Picture a retired schoolteacher who became treasurer of a Silver City after-school program in July. In the draft 2025 Form 990 she finds $85,000 listed as “loans and other receivables” from officers, owed by the founder’s LLC on a note the founder signed for both sides. Nobody voted on it. Whose problem is this?
Mostly the founder’s, though not only hers. In an opinion filed September 24, 2026, the Tax Court sustained $1,327,500 in excise taxes against the president of a Tennessee charity over a $590,000 note much like this one. The taxes land on people, not the charity, and the clock behind the largest one is already running.
When is a nonprofit loan to an insider an excess benefit transaction?
The definition in 26 U.S.C. § 4958(c)(1)(A) covers any transfer from a public charity to a disqualified person worth more than what the charity gets back.
The taxes, called intermediate sanctions, reach anyone positioned to exercise substantial influence during the five years before the deal. Treas. Reg. § 53.4958-3(c) puts voting directors, presidents, executive directors and treasurers in that group automatically, along with their family members and any corporation, partnership or trust in which they hold more than 35 percent. A benefit routed through the insider’s own LLC counts as one provided indirectly (Treas. Reg. § 53.4958-4(a)(2)).
Why did the Tax Court refuse to treat the Jagannath note as a real loan?
In Jagannath v. Commissioner, T.C. Memo. 2026-92, $590,000 left the charity’s money market account on April 4, 2016. Eleven days later the president signed an interest-free note for the charity as lender and for Pingala Group, LLC, his single-member company, as borrower. Nothing was repaid. The charity’s 2016 and 2017 returns showed the $590,000 as a receivable from officers, without the required Schedule L, Part II.
At trial he dropped the loan theory, pointing instead to a December 2016 wire and a 2018 building purchase. Judge Weiler trusted the bank records and the original Forms 990 (no amended returns were offered), found no consideration, and taxed all $590,000. With real debt, the fight would have been over the value of free interest. A note the borrower approves for the lender also never reaches the rebuttable presumption of reasonableness in Treas. Reg. § 53.4958-6, which needs advance approval by an unconflicted body relying on comparable data, with minutes kept at the time.
The Tenth Circuit has said little. My search found only Farr v. Commissioner, No. 18-9002 (10th Cir. Oct. 1, 2018), unpublished, affirming both tiers against a charity head who argued, among other things, that personal charges on its account repaid her own loans.
How do the 25 percent, 200 percent and manager taxes add up?
The insider owes 25 percent of the excess benefit under § 4958(a)(1), and § 4958(b) adds 200 percent if it is not corrected within the “taxable period.” A manager who knowingly participated owes 10 percent under § 4958(a)(2), unless the participation was not willful and was due to reasonable cause, with a $20,000 ceiling per transaction (§ 4958(d)(2)). The IRS must prove the knowing part (26 U.S.C. § 7454(b)), and relying on a reasoned written professional opinion ordinarily defeats it (Treas. Reg. § 53.4958-1(d)(4)(iii)).
Jagannath ran $147,500 plus $1,180,000. Ten percent of $590,000 is $59,000, which is why the manager tax the IRS conceded before trial was exactly $20,000.
Under Treas. Reg. § 53.6011-1(b), anyone owing § 4958(a) tax also files Form 4720 for the year of the transaction, due May 15 for a calendar-year individual (§ 53.6071-1(f)). He never did, and the court sustained additions under 26 U.S.C. § 6651(a)(1) and (2). The notice’s figures, $33,187.50 and $36,875, equal 22.5 and 25 percent of the first-tier tax.
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Does repaying the loan before the IRS mails a notice of deficiency still matter?
Yes, though it is not the last chance. The taxable period ends when the IRS mails a notice of deficiency for the 25 percent tax or assesses it (§ 4958(f)(5)). Correct inside that window and the 200 percent tax never arises. If an examiner has already opened the year, get the IRS’s correction figure in writing and pay before the notice issues. Correction under Treas. Reg. § 53.4958-7 means repaying in cash, never with a new note, plus interest compounded annually at least at the applicable federal rate for the transaction month.
Section 4961(a) wipes out the 200 percent tax if correction comes within the “correction period,” which under § 4963(e) runs 90 days past the notice and stretches while a Tax Court case bars assessment. The 25 percent tax is abated under § 4962 only with correction plus reasonable cause, a hard showing for someone who signed both sides.
In February 2020 the IRS told Mr. Jagannath correction required $590,000 plus $26,215.21 of interest. The opinion never mentions § 4961. Rule 155 computations are due December 27, 2026, so no decision exists to appeal, and an appeal would go to the Sixth Circuit, where he lived. On my reading of § 4963(e), his correction period may still be open.
What would a $120,000 insider loan cost a Farmington nonprofit?
Illustration only: on November 4, 2024, the executive director of a Farmington youth-services nonprofit moves $120,000 to her solely owned LLC to close on a duplex, signing an interest-free note for both sides. The treasurer, who knows the LLC is hers, releases the wire without a board vote.
Her first-tier tax is $30,000. Left uncorrected until a notice of deficiency, the second tier adds $240,000. The 10 percent manager tax is $12,000, under the cap, and if the IRS proves knowledge she and the treasurer are jointly and severally liable for it. That makes $282,000 before additions for her missed May 15, 2025 Form 4720.
Now suppose she pays $129,792 in cash on November 4, 2026, before any notice. That is $120,000 plus two years at 4.00 percent, the November 2024 short-term rate in Rev. Rul. 2024-24, compounded annually. The $240,000 never arises; the $30,000 and any manager tax remain.
Can New Mexico law or the IRS also reach the board and the nonprofit?
The IRS can also pursue exemption, because private inurement of net earnings to insiders disqualifies a charity (Treas. Reg. § 1.501(c)(3)-1(c)(2)). Under § 1.501(c)(3)-1(f)(2) the IRS compares the benefit with the charity’s programs and then looks hard at what the board did, and correction after the IRS discovers the problem is never enough alone. Collecting the cash and adopting a conflict policy before any exam counts most. Report the transaction as an excess benefit on Schedule L, Part I, not as a loan in Part II; for an earlier year, Part IV, line 25b of the next return asks about it (see also the firm’s note on the Form 990 rewrite). What follows a revocation is in the firm’s post on 501(c)(3) revocation and section 7428.
Gross receipts tax follows the federal answer. NMSA 1978, § 7-9-29(A) exempts receipts of organizations the IRS has recognized under 501(c)(3), so an insider loan alone changes nothing, while a revocation removes the footing.
NMSA 1978, § 53-8-29 does not ban these loans or offer a disinterested-vote safe harbor; it says a director or officer “who assents to or participates in the making of any loan to a director or officer shall be personally liable to the corporation for the amount of the loan until the repayment thereof.” Whether it reaches a loan to a director’s LLC is a question for New Mexico counsel. The Charitable Solicitations Act sets a trustee’s standard of care (§ 57-22-10), puts the Form 990 in the Attorney General’s file each year (§ 57-22-6), and lets the Attorney General investigate and seek restitution (§ 57-22-9).
| Who | Exposure | Amount | How it is avoided or reduced |
|---|---|---|---|
| Disqualified person | First-tier tax, § 4958(a)(1) | 25% of excess benefit | Abated only with correction plus reasonable cause (§ 4962) |
| Disqualified person | Second-tier tax, § 4958(b) | 200% of excess benefit | Correct before the notice, or within the correction period (§ 4961) |
| Knowing organization managers | Manager tax, § 4958(a)(2) | 10%, capped at $20,000 per transaction | IRS bears the burden on knowledge; reasoned written opinion |
| The nonprofit | Revocation for inurement | Loss of 501(c)(3) and the GRT exemption | Correction and safeguards before an exam |
| New Mexico directors and officers | NMSA § 53-8-29 | Unpaid balance, owed to the nonprofit | Repayment ends the liability |
Frequently Asked Questions
Is an interest-free loan to a nonprofit director automatically an excess benefit transaction?
Not for most public charities. On my reading, a real loan is measured mainly by the forgone interest, but a note nobody expects repaid can be taxed in full, as in Jagannath. Supporting organizations are different, because § 4958(c)(3) treats any loan to a disqualified person as an excess benefit.
Who files Form 4720 for an excess benefit transaction?
The disqualified person files it personally, as does any manager who owes the 10 percent tax. A calendar-year individual’s return is due May 15 of the following year.
Can a nonprofit pay the excise tax for its executive director?
It can, but not for free. Under Treas. Reg. § 53.4958-4(b)(1)(ii)(B)(2), a charity’s payment or reimbursement of a section 4958 tax counts as compensation to the insider. If her pay was already at market, the reimbursement becomes a second excess benefit.
Does repaying the loan after the IRS opens an examination help?
Yes. Cash repayment with interest ahead of the deficiency notice prevents the 200 percent tax, and correction within the later correction period abates it. Correction made after the IRS finds the problem does not, by itself, protect exemption.
Are New Mexico board members personally liable for a loan to the executive director?
Potentially, twice over. A manager who knowingly participated owes the federal 10 percent tax, up to $20,000 per transaction. Under NMSA § 53-8-29, a director or officer who assented to or participated in a loan to a director or officer is liable to the corporation until it is repaid.
How North Star Law Firm Can Help
North Star Law Firm represents disqualified persons and organization managers in IRS examinations of Form 990 insider transactions, computes correction amounts, and contests section 4958 notices in Tax Court litigation. It also seeks penalty abatement where a missed Form 4720 had reasonable cause.
Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. If an insider note is sitting on your nonprofit’s balance sheet, contact North Star Law Firm.