The 7 Deadly Sins of Self-Dealing
According to the Foundation Center, there are more than 85,000 foundations in the U.S. with $715 billion in assets and annual giving in the $50 billion range. They serve important functions across a variety of areas, including health care, social services, the environment, education and others.
During the ordinary course of business, these foundations must be careful not to engage in transactions deemed by IRC 4941 as “self-dealing.” This exists when a foundation engages in transactions with those persons who have influence over the foundation’s decision-making process. They would be considered “disqualified” from taking part in the transaction. The IRS includes in its definition of “disqualified persons” all substantial contributors to the founda¬tion, all foundation managers, and an owner of more than 20% of: (i) the total combined voting power of a corporation; (ii) the profits interest of a partnership; or (iii) the beneficial interest of a trust or unin¬corporated enterprise, which is, during the ownership, a substantial contributor to the foundation. The definition also extends to family members of any of the aforementioned individuals.
According to the IRS, there are 7 scenarios where a private foundation would be considered engaging in self-dealing. In order to avoid an audit and potential penalties, it is imperative foundations understand what these are:
- Sales or Exchanges of Property – Any sale or exchange of property between a private foundation and a disqualified person.
- Leasing – The leasing of property between a disqualified person and a private foundation.
- Loans – Lending money or extending credit between a private foundation and a disqualified person.
- Providing Goods, Services or Facilities – Such as a disqualified person providing office space or vehicles to a private foundation for a fee. Similarly, an issue could arise if the foundation is providing services or facilities that personally benefit a disqualified person such as leasing space for personal use.
- Paying Compensation – Includes payments and reimbursements by a private foundation to a disqualified person. Reasonable and necessary payments to carry out the foundation’s exempt purposes do not apply.
- Use of Foundation's Income or Assets – A private foundation’s income or assets transferred to, used by, or benefitting a disqualified person.
- Payment to a Government Official – Where the foundation agrees to pay money or property to a government official.
An indirect act of self-dealing generally occurs as a transaction between a disqualified person and an organization controlled by a private foundation. There are some transactions between a disqualified person and an organization that will not be treated as indirect, such as certain grants and revocable trusts.
There are situations where the aforementioned transactions between a private foundation and a disqualified person are not considered self-dealing. These include the lease of property by the foundation from a disqualified person for no rental payment. Additionally, a disqualified person can lend money to a foundation if there is no interest charged and there is a charitable purpose for the loan.
In addition to self-dealing scenarios, private foundations (and their business advisors) should also be well-versed on indirect self-dealing and transition exceptions when completing Form 990. Once self-dealing is identified, there are steps that a foundation can take to correct the action and this can be best achieved under the guidance of your accounting/tax professional.
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