IRS rules governing private foundations are complex and include many exceptions, which is why your foundation needs to write and follow a detailed conflict-of-interest policy. Taking this proactive step can help you avoid potentially costly public and IRS attention.
Casting a wide net
Conflict-of-interest policies are critical for all nonprofits. But foundations are subject to stricter rules and must go the extra mile to avoid anything that might be perceived as self-dealing. Specifically, transactions between private foundations and disqualified persons are prohibited.
The IRS casts a wide net when defining “disqualified persons,” including 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.
Avoiding dangerous transactions
Prohibited transactions can be hard to identify because there are many exceptions. But your foundation should generally prohibit disqualified persons from:
- Selling, exchanging or leasing property to or from your foundation,
- Making or receiving loans or extending credit,
- Providing or receiving goods, services or facilities,
- Receiving compensation or reimbursed expenses, and
- Agreeing to pay money or property to government officials on your behalf.
Note that payment and reimbursement for services provided by disqualified persons isn’t considered self-dealing if such payments are reasonable and necessary.
You also must be careful to prevent indirect self-dealing. This refers to a transaction involving a disqualified person and third-party organization controlled by your foundation.
Facing the consequences
What happens if you violate the rules? Your foundation’s manager and the disqualified person may initially be subject to an excise tax (5% or 10%, respectively) of the amount involved and an additional tax of up to 200% of the amount, if the transaction isn’t corrected quickly. 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.
Private foundations that run afoul of the IRS usually have good intentions. You may assume, for example, that transactions with insiders are acceptable so long as they’re fair or benefit your foundation. Unfortunately, this isn’t the case. Most activities defined by the IRS as self-dealing — regardless of whom or what they reward — are off limits.
Asking the experts
Given the far-reaching nature of self-dealing prohibitions, expert advice is essential. If you’re unsure about whether a transaction might violate IRS rules, please contact us.
BPM for Nonprofits
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Nonprofit services group, one of BPM’s most established practice groups, consists of over sixty professionals across our tax, assurance and consulting practices. One of our founding goals was to make a difference in the manner nonprofits were served by our profession. Each member of our group brings differing expertise from our tax, audit, consulting and accounting departments - together we provide a comprehensive understanding of the functions needed to operate a nonprofit organization. For more information, contact Daniel Figueredo at (415) 288-6284, Nathan Farris at (925) 296-1014 or Shannon Silverman at (408) 961-6308.