What is a disqualified person for private foundations?

A "disqualified person" refers to an individual or entity with close ties to a foundation, often labeled a 'foundation insider.' Defined under the Internal Revenue Code, this designation can extend beyond individuals to include various entities such as corporations, partnerships, and trusts. Disqualified persons are typically positioned to exert significant control or influence over the foundation. Due to this potential for influence, disqualified persons are generally prohibited from engaging in most financial transactions with the foundation under the self-dealing rules. These rules are in place to prevent foundations from being exploited for personal gain and to ensure they remain dedicated to their philanthropic mission.

Identifying Disqualified Persons in Private Foundations:

1. Foundation Managers: This group encompasses officers, directors, trustees, managers, and others in positions of power or responsibility within the foundation.

2. Substantial Contributors: This category includes individuals or entities that have provided significant financial support to the foundation. Specifically, it refers to those who have donated more than 2% of the foundation's total lifetime contributions, provided this amount exceeds $5,000. This category can extend to various legal entities, such as corporations, partnerships, and trusts.

3. Family Members: Relatives of a disqualified person are often also considered disqualified persons. This encompasses a disqualified person's spouse, ancestors, lineal descendants, and the spouses of those descendants. Notably, siblings of a disqualified person are not included in this category.

4. Owners of Substantial Contributor Entities: This category encompasses owners of businesses that make significant contributions to a foundation (and controllers of other entities). Such owners become disqualified persons if they exercise control over more than 20% of the voting power of the contributing business or entity. For example, if Golden Goose Enterprises, a major donor to a private foundation, falls into the disqualified person category due to its hefty charitable contributions, the individuals owning this business are similarly considered disqualified persons if they have sufficient voting power.

5. Controlled Entities: In this category, entities like corporations, partnerships, and trusts are classified as disqualified persons if they fall under the influence of other disqualified entities. Specifically, this occurs when 35% or more of their voting power or beneficial interest is controlled by disqualified persons. For example, if Richie Rich Jr. is a disqualified person due to substantial contributions to a foundation, this designation may also apply to any business he owns. If he, together with other disqualified persons, collectively hold more than 35% control of a business, that business is then also considered a disqualified person.

6. Government Officials: Certain high-ranking U.S. government officials also fall into this category based on their office or position.

Disqualified persons face restrictions under self-dealing rules, prohibiting them from participating in various financial transactions with the foundation. These transactions include, but are not limited to, selling, leasing, or lending money or property, and situations involving excess compensation. However, some interactions between the foundation and disqualified persons are permissible, as detailed in our write-up on self-dealing here.

If a disqualified person engages in self-dealing, they may face substantial excise taxes, with possible penalties extending to foundation managers who authorize such transactions. To prevent self-dealing and to maintain tax-exempt status, private foundations are advised to establish policies and procedures for identifying disqualified persons and monitoring transactions with them. Understanding and complying with these rules is vital for private foundations to maintain their tax-exempt status and to avoid penalties.

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