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Initial Contract Exception - Intermediate Sanctions

Section 4958 does not apply to any fixed payments made by an organization to a disqualified person pursuant to an initial contract.  An initial contract is a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately before entering into the contract.  A fixed payment is an amount of cash or other property specified in the contract, or determined by a fixed formula specified in the contract, that is paid or transferred in exchange for the provision of specified services or property.  A fixed formula may, in general, incorporate an amount that depends upon future specified events or contingencies, as long as no one has discretion when calculating the amount of a payment or deciding whether to make a payment.

A binding written contract providing that it may be terminated or cancelled by the applicable tax-exempt organization without the other party’s consent and without substantial penalty, is treated as a new contract, as of the earliest date that any termination or cancellation would be effective.  Also, a contract in which there is a material change, which includes an extension or renewal of the contract (except as the result of an option), or a more than incidental change to the amount payable under the contract, is treated as a new contract as of the effective date of the material change.  Treatment as a new contract may cause the contract to fall outside the initial contract exception, and it thus would be tested under the fair market value standards of section 4958.

Page Last Reviewed or Updated: 22-Apr-2014