group’s prior tax returns became important following enactment of the CARES Act which, as explained earlier, expanded the ability of corporations to offset tax liabilities from prior years with business losses generated in later years. Corporations could claim these tax benefits by amending prior returns to show they had overpaid in light of the retroactive tax changes.[v]

The Refund Claim

After striking an agreement with the former owners of Target, Acquirer sought to obtain the benefit of the Target group’s NOLs by filing amended returns for the consolidated group from 2015 to 2018 in which it claimed total refunds in excess of $8 million.[vi]

However, the amended returns identified Target, instead of Acquirer, as the filing entity name for each tax year. The filing included a cover letter from Acquirer’s accounting firm (“CPA”).

When the IRS failed to issue a refund within six months of the filing of the refund claim, Acquirer filed suit in Federal District Court to obtain the overpaid taxes.  

No Jurisdiction?

The government then moved for judgment on the pleadings.[vii] It asserted that the Court lacked subject matter jurisdiction because Acquirer’s refund claim had not been properly filed. The government stated that, under the Code,[viii] a taxpayer seeking a refund “first must file a valid claim with the Secretary of the Treasury before it is entitled to bring an action in the district court.”

The government argued that Acquirer’s refund claims were not “properly executed” in accordance with the applicable regulations because the returns did not identify the agent; i.e., Acquirer.

The government explained that “[a] taxpayer seeking a refund of taxes erroneously or unlawfully assessed or collected may bring an action against” the Federal government either in District Court or in the Court of Federal Claims; as a prerequisite, however, “a taxpayer must comply with the tax refund scheme established in the Code.” Specifically, a taxpayer may not sue “until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law in that regard, and the regulations of the Secretary established in pursuance thereof.”[ix] In order for a return to have been “duly filed,” it must have been “properly executed.”[x]

Acquirer did not dispute that properly executing the amended return on which the refund claim was made was a jurisdictional requirement; still, it resisted the government’s objection and argued that, even if naming Target was erroneous, the Court should overlook that error.

The Court’s Opinion

Unfortunately for Acquirer, the Court agreed with the government.

Did Acquirer Properly Execute the Amended Returns?

The government pointed to a few regulations supporting its argument that by naming Target, the forms for the 2015 to 2018 tax years were not valid refund claims. Chief among these was a regulation explaining that the agent is the “sole agent that is authorized to act in its own name regarding all matters relating to federal income tax liability” for the group.[xi] The government also highlighted regulations instructing that the “consolidated return must be made … for the group by the agent,”[xii] and that “[t]he agent files claims for refund, and any refund is made directly to and in the name of the agent…”[xiii] In light of these requirements, the government stressed that the relevant returns nowhere referenced Acquirer.

Acquirer disagreed that it violated any of the regulations but, according to the Court, its arguments were unavailing. And by highlighting ways in which the Court or the IRS could discover that Acquirer filed the amended returns, Acquirer only underscored the importance of properly naming itself in the first place.

Acquirer contended these regulations did not require that the agent name itself on the amended return. It argued that the regulations[xiv] indicated “nothing about whose name is listed atop the return” and instead merely “describe[] the agent’s legal authority to bind the affiliated group.” Acquirer argued that this requirement’s satisfaction could be inferred from other information indicating Acquirer “in fact ‘filed’ the [Target] Amended Returns.” First, it stated that it was reasonable to infer Acquirer filed the returns from the very impossibility of a liquidated corporation filing them: “since [Target] did not exist, and … [Acquirer] was the sole agent …, the only logical inference from the pleadings and exhibits was that [Acquirer] filed the refund claims.” It also pointed to other documents and exhibits that support the inference that Acquirer authorized the filing of the returns. It placed particular emphasis on the signature of its Chief Financial Officer in his capacity as “CFO” or “Officer,” noting that even though this title did not reference Acquirer, other relevant exhibits before the Court, including a declaration, supported the signatory as holding that position on behalf of Acquirer.

The Court responded that, just because the it could piece together this information did not mean the IRS could have done so, nor did it render the form validly executed. Indeed, the Court continued, “the IRS has the right to insist that its regulations be followed.” According to the Court, it was not enough that “somewhere under the Commissioner’s roof is the information which might enable him to pass on a claim for refund.”

If anything, the Court observed, Acquirer’s “arguments only underscore the critical role of a return naming the filer.” The regulations identify this importance by saying that “[t]he agent files claims for refund, any refund is made directly to and in the name of the agent.”[xv] In other words, the name of the filer on the return mattered.

“Moreover,” the Court continued, “there is little to support that the regulations merely require the agent ‘cause’ the filing of refund claims.” Acquirer’s contention, the Court stated, “reads out of [the Regulation] that the agent acts ‘in its own name.’” This applies comprehensively, too, “regarding all matters relating to the federal income tax liability.” Here, Acquirer failed to act in its name by listing Target as the taxpayer on the amended returns.

An agent’s self-identification, the Court explained, was not just practically important but also reflected the agent’s legal relationship to affiliates. The point of a consolidated return, the Court stated, was that, rather than “requiring each member company of ‘[a]n affiliated group of corporations’ to file a separate tax return, the Code permits the group to file a single consolidated return,” through the agent. That single return is “based on the legal fiction that the consolidated group of corporations is ‘for purposes  of United States income tax, one taxpayer.’” The agent is that “one taxpayer.” More than simply “causing” a return’s filing, the agent “files the return, pays the tax, receives any refunds, and generally deals with the IRS.” A requirement that the agent name itself as the filer reflected the agent’s role as the representative of the group.

The Court found that this role and naming requirement was well-supported by caselaw.[xvi]

Still, Acquirer argued that the amended returns had to be in Target’s name because Target was the common parent for the relevant tax years, in respect of which the refund was claimed. Acquirer also emphasized the oddity of naming itself when it “had no connection to the affiliated group during the relevant years” and “had returns of its own for those years.”

The Court rejected Acquirer’s position, stating that its arguments ran “headfirst into its factual allegation that, by succession as the common parent, it “bec[a]me the ‘agent’ … for the [Target] consolidated group’s 2015 through 2018 taxable years” and was thereby responsible for filing amended returns, despite having no connection to those prior years.

The Court pointed out that the Treasury’s regulations spotlighted this arrangement. They referred to the agent for a “completed year” as possibly a “default successor” of a common parent, which was relevant in the present case, where the prior common parent had been liquidated.[xvii] The same regulations also provided an analogous example in which the IRA explained that where a parent of a consolidated group merged with and into an acquiring corporation, the latter was the “default successor and agent for the [past] group” and “must file” the past group’s consolidated return for a pre-merger year.[xviii] Therefore, Acquirer’s arguments “defending the propriety of naming a defunct parent company on the amended tax returns [were] unavailing.”

Did Acquirer Justify Ignoring the Error?

Alternatively, Acquirer argued that the Court should overlook any error because it “had a good excuse … for failing to comply with either an unimportant requirement or one unclearly or confusingly stated in the regulations,” so as to qualify under the substantial compliance doctrine. Acquirer contended that any requirement to name itself was confusing because it was “counterintuitive and is unimportant” because it was merely “procedural.”

The Court was not persuaded. The substantial compliance doctrine, it stated, “should be interpreted narrowly.” According to the Court, this holds all the more so in the context of consolidated returns because the “privilege” of consolidated return filing is granted “upon the condition that all corporations” in a group “consent to all the consolidated return regulations.”[xix] There was no “good excuse” for non-compliance in the present case, the Court continued, where Acquirer “relied on a large accounting firm” (CPA) to prepare the forms and the requirement for the correct name was fundamental, if only to ensure the correct party was repaid.[xx] Acquirer was no doubt “well aware that a substantial tax deduction was at stake.” These considerations lead the Court to reject the applicability of substantial compliance.

Acquirer also argued that the Court should have declined to “elevate the form of … claims over their substance” given the IRS received adequate notice and would not be prejudiced. The Court noted that Acquirer’s brief did not identify any authority in the context of a consolidated return to support its request.[xxi] According to the Court, when the conditions for substantial compliance “are not satisfied, it makes compellingly good sense to hold a taxpayer to the requirements of the tax code.”

Finally, Acquirer argued that a “plausible inference should be made” that the IRS waived the regulatory requirements by investigating the claim. The Court responded, “But, in its cursory point, [Acquirer] acknowledged it [lacked] facts or allegations that could come close to supporting a plausible inference the Commissioner “clear[ly] … understood the specific claim that was made even though there was a departure from form in its submission.” Acquirer’s failure to prove such a waiver was “fatal,” the Court added.

Court’s Conclusion

By submitting amended tax returns in Target’s name, Acquirer did not “properly execute” those returns by providing the name of a defunct corporation rather than its own name. As a consequence, the amended returns were not “duly filed” with the IRS.

With that, the Court dismissed Acquirer’s claims for lack of subject matter jurisdiction; however, it did so without prejudice, meaning that Acquirer could remedy its procedural error and resubmit its claim, provided it did so on a timely basis because the dismissal did not pause the running of the limitations period.

In Summary

Who said it was easy to secure a refund of an overpayment of income tax? The “refund regime” can be every bit as challenging as the regime for assessing and collecting an income tax deficiency.

The taxpayer has to determine whether there has been an overpayment of tax in an earlier tax year – perhaps paid because the taxpayer missed the filing deadline for Tax Court and didn’t have a sufficiently equitable “excuse” for the Court to waive it, or because the taxpayer resided in one of appellate jurisdictions that still viewed the 90-day rule as jurisdictional[xxii] – and, having done so, it must be prepared to prove it.

A claim for refund of an overpayment must be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later.[xxiii] No refund will be made after the expiration of the period of limitation for the filing of a claim for refund, unless a claim was filed by the taxpayer within such period.[xxiv]

Having filed a refund claim, the taxpayer must wait at least six months from the date of filing the claim before commencing a suit or proceeding in any court for the recovery of the overpayment, unless the government denies the claim sooner.[xxv] If the claim is disallowed, the taxpayer must bring an action within two years of the date of mailing to the taxpayer of the notice of the disallowance.[xxvi] If the taxpayer decides to pursue recovery of the tax, the suit must be brought in a federal district court or the U.S. Court of Federal Claims.[xxvii]

However, the foregoing process is meaningless unless the proper party files the refund claim, as Acquirer discovered, to its detriment. As it turned out, it wasn’t enough that the claim was filed in the name of the taxpayer on which the tax was imposed and by which the tax was paid. Target ceased to exist; thus, it was no longer part of the affiliated group the consolidated return of which was at issue. Acquirer and Target contemplated this scenario, and Acquirer became the agent for the Target group’s open consolidated years.

In light of the above, was the District Court’s decision harsh, nonetheless? I think so.

The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.

Sign up to receive my blog at www.TaxSlaw.com. 

[i] I imagine that few thoughtful people would take issue with this statement. Having said that, the same thoughtful people will certainly have differing opinions over which expenditures of a business should be considered in computing its NOLs, how to curb abuses in the creation of NOLs, and the periods to which such NOLs may be carried, among other relevant topics. Policy questions.

[ii] Pub. L. 115-97.

[iii] See Pub. L. No. 116-136, § 2303(b).

[iv] pH Beauty Holdings III, Inc., v. U.S., No. 25 CV 13467 (N.D. Ill. 2026).

[v] Reg. Sec. 301.6402-3(a)(5).

[vi] In case you’re wondering, even when there is an “ownership change,” IRC Sec. 382 limits the carryforward of pre-change losses to post-change years. The issue in the present case involved a carryback. Of course, the SRLY (separate return limitation year) rules would still have to be considered if the carryback involved a specific member’s separate return (pre-consolidated) year. Reg. Sec. 1.1502-21.

[vii] Under Federal Rule of Civil Procedure 12(c).

[viii] IRC Sec. 7422.

[ix] IRC Sec. 7422(a).

[x] Reg. Sec. 301.6402-3(a)(5).

[xi] Reg. Sec. 1.1502-77(a)(1).

[xii] Reg. Sec. 1.1502-75(h)(1).

[xiii] Reg. Sec. 1.1502-77(d)(5).

[xiv][xiv] Reg. Sec. 1.1502-77(d)(5) and (c).

[xv] Reg. Sec. 1.1502-77(d)(5).

[xvi] The Court cited an opinion of the Second Circuit Court of Appeals to support its statement. The higher court explained the mechanics of consolidated returns as follows: they “are filed in the name of the ‘common parent’, who acts as the agent for each subsidiary in the group and acts on behalf of the group in all matters related to tax liability for the consolidated group.” In re Prudential Lines Inc., 928 F.2d 565, 569 (2d Cir. 1991).

[xvii] Reg. Sec. 1.1502-77(c).

[xviii] Reg. Sec. 1.1502-77(g)(8)(ii).

[xix] IRC Sec. 1501.

[xx] Reg. Sec. 1.1502-77(d)(5) (“The agent files claims for refund, and any refund is made directly to and in the name of the agent….”).

[xxi] “[T]axpayers, by electing to file consolidated returns, have necessarily consented to all regulations in effect … prescribed by law for filing returns.”

[xxii] Remember that? The Notice of Deficiency, or 90-Day Letter? Don’t get me started. Congress intended the 90-day deadline as jurisdictional. The Tax Court itself was of the same opinion. Then several federal Appellate Courts revised the rule.

[xxiii] IRC Sec. 6511(a).

[xxiv] It should be noted that if the claim was filed by the taxpayer during the above 3-year period, the amount of the refund cannot exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return. If the claim was not filed within such 3-year period, the amount of the refund cannot exceed the portion of the tax paid during the 2 years immediately preceding the filing of the claim. IRC Sec. 6511(b)(2).

[xxv] IRC Sec. 6532.

[xxvi] When the IRS has not issued a notice of claim disallowance and the taxpayer has not waived the requirement to receive that notice, the taxpayer may file a refund suit any time after six months from the administrative claim filing because the two-year period under IRC Sec. 6532(a) is triggered only by the taxpayer’s waiver or the Service’s mailing of the notice of claim disallowance. 

[xxvii] IRC Sec. 7422(e).

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Surprises

As is the case in so many fields of endeavor, the more time you spend practicing tax law, the more likely it becomes that you will encounter something absurd. Such moments of “revelation” most often occur during the due diligence stage of a transaction or in the course of a tax controversy.

The first of these contexts involves a potential private party that is investigating the accuracy of what the taxpayer has told it regarding the financial condition of the taxpayer’s business, including its exposure to tax liability. The second involves a taxing authority that is examining the accuracy of the facts reported by the taxpayer on its tax return and the strength of the legal positions taken on the return.  

Continue Reading Taxes and Corporate “Formalities” – Timing May Be Everything
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Remember “CTA Light”?

Do you recall the relief you felt when, in early March of 2025, the Treasury Department announced that it would not enforce any penalties or fines associated with the beneficial ownership information (“BOI”) reporting rule under the then existing regulatory deadlines issued under the Corporate Transparency Act (the “CTA”)?

What about the elation that followed when, in the same breath, the Treasury added that it would be issuing proposed rules that would narrow the scope of the BOI disclosure rule to foreign reporting companies only?[i] 

Continue Reading The Reanimation of The Corporate Transparency Act – Frankenstein’s Monster Has a Regular Pulse
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Word Association

What’s the first thing that comes to mind when you hear the term “remote work”?

I think of empty offices for which an employer is paying fair market rent, of difficulties in communicating with physically absent employees who would otherwise have been a short walk down the hall, and of lost opportunities for younger persons to learn from observing, or from being mentored in “real time” by, more knowledgeable and experienced folk.

Continue Reading Remote Work, Economic v. Physical Nexus Where Are We Heading?
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Challenges Ahead

Earlier this month, the Fed raised the federal funds rate for the first time in three years. Inflation remains high relative to the Fed’s target rate. Energy costs continue their upward trend. The Federal deficit for the 2026 fiscal year is expected to reach $2 trillion, and the Federal debt has topped $40 trillion. Business borrowing costs are trending upward. There is a reasonable prospect of federal and state tax increases in the foreseeable future. Trade and tariff tensions are re-escalating. Household debt (including mortgages, credit card debt, and student loans) stands at almost $19 trillion. Many workers are viewing the rise of artificial intelligence as an existential threat. Polling services tell us that consumer confidence is trending downward.

Funding Sources?

Under such circumstances, many closely held businesses and their owners are rightfully concerned about their prospects. The vast majority of owners will do what they can, within the bounds of the law, to keep their businesses viable.

However, they may be especially challenged in the face of a cash crunch, as a result of which they may not have sufficient liquidity to pay operating expenses.

Unfortunately, a not insignificant number of such owners and businesses may consider, and ultimately follow through with, a “strategy” that has often been utilized by businesses in distress: “borrowing” funds from sources to which they have easy access, but to which they have no claim of right.

Taxes Withheld

Most instances of such “self-help” involve a business that fails to remit to the taxing authorities those taxes that the business has withheld or collected on their behalf – typically, its employees’ share of employment taxes on wages paid by the employer-business, or state and local sales taxes collected on the business’s retail sale of certain products and services.

Charitable Assets

Much less frequently but, regrettably, not rarely enough, a business or its owner will “borrow” funds from a tax-exempt charitable organization they created and funded years before – during better times, perhaps with the assistance of employee contributions – and that, for all intents and purposes, remains under the owner’s control.    

Such a charitable organization, even one that is treated as a publicly supported charity, typically does not engage in the direct and active operation of its own charitable program; instead, it makes grants to fund specific programs operated by other charitable organizations.

Thus, the assets of such a grant-making organization are often comprised primarily of liquid assets.

Rationale?

Why would a business or its owner borrow funds from “their” charity? For the same reason they would divert the use of tax dollars that they withheld or collected as an agent of the taxing authorities.

The reasoning goes something like this: “Revenues were down. We just needed some time to recover. The money ‘borrowed’ was going to help us pay some bills and sustain the business until its cash flow improved and it became profitable once again. At that point, we would have returned the funds.”[i]

With respect to borrowing from a “controlled” grant-making charity, there is the additional rationalization that the “temporary” absence of the funds would not adversely affect the grant-making activities of the organization.[ii]   

The U.S. Tax Court recently considered[iii] a scenario, similar to the one described above, in which Taxpayer engaged in a loan transaction with Charity.

The Transaction

Taxpayer organized Charity as a nonprofit corporation in 2015 (the year immediately preceding the tax year in question). The organization’s purpose was to assist indigent individuals with basic living necessities. The IRS recognized[iv] Charity’s exemption from corporate income tax[v] and granted it public charity status.[vi]

During 2016, Taxpayer served as Charity’s president, his father served as a director on Charity’s board, and Taxpayer’s daughter served as its treasurer.

LLC

About ten years earlier, Taxpayer had formed LLC to engage in real estate investment and management.

During 2016, Taxpayer was LLC’s sole member, and LLC was treated as a disregarded entity for federal income tax purposes;[vii] thus, all of LLC’s assets, liabilities, and items of income, deduction, etc., were treated as belonging to Taxpayer and were reported directly on Taxpayer’s individual income tax return.[viii]

The Loan

In April 2016, Charity’s money market account reflected an “Over the Counter Withdrawal” for $590,000. At that time, Taxpayer, as Charity’s president and as the sole member of LLC, executed a promissory note (the “Note”) whereby LLC apparently borrowed this amount as a no-interest, 5-year balloon loan from Charity. Taxpayer signed the Note on behalf of both the borrower (LLC) and the lender (Charity).

On or about that time, however, neither LLC’s money market account nor its checking account reflected a deposit or credit for an amount equal to the loan. In December 2016, Charity’s checking account reflected a deposit of $600,000 that was described as a wire transfer.

Whither the Loan?

During 2016, one of Taxpayer’s children worked for Immigration Charity (“IC”), an organization that advised indigent clients on immigration issues.

IC was looking to purchase a building as its principal office; however, it was unable to secure favorable financing for the acquisition. IC reached out to Charity for assistance. The latter apparently applied for a loan itself – presumably to share the proceeds with IC – but did not qualify.

In the absence of funding, the acquisition of the building by IC was delayed for two years (to 2018), at which time LLC provided almost $562,000 to help finance the acquisition of the property. Charity’s money market account reflected a withdrawal recorded as a wire transfer for almost $537,000.

Charity’s Tax Returns

Charity’s initial tax return[ix] was signed by Taxpayer as president, reported his home address as Charity’s address, and identified Taxpayer as the individual possessing Charity’s books and records. The return showed contributions of $608,700;[x] $600,000 of this was reported as having come from Taxpayer’s half-brother, and the rest from Taxpayer.

For 2016 (i.e., the year in question), Charity again identified Taxpayer as the individual possessing Charity’s books and records. Charity reported contributions of $600,000, but failed to include with its return the required schedule of contributors.  Its balance sheet reported beginning-of-year assets, consisting entirely of cash and savings balances, of just over $600,000, and year-end balances of nearly the same amount.

However, Charity’s 2016 balance sheet also reported a year-end asset identified as “[l]oans and other receivables from current and former officers, directors, trustees, key employees, and highest compensated employees” of $590,000 – the face amount of the Note. The year-end balance sheet reflected total assets of $1,201,200; i.e., year-end cash of $611,200, plus a loan of $590,000.

Charity failed to attach a statement to the balance sheet reflecting the details of any loans and other receivables from current and former officers, directors, trustees, key employees, and highest compensated employees.[xi]

For 2017, Taxpayer was again listed on Charity’s return as the individual possessing the organization’s books and records. The balance sheet again reported $590,000 in “[l]oans and other receivables from current and former officers, directors, trustees, key employees, and highest compensated employees.” Charity once again failed to include the details of such loans.

On its return for 2018, Charity reported “[n]otes and loans receivables, net” having a beginning of year balance of $1,090,000[xii] and a year-end balance of $1,626,920. The difference of approximately $536,920 was described[xiii] as a  “Loan to [LLC] a single member LLC owned by [Taxpayer]. Purpose of loan – to purchase building for nonprofit organization [IC].” LLC was also identified as an interested person on Charity’s balance sheet. The return did not report the $590,000 of “[l]oans and other receivables from current and former officers, directors, trustees, key employees, and highest compensated employees” shown on the preceding year’s return.

The Audit

The IRS conducted an excise tax examination of Charity’s annual tax return on Form 990 for 2016, upon the completion of which the agency (i) asserted that the loan between Charity and LLC, as evidenced by the $590,000 Note, was an excess benefit transaction, and (ii) proposed the imposition of the excise tax on Taxpayer.[xiv]

The IRS explained that (1) Charity was an applicable tax-exempt organization; (2) Taxpayer, as president of Charity, was a disqualified person[xv] who was subject to the 25% excise tax; (3) Taxpayer was subject to a $20,000 excise tax as the organization manager of Charity;[xvi] (4) Taxpayer, as the sole member of LLC, was required to correct the excess benefit transaction by returning the $590,000 plus interest to Charity; and (5) if Taxpayer did not return the funds, he would also be subject to a second tier tax of 200%.[xvii]

Taxpayer’s Protest

In response, Taxpayer filed a protest with the IRS Office of Appeals in which he challenged both (i) the characterization of the loan as an excess benefit transaction, and (ii) the imposition of the related excise tax.

The protest did not dispute that Charity was a tax-exempt organization or that Taxpayer was its manager. However, Taxpayer disputed that he was a disqualified person. He also argued that the loan between Charity and LLC was a bona fide loan; specifically, he argued that he satisfied the factors in favor of finding a loan.[xviii]

A couple of months later, Appeals issued a notice of deficiency to Taxpayer for 2016. Taxpayer timely filed a Petition with the Tax Court.

Tax Court

The Court began with a description of the Code’s “excess benefit” and “intermediate sanctions” rules.

Excess Benefit Transaction

The Code defines an “excess benefit transaction” as “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.”[xix]

Thus, a below-market loan from an applicable tax-exempt organization to a disqualified person would be an excess benefit transaction.[xx]

Applicable Tax-Exempt Organization

An “applicable tax-exempt organization” is defined to include an organization described in section 501(c)(3) – basically, a charitable organization[xxi] – and exempt from tax under section 501(a) of the Code.[xxii]

The parties stipulated that Charity was an applicable tax-exempt organization during the 2016 tax year.

Disqualified Person

A “disqualified person” is defined to include “any person who was, at any time during the 5-year period ending on the date of [the excess benefit] transaction, in a position to exercise substantial influence over the affairs of the organization.”[xxiii]

The parties stipulated that Taxpayer was a disqualified person[xxiv] during the 2016 tax year.

The Tax

The Code imposes[xxv] on each excess benefit transaction an excise tax “equal to 25 percent of the excess benefit,” and provides that this tax “shall be paid by any disqualified person with respect to such transaction.”

If the excess benefit transaction is not corrected within the taxable period, the disqualified person is liable for a second-tier tax equal to 200% of the excess benefit.[xxvi]

The term “taxable period” means, with respect to any excess benefit transaction, the period beginning with the date on which the transaction occurs and ending on the earlier of (1) the date of mailing a notice of deficiency[xxvii] with respect to the excise tax; or (2) the date on which such tax is assessed.[xxviii] Thus, the “taxable period” is the period beginning with the date on which the excess benefit transaction occurred and ending on the date the notice of deficiency was mailed.

Rationale for the Tax

The Court explained that Congress enacted this excise tax to “deter insiders of an organization from using their positions of influence to receive unreasonable compensation.”[xxix]

Before the enactment of the excise tax, the Court continued, if an organization did not comply with the rules regarding tax exemption, the IRS’s only recourse was to revoke the organization’s tax exemption.

Because revocation of tax-exempt status was a harsh result, and because its impact was felt most by the organization and its constituents or beneficiaries, rather than by the individuals who had improperly benefited from their relation to the organization, Congress recognized the need for “intermediate sanctions.”

These rules were enacted to deter malfeasance by insiders and to incentivize them to restore the charity to its condition before the sanctioned act; i.e., to correct the transaction by transferring to the charity an amount equal to the sum of the excess benefit plus an amount of interest on the excess benefit.[xxx]  

Parties’ Arguments

Taxpayer argued that he never received an economic benefit of $590,000 from Charity during 2016. He contended that the “Over the Counter Withdrawal” from the organization’s money market account for $590,000 was returned in December 2016 and was evidenced by an incoming wire of $600,000 to Charity’s checking account.

Interestingly, Taxpayer did not argue at trial (as he had in his protest) that the $590,000 amount was a bona fide loan. Instead, he testified that the Note for $590,000 was not an actual transfer of money but part of a plan to purchase the property for IC; specifically, Taxpayer stated that in 2016 Charity was trying to help IC with the acquisition of the property, though the transaction was not completed until two years later. At trial, Taxpayer provided the escrow statement for the transaction, which reflected an earnest deposit of $536,920 from LLC toward the purchase, and a corresponding outgoing wire from Charity’s money market account for $536,920, in October 2018.  

The IRS contended that Taxpayer received $590,000 from Charity in 2016, and that this $590,000 withdrawal was reflected on Charity’s bank statement as an “Over the Counter Withdrawal” with the loan evidenced by Taxpayer’s signing the Note for a principal balance of $590,000, as both borrower and lender.

The IRS further contended that Charity’s 2016 and 2017 tax returns reported the $590,000 as a loan to an officer.

Next, the Court considered the application of the intermediate sanction rules in light of the foregoing assertions.

Excess Benefit Transaction

The term “excess benefit transaction” means “any transaction in which an economic benefit is provided by an applicable tax-exempt organization . . . to . . . any disqualified person if the value of the economic benefit provided [by the organization] exceeds the value of the consideration (including the performance of services) received [by the organization] for providing such benefit.”[xxxi]

To ascertain Taxpayer’s excise tax liability, the Court explained that it, first, had to determine the aggregate “economic benefits” that Charity provided to Taxpayer. From the sum of these economic benefits (the value of which is expressed in dollars), the Court then had to subtract any consideration that Charity received from Taxpayer in exchange for providing such benefits.

No Benefit?

The Court noted that, at trial, Taxpayer no longer maintained that the $590,000 was a bona fide loan but, instead, testified that the $590,000 withdrawal was not retained by him but was repaid by a $600,000 wire transfer made in December 2016.

Unfortunately for Taxpayer, the Court did not find his testimony credible.[xxxii]

Charity’s 2016 return reported $600,000 as “[a]ll other contributions, gifts, grants, and similar amounts.” It was unclear, the Court stated, who made the $600,000 contribution in 2016 since the required schedule identifying the contributor was not filed, and Taxpayer testified that he was unsure who made the contribution. The $600,000 “repayment” was paid into Charity’s checking account while the $590,000 was an “Over the Counter Withdrawal” from its money market bank account. It was also unclear, the Court added, why a repayment would be $600,000 when there was only a $590,000 withdrawal.  

In sum, it remained unclear whether the $600,000 was the repayment of Taxpayer’s prior loan of $590,000.

Taxpayer also contended that he never actually received $590,000 from Charity in 2016. In fact, he testified that he could not recall where the $590,000 went and whether there was a loan.

The Court observed, however, that Charity had only been formed months before the events in question. “We find it to be rather doubtful,” the Court stated, “how [Taxpayer], as [Charity’s] president during the first and second years of operation, cannot recall the source of and withdrawal of nearly all of [Charity’s] reported contributions.”  

Still, Taxpayer contended that the Note was not an actual transfer of money in 2016 but only represented the anticipated purchase of the IC property in 2018.

While this proposition was generally true, and although LLC’s bank accounts did not reflect a $590,000 deposit, the Court pointed out that there was an “Over the Counter Withdrawal” of $590,000 from Charity’s account. The Note for $590,000 was signed by Taxpayer as both the officer for Charity (the lender) and as the sole member of LLC (the borrower) only days after the bank records reported the withdrawal.

Lastly, Charity’s 2016 and 2017 returns reported the $590,000 withdrawal amount as “[l]oans and other receivables from current and former officers, directors, trustees, key employees, and highest compensated employees.”[xxxiii]

The Holding

Based on the foregoing, the Court found that Taxpayer, as a disqualified person, withdrew $590,000 (the “Over the Counter Withdrawal”) from Charity’s bank account and, 11 days later, executed the Note that acknowledged LLC’s receipt of $590,000 from Charity.

The Court also determined that Charity received no consideration in exchange for providing the loan.

With that, the Court concluded that Taxpayer engaged in an excess benefit transaction of $590,000 and, under the Code’s intermediate sanctions rule, the 25% excise tax was properly imposed.

In addition, the Court determined that the 200% tax was also properly imposed on the $590,000 excess benefit because it did not find that Taxpayer had restored the amount of excess benefit to Charity within the taxable period.[xxxiv]

Observations

You may be thinking that Charity’s experience with Taxpayer was an outlier in the world of transactions in which not for profits and their insiders engage. If only that were so.[xxxv] Indeed, the accuracy of the statement depends upon several factors.

Although our focus in this post has been on public charities, it is worth noting that the Code treats any loan by a private foundation to a disqualified person as a prohibited act of self-dealing.[xxxvi] The fact that the loan represents bona fide debt and is made on arm’s length terms is irrelevant – the transaction must be undone as soon as possible.

Where the charity is publicly supported, the Code does not prohibit a loan to a disqualified person, provided the loan does not constitute an excess benefit transaction.[xxxvii]

However, such a loan may still be prohibited under the common law or statutes of the jurisdiction in which the charity is organized.[xxxviii] For example, New York’s not-for-profit corporation law[xxxix] provides as follows:

“No loans, other than through the purchase of bonds, debentures, or similar obligations of the type customarily sold in public offerings, or through ordinary deposit of funds in a bank, shall be made by a corporation to its directors, officers or key persons, or to any other corporation, firm, association or other entity in which one or more of its directors, officers or key persons are directors, officers or key persons or hold a substantial financial interest, except a loan by one charitable corporation to another charitable corporation.  A loan made in violation of this section shall be a violation of the duty to the corporation of the directors or officers authorizing it or participating in it, but the obligation of the borrower with respect to the loan shall not be affected thereby.”[xl]

Unfortunately, regardless of what federal or state law may provide in the way of proscribed activities, a charity that is governed by a relatively small board (especially one comprised of related individuals), or that is managed by an especially strong or influential personality (perhaps the owner of the business that founded the charity) – even if the charity is treated as publicly supported for tax purposes – may be susceptible to being pressured into making a loan to an insider or to the insider’s business.

In that scenario, it will be important for the charity’s advisers to remind the board, as well as the insider in question, of the excise tax. Even better, they should try to dissuade these parties from engaging in such a transaction.

The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.

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[i] As you can imagine, it rarely works out that way.

[ii] Publicly supported grant-making charities do not have a minimum payout requirement similar to the annual 5% of non-charitable assets to which private foundations are subject. IRC Sec. 4942.

[iii] T.C. Memo. 2026-92 Jagannath v. Comm’r Docket No. 18629-22. Filed September 24, 2026. https://www.law360.com/tax-authority/articles/2529826/attachments/0

[iv] IRC Sec. 508.

[v] Under IRC Sec. 501(a), as an organization described in IRC Sec.501(c)(3).

[vi] Under IRC Sec. 509(a).

[vii] Reg. Sec. 301.7701-3.

[viii] IRC Form 1040.

[ix] On IRS Form 990, Return of Organization Exempt From Income Tax.

[x] On Schedule B, Schedule of Contributors, attached to the Form 990.

[xi] Despite the instructions to the tax return for Part X of Form 990, which read as follows: “Report on line 5 loans and other receivables due from current or former officers, directors, trustees, key employees, and creator or founder, substantial contributor, or 35% controlled entity or family member of any of these persons”

Part II, Loans to and/or From Interested Persons, of Schedule L, Transactions With Interested Persons.

[xii] On Charity’s 2017 year-end balance sheet, two separate assets were reported: $590,000 was reported on line 5 and $500,000 was reported on line 10 of land, buildings, and equipment. However, on the 2018 beginning of year balance sheet, these amounts were somehow combined into a single asset of $1,090,000.

[xiii] On Schedule L, Part IV, Business Transactions Involving Interested Persons.

[xiv] IRS attached Form 4883, Exempt Organizations Excise Tax Audit Changes, and Form 4621, Exempt Organizations – Report of Examination.

[xv] Under IRC Sec. 4958(f)(1).

[xvi] Pursuant to section 4958(f)(2).

[xvii] Under IRC Sec. 4958(b).

[xviii] Your guess is as good as mine. Perhaps he was concerned about private inurement and revocation of Charity’s exempt status. Treatment as a loan indicated an obligation to return the funds.

[xix] IRC Sec. 4958(c)(1)(A).

[xx] Reg. Sec. 53.4958-4(a)(3)(vii), Ex. 10.

Compare the self-dealing rules applicable to private foundations, under IRC Sec. 4941(d)(1(B), which prohibit any loan from the foundation to a disqualified person, even where the loan bears adequate interest.

[xxi] The term “charitable” is used in IRC Sec. 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as limited by the separate enumeration in Sec. 501(c)(3) of other tax-exempt purposes which may fall within the broad outlines of charity as developed by judicial decisions. Reg. Sec. 501(c)(3)-1(d)(2).

[xxii] IRC Sec. 4958(e)(1).

[xxiii] IRC Sec. 4958(f)(1).

[xxiv] For purposes of IRC Sec. 4958.

[xxv] IRC Sec. 4958(a)(1).

[xxvi] IRC Sec. 4958(b).

[xxvii] Under IRC Sec. 6212.

[xxviii] IRC Sec. 4958(f)(5). A taxpayer’s liability is assessed “by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.” IRC Sec. 6203. According to those regulations, the assessment is by an assessment officer signing the “summary record of assessment.” The summary record, through supporting records, provides identification of the taxpayer, the character of the liability assessed, the taxable period, if applicable, and the amount of the assessment. In the case of the tax shown on a return filed by the taxpayer, the amount of the assessment is the amount so shown; in all other cases the amount of the assessment is the amount shown on the supporting list or record. The date of the assessment is the date the summary record is signed by an assessment officer. Reg. Sec. 301.6203-1.

[xxix] See U.S. Department of the Treasury’s Proposals to Improve Compliance by Tax-Exempt Organizations: Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways & Means, 103d Cong. 15 (1994) (statement of Leslie B. Samuels, Assistant Secretary for Tax Policy).

[xxx] Reg. Sec. 53.4958-7(c).

[xxxi] IRC Sec. 4958(c)(1)(A).

[xxxii] According to the Court, Taxpayer’s testimony was self-serving and intended to support his position. What’s more, the Court continued, his testimony at times was questionable, vague, conclusory, and unsupported by the evidence in the record. Under such circumstances, the Court asserted, it was not required to, and did not, rely on Taxpayer’s testimony to establish error in the IRS’s determinations.

[xxxiii] Taxpayer argued the withdrawal made on October 22, 2018, for $536,919.89 was related to the withdrawal made on April 4, 2016, for $590,000. The Court disagreed because these two withdrawals appeared to be independent. Moreover, it remained unclear how the Note of $590,000 was related to the purchase of the IC property in 2018.

[xxxiv] IRC Sec. 4958(f)(5) and (6).

[xxxv] I’ve seen too many instances of such misbehavior, and I’ve fielded too many questions from persons who contemplated such behavior.

[xxxvi] IRC Sec. 4941(d)(1(B).

[xxxvii] N.B., there may be situations in which a below market loan may be of a compensatory nature,, such that the recipient’s overall compensation package is not unreasonable.

[xxxviii] As I recall, Delaware’s non-stock corporation law does not include a provision similar the New York provision described immediately below.

[xxxix] N-PCL Sec. 716. The term “key person,” as used in this section,  is defined as follows: “any person, other than a director or officer, whether or not an employee of the corporation, who (i) has responsibilities, or exercises powers or influence over the corporation as a whole similar to the responsibilities, powers, or influence of directors and officers;  (ii) manages the corporation, or a segment of the corporation that represents a substantial portion of the activities, assets, income or expenses of the corporation;  or (iii) alone or with others controls or determines a substantial portion of the corporation’s capital expenditures or operating budget.” N-PCL Sec. 102(a)(25).

[xl] As burdensome as some may find New York’s N-PCL, I believe it provides an appropriate framework for those who choose to assume the quasi-public function of founding and operating a not-for-profit corporation. It generally ensures that a well-intentioned individual will not run afoul of applicable rules.

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