Of all the rules and regulations private foundations are subject to, those addressing self-dealing may be the most complex. Violating those self-dealing rules can result in substantial tax consequences. While publicly supported organizations can engage in transactions with persons related to the organization, as long as certain rules and guidance are followed, private foundations are prohibited from engaging in any transactions with disqualified persons.
In order to be considered a disqualified person the individual must either be; a substantial contributor or a foundation manager. Certain individuals who own an entity that is considered to be a substantial contributor are also considered disqualified persons, as are family members of substantial contributors or foundation managers.
In order for an act of self-dealing to occur, there must be a direct or indirect transaction between a private foundation and a disqualified person. Indirect transactions can occur when the foundation engages in a business deal with an entity that is owned 20% or more by a disqualified person. Examples of self-dealing include:
- Selling, exchanging, 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 foundation’s income or assets to, or allowing their use by, a disqualified person
An excise tax is imposed on self-dealing transactions. The taxes imposed on these types of transactions can be substantial and it is possible for one transaction to result in multiple acts of self-dealing. For example, if a foundation lends money to a foundation manager then there will be tax assessed in the year the loan was entered into, and in every year thereafter until the act is corrected.
There are some exceptions to the self-dealing rule, one being compensation to a disqualified person for personal professional services necessary to carrying out the foundation’s exempt purpose, as long as the compensation paid is not excessive. Typically this is seen when a foundation manager is paid a fee for managing the exempt activities of the foundation and/or overseeing the grant-making process. Other exceptions to the self-dealing rule include:
- Transactions that result in an individual being classified as a disqualified person
- Transactions with former disqualified persons (i.e. previous foundation managers who were not otherwise disqualified persons)
- Interest free loans made to a private foundation by a disqualified person, as long as no other charges are incurred and the proceeds are used exclusively for the foundation’s exempt purpose
- Incidental benefits to a disqualified person
For questions or additional guidance, please contact your HBK Advisor or a member of the HBK Non-Profit Solutions Group.