Private Foundation Self-Dealing
Foundation abuses that reach public notice are often related to apparent violations of federal self-dealing laws by foundation officials. Because self-dealing transactions involve individuals with influence over a foundation using charitable assets for personal gain, they can erode public trust in the field. Self-dealing transactions can also carry serious tax penalties.
Here are things all grantmakers should know about the self-dealing prohibition, which applies to private foundations (most corporate foundations, family foundations and independent foundations). For a description of tax laws barring similar transactions involving community foundations and other public charities, see Excess Benefit Transactions.
Self-dealing laws prohibit financial transactions between a private foundation and its "disqualified persons." The definition of a disqualified person includes the foundation's officers, directors, trustees, key employees, substantial contributors, their family members, corporations, partnerships, trusts or estates in which any of the foregoing has more than 35 percent of the voting power, profits or beneficial interest, and any owner of more than 20 percent of a corporation, partnership or trust that is a substantial contributor.
The definition of self-dealing is broad and includes the following transactions involving foundations and their disqualified persons: (a) sales, exchanges or leases of property; (b) loans; (c) the provision of goods, services or facilities; and (d) transfers of foundation assets. In addition, most payments to government officials -- regardless of their relationship to the foundation -- are considered self-dealing.
Self-dealing laws prohibit these transactions even though they may be fair to the foundation. It is therefore important for foundation managers to know who the foundation's disqualified persons are and carefully evaluate every transaction between the foundation and a disqualified person.
There are exceptions to the definition of self-dealing, which include the following:
- Gifts to the Foundation: A disqualified person may transfer or furnish goods, services or facilities to a private foundation without charge.
- Reasonable Compensation: A private foundation may pay reasonable compensation to a disqualified person for providing necessary professional services to the foundation. The compensation for such services must be reasonable in amount. For example, a foundation can pay an accountant who serves on the foundation's board of directors reasonable fees for accounting services provided to the foundation.
- Meals and Lodging: A private foundation may provide transportation, meals and lodging (or reimbursement for such expenses) to a disqualified person to the extent the expenses are reasonable and necessary for the foundation to conduct business.
- Comparable to Public Availability: A private foundation may furnish goods or facilities to a disqualified person on terms that are no more favorable than those on which it makes the goods or services available to the general public. For example, a disqualified person may enjoy a museum operated by the foundation on the same terms as the public.
- Incidental Benefits: Self-dealing does not include "incidental and tenuous benefits" derived by a disqualified person from a private foundation's use of its income or assets. For example, public recognition or goodwill afforded to the disqualified person as a result of a foundation grant will normally be considered an incidental or tenuous benefit.
Penalties for Self-Dealing Violations
The Internal Revenue Service may impose substantial excise (penalty) taxes on disqualified persons who engage in self-dealing transactions under a two-tier tax system. The first-tier taxes are imposed on disqualified persons who engage in the self-dealing transaction with the private foundation. The amount of the first-tier tax on disqualified persons is 10 percent of the amount involved.
In addition, a foundation manager is subject to first-tier taxes if he or she participated in a self-dealing transaction knowing that it was self-dealing, unless the participation was not willful and was due to reasonable cause. The amount of the first-tier tax for a foundation manager is 5 percent of the amount involved.
If a self-dealing transaction is not undone or "corrected" within a certain period of time, the IRS may impose confiscatory second-tier taxes of 200 percent of the amount involved on the disqualified person, and 50 percent of the amount involved on a foundation manager who refused part or all of the correction.
Self-Dealing Pitfalls to Avoid
Private foundations that violate the self-dealing rules often do so unknowingly. Here are some common self-dealing pitfalls to avoid:
- Paying for Spouse Travel: Generally, travel expenses incurred by the spouse or family member 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 constitute self-dealing (and may also be a taxable expenditure), unless (a) the spouse independently performs necessary services on behalf of the foundation, or (b) the payment is treated as compensation for services to the board member or employee, and the total compensation paid to that individual is reasonable.
- Fulfilling Personal Charitable Pledges: A foundation cannot satisfy a legally binding personal charitable pledge of a disqualified person. A pledge is treated like any other legal obligation of the disqualified person and therefore cannot be paid by the foundation.
- Buying Tickets to Fundraising Events: A private foundation cannot purchase tickets to a charitable fundraising event and then provide the tickets to disqualified persons or to third parties if doing so benefits a disqualified person. There is an exception that permits foundation managers to use the tickets if attending the event furthers their duties for the foundation. This issue arises most frequently with corporate foundations, which may wish to make tickets available to the corporation's employees or customers. Such uses of the tickets are barred by the self-dealing rules. Tickets for fundraisers should be purchased by the corporation or the individual attendees.
- Using Credit Cards: If a disqualified person uses a foundation credit card for personal expenses and later reimburses the foundation for the expenses, this is considered a loan and a form of self-dealing, even if the person reimburses the full amount within a month of the transaction.
- Paying Rent: If a foundation pays any type of rent to a disqualified person, even at below-market rates, this is considered self-dealing.
Even if a transaction is acceptable under the self-dealing rules, it may present a conflict of interest. See Conflicts of Interest.
See also Frequently Asked Legal Questions: Private Foundation Self-Dealing.