While both exempt under IRC Section 501(c)(3), private foundations have several restrictions that do not apply to public charities. One major restriction is the self-dealing rules.
Private foundations are prohibited to engage in acts of direct or indirect self-dealing with disqualified persons. There are six specific acts of self-dealing between a private foundation and a disqualified person:
- Selling, exchange, or leasing of property
- Lending money or extending credit
- Furnishing goods, services, or facilities
- Paying compensation (or reimbursing expenses) to a disqualified person
- Transferring a private foundation’s income or assets to (or allowing their use by) a disqualified person
- Agreement by a private foundation to pay money or other property to a government official
While there are some exceptions to these acts, most notably relating to reasonable compensation, they are generally prohibited. There are also substantial excise taxes imposed for acts of self-dealing. A first-tier tax of 10 percent of the transaction amount is assessed on the disqualified person involved in the act of self-dealing. A 5 percent tax can also be imposed on any foundation manager that knowingly participates in the self-dealing act, up to a maximum of $200,000. However, if the act is not corrected, a second-tier tax is imposed. This is an additional 200% tax on the disqualified person and an additional 50% tax on any foundation manager.
Knowing who your foundation’s disqualified persons are is key to avoiding the excise tax. Disqualified persons are:
- Substantial contributors – any person or entity that has contributed more than 2 percent of the total contributions received by the private foundation since inception
- Foundation managers – officers, director or trustee of the private foundation
- The owner of more than 20 percent of any entity that is a substantial contributor
- Family members of any person listed in 1-3 – includes spouses, ancestors, descendants, and spouses of descendants
- A corporation, partnership, trust or estate in which any person included in 1-4 owns more than 35 percent
- A government official
One of the most common, but often overlooked, acts of self-dealing is sponsoring an event where the foundation receives seats, a table or other goods for an event as part of the donation. Allowing a disqualified person to go to the event is generally considered providing goods to that person and is an act of self-dealing. While it may seem like a good idea to merely have the disqualified person reimburse the private foundation for the seat, table, or goods, it actually creates a second act of self-dealing as the foundation has then extended credit to the disqualified person. There are some very limited exceptions; however, a best practice would be to have a thorough understanding of the self-dealing rules and how they apply to your situation before you partake in any transaction of this nature.
If you have any questions regarding self-dealing, disqualified persons, or any other issue affecting your Not-for-Profit organization, please contact your Blue & Co. advisor.