Private Foundations: “Disqualified Persons” Must Be Careful of the Complex Rules of Self-Dealing
“Disqualified Persons” Must Color Between the Lines
Although conflict-of-interest policies are essential for all not-for-profits, private foundations must be particularly careful about adhering to them. In general, stricter rules apply to foundations. For example, you might assume that transactions with insiders are acceptable so long as they benefit your foundation. Not true. Although such transactions might be permissible for 501(3)(c) nonprofits, they definitely aren’t for foundations. Specifically, transactions between private foundations and “disqualified persons,” such as certain insiders, are prohibited.
A wide net
The IRS casts a wide net when defining “disqualified persons.” Its definition includes substantial contributors, managers, officers, directors, trustees and people with large ownership interests in corporations or partnerships that make substantial contributions to the foundation. Their family members are disqualified, too. In addition, when a disqualified person owns more than 35% of a corporation or partnership, that business is considered disqualified.
Prohibited transactions can be hard to identify because there are many exceptions. But, in general, you should ensure that disqualified persons don’t engage in these activities with your foundation:
- Selling, exchanging or leasing property,
- Making or receiving loans,
- Extending credit,
- Providing or receiving goods, services or facilities, and
- Receiving compensation or reimbursed expenses.
Disqualified persons also shouldn’t agree to pay money or give property to government officials on your behalf.
What happens if you violate the rules? The disqualified person may be subject to an initial excise tax of 10% of the amount involved and, if the transaction isn’t corrected quickly, an additional tax of up to 200% of the amount. What’s more, an excise tax of 5% of the amount involved is imposed on a foundation manager who knowingly participates in an act of self-dealing, unless participation wasn’t willful and was due to reasonable cause. An additional tax of 50% is imposed if the manager refuses to agree to part or all of the correction of the self-dealing act.
Although liability is limited for foundation managers ($40,000 for any one act), self-dealing individuals enjoy no such limits. In some cases, private foundations that engage in self-dealing lose their tax-exempt status.
Go the extra mile
If you lead a private foundation, you must go the extra mile to avoid anything that might be perceived as self-dealing. Transactions between foundations and disqualified persons are firmly prohibited, and violating this rule can be costly. But it’s easy to get tripped up by IRS rules. So contact us to help ensure you’re coloring well within the lines.