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Davis Brown Tax Law Blog: New IRS Standards for Qualified Management Contracts - November 20, 2014

A few weeks ago the Internal Revenue Service released a new notice with allows 501(c)(3) organizations with tax-exempt bonds greater flexibility in drafting their management agreements.  In the past, entities with outstanding tax-exempt bonds have been bound by the safe harbor rules under Revenue Procedure 97-13, which tests are basically require that a big portion of the contract be a fixed fee.  

IRS Notice 2014-67 was released late October of this year and expands Rev. Proc. 97-13 to allow for a productivity award based on quality of services rather than increases in revenues or decreases in expenses in instances where the award is a fixed fee, stated dollar amount or tiered system based solely on level of performance achieved.  

Additionally the new rules expand the safe harbor rules to add a new standard that allows compensation to be based on a stated amount, periodic fixed fee, capitation fee, per-unit fee or a combination of the preceding and may also include a percentage of gross revenues, adjusted gross revenues, or expenses (but not both). The IRS has informally commented that this standard thus allows management contracts to be based 100% on variable fees as long as those fees are not based on a net profits arrangement.  Furthermore, it allows the contract to be for a term of 5 years (including renewals), and does not require the contract to be terminable by the qualified user prior to the end of the term.

This is great news as many entities now struggle with trying to fit the management contract provisions under one of the old safe harbor procedures.  The new standard is applicable to contracts entered into, materially modified or extended, other than pursuant to a renewal option, on or after January 22, 2015 but may be applied to contracts entered into before January 22, 2015.