By Rebekuh Eley, CPA, MST
What may seem like a simple transaction could pose a big problem for private foundations. The self-dealing rules unique to private foundations prohibit any transactions between the foundation and insiders of the organization or other disqualified persons, such as an officer, a trustee or a relative of one of those persons. Simply put, if a person has influence over the decisions of the private foundation, it’s likely that he or she is a disqualified person.
There are six types of prohibited transactions affected by these rules:
- Sale, exchange or leasing of property
- Lending of money or other extension of credit
- Furnishing of goods, services or facilities
- Payment of compensation or payment or reimbursement of expenses
- Transfer to, or use by or for the benefit of a disqualified person, any income or assets of the private foundation
- Agreement to pay a government official
The prohibited transaction rules are all-encompassing and are strictly interpreted by the Internal Revenue Service (IRS). As a result, private foundations have been surprised when they are faced with the consequences—including severe excise taxes and correction requirements—of a transaction they didn’t think was subjected to these rules.
With such broad coverage of transactions, how can organizations ensure they do not inadvertently become exposed to these rules and their potential consequences? Below are 10 common examples of how private foundations can go wrong and how they can stay on the straight and narrow to avoid penalties.
- When accepting non-cash gifts such as property, there should be no mortgage or lien on the property; otherwise it may be considered a sale from a disqualified person.
- Grants should not satisfy the pledge of the founder or other disqualified person, as that would be considered payment of an obligation or debt of the disqualified person.
- Private foundations should not advance foundation managers more than $500 for private foundation expenses that are reasonable in relation to the duties of the manager to ensure the transaction is not an act of self-dealing.
- Document any operating arrangement the private foundation has alongside the founder’s family office or corporation to ensure there are no direct or indirect benefits to the family office (such as a reduced rental rate).
- Expense payments for use of a disqualified person’s property should be made to a third-party vendor when appropriate, not directly to a disqualified person.
- Do not arrange for the foundation and a disqualified person to jointly pay for a ticket to a benefit event. Disqualified persons should only attend as representatives of the foundation if appropriate for their role and if they would not otherwise have attended the event; otherwise, the disqualified persons should pay their way in full.
- Unless there is a business reason for the spouse of a disqualified person to attend an event, the spouse should pay his or her own way.
- If a grantee provides special privileges to the foundation in exchange for its grant, adopt a conservative policy of disclaiming membership privileges, requiring that disqualified persons pay for their own memberships or pass along the privileges to employees who are not disqualified persons.
- As government officials are considered disqualified persons, avoid any payment to a government official that does not clearly qualify as one of a few exceptions, such as an employment payment after the official’s term ends.
10.Vet vendors to avoid indirect self-dealing with an entity controlled by the private foundation or by a disqualified person.
Aside from these basic preventive measures, private foundations should take steps to be well versed in complex self-dealing regulations to identify other transactions that could trigger penalties such as an excise tax. All proposed transactions with anyone who is considered a disqualified person, as well as a disqualified person’s relatives and related entities, should be carefully scrutinized prior to making any arrangement. To ensure this happens on a continuous basis, private foundations should develop and maintain policies and procedures to avoid any potential self-dealing transactions.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2016). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com