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.