Private Foundation Self-Dealing

Q1: What common activities constitute self-dealing when undertaken between a private foundation and a disqualified person?

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This is part of "What Every Grantmaker Should Know & Frequently Asked Legal Questions."

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The definition of self-dealing covers a wide range of transactions that are prohibited even though they may be fair to the foundation and advantageous to all parties to the transaction. It is therefore important for private foundation managers to know who the foundation's disqualified persons are and carefully evaluate every transaction between the foundation and a disqualified person (see next question).

Common activities that a private foundation might undertake that are generally covered by the definition of self-dealing include sales, exchanges or leases of property (both real estate and personal property) between a foundation and a disqualified person, most loans, and the provision of goods, services or facilities between a disqualified person and a private foundation. These categories of activities are generally self-dealing regardless of whether the foundation is the provider or receiver in the transaction. Compensation paid to, or reimbursement expenses of, a disqualified person by a private foundation; the transfer or use of the foundation's assets or income by a disqualified person; and certain transactions with government officials also fall within the definition of self-dealing.

Q2: Who is considered a "disqualified person"?

A disqualified person is defined as:

An officer, director or trustee of the foundation (or an individual having powers or responsibilities similar to those of officers, directors or trustees of the foundation).
A substantial contributor to the foundation. A "substantial contributor" is defined as any person who contributed or bequeathed an aggregate amount of more than $5,000 to the private foundation, if such amount is more than 2 percent of the total contributions and bequests received by the foundation before the close of the taxable year in which the contribution or bequest is received by the foundation from such person. In the case of a trust, the term "substantial contributor" also means the creator of the trust.
Family members of any disqualified person. This includes spouses, ancestors, children, grandchildren, great-grandchildren and the spouses of children, grandchildren and great-grandchildren.
A corporation of which a disqualified person owns more than 35 percent of the total combined voting power.
A partnership in which a disqualified person owns more than 35 percent of the profits interest.
A trust or estate in which a disqualified person holds more than 35 percent of the beneficial interest.

It is important to note that this definition of "disqualified person" differs from the definition used for purposes of the "intermediate sanctions" rules that apply to public charities.

Q3: What are some frequently used exceptions to the definition of self-dealing?

A disqualified person (see previous question) may transfer or furnish goods, services or facilities to a private foundation without charge. Thus, a foundation can share space or office equipment with its corporate sponsor or family members or business as long as the foundation does not pay the disqualified person rent or other fees.

A foundation may also pay reasonable compensation to a disqualified person for personal services to the foundation, including reimbursement of expenses associated with the personal services. For example, a foundation can pay an accountant who serves on the foundation's board of directors for accounting services provided to the foundation.

Another exception to the self-dealing rules is that a foundation may furnish goods or facilities to a disqualified person on a basis at least as favorable as it makes the goods or services available to the general public. For example, a disqualified person may enjoy a park or museum operated by the foundation on the same basis as these facilities are available to the public.

Q4: What are the consequences if a person doesn't know that an activity he or she engages in is prohibited under the self-dealing rules?

The Internal Revenue Service may impose penalty taxes ("excise taxes") on disqualified persons who engage in self-dealing transactions, under a two-tier tax system.

First-tier taxes are imposed on disqualified persons (other than foundation managers acting only as such) who engage in the self-dealing transaction with the private foundation, whether or not they knew the activity constituted self-dealing. The amount of the first-tier tax on disqualified persons is generally 10 percent of the amount involved. By contrast, a foundation manager is subject to first-tier taxes only if he or she participated in the transaction knowing that it was self-dealing and the participation was willful and not due to reasonable cause. The amount of the first-tier tax for a foundation manager is 5 percent of the amount involved. It is worth noting that, unlike other private foundation excise taxes, the tax on self-dealing cannot be abated at the discretion of the Internal Revenue Service.

If the self-dealing act is not undone or "corrected" within a certain period of time, the IRS may impose confiscatory second-tier taxes. However, the disqualified persons will have an opportunity to correct the transaction and obtain court review of the issue before the second-tier taxes are imposed.

Q5: Can a private foundation pay its board members?

Yes, a private foundation can pay its board members reasonable compensation for their personal service as board members. A foundation can also pay board members' reasonable and necessary expenses associated with their services to the foundation.

Board compensation cannot be excessive, and should be evaluated for reasonableness based on the functions or services required and actually performed by board members; the level of skill and experience necessary for board members to fulfill their duties; and the amount of time spent by board members in fulfilling their duties. Payment of compensation to board members may cause them to lose immunity from liability under Minnesota and federal volunteer protection statutes.

For guidance on compensation for board directors and trustees, and for executives, consult the following guidance memoranda from the board of directors of the national Council on Foundations: Determining Reasonable Compensation for Foundation Directors and Trustees (PDF) and Recommended Best Practices in Determining Reasonable Executive Compensation (PDF).

Q6: Can a private foundation pay for spouse travel?

Generally, travel expenses incurred by the spouse of a foundation employee or board member are not "reasonable and necessary" expenses incurred in connection with the foundation's charitable activities. Thus, payment of such expenses by the foundation will usually constitute self-dealing (and may also be a taxable expenditure), unless the spouse is also a foundation manager or employee or independently performs necessary services on behalf of the foundation.

Under some circumstances, reimbursement of spousal travel expenses may be permissible if it is treated as compensation to the board member rather than the spouse and if it is reasonable in amount when combined with all other compensation provided to the board member.

Q7: Can a foundation satisfy a personal charitable pledge of a family member who is a disqualified person?

No. A charitable pledge is usually a binding legal obligation of the person making the pledge, and it is considered self-dealing for a foundation to make a grant or other payment to satisfy the legal obligation of a disqualified person.

Q8: Is it self-dealing for a foundation to make a grant to a charity where a family member or other disqualified person serves on the board?

Unless the grant is made by the foundation in satisfaction of an obligation of the disqualified person to the grantee, as discussed in the question above, such a grant does not constitute self-dealing. There is an exception to the definition of self-dealing for "incidental and tenuous benefits" derived by a disqualified person from a private foundation's use of its income or assets. Any public recognition or goodwill afforded to the disqualified person as a result of the foundation grant will normally be considered an incidental or tenuous benefit. However, any such grant must be made in accordance with the foundation's conflicts of interest policy and procedures.

Q9: Under what circumstances can a corporation provide office space, equipment and staff services to its corporate foundation?

A corporation can provide facilities or services to its foundation without charge. The corporation and the foundation may also share employees under a time-sharing arrangement in which each pays for its respective share of the employees' time. Finally, the corporation and its foundation may share staff services, facilities or equipment provided by a third party, whom they each pay for their respective share of the services, facilities or equipment.

Q10: Is it self-dealing for a foundation to buy tickets to a charitable fundraising event and provide them to corporate officers or staff?

Normally, it is considered self-dealing for a corporate foundation to purchase tickets to an event and then provide the tickets to corporate directors or personnel to attend the event. The corporation, as a disqualified person, is clearly prohibited from receiving a tangible economic benefit, such as tickets to the event, from the foundation. It is unclear whether all managers and employees of the corporation are also disqualified persons, but the better approach would be to have the corporation itself or the individual attendees purchase the tickets.