The general definition of self-dealing is a transaction of any kind between a private foundation and a disqualified person (foundation insider) no matter how insignificant the monetary benefit. It is rare for private foundations to have legal problems, but when they do the most common reason is they run afoul of the self-dealing rules. Any business or transactional relationship involving the foundation and foundation insiders should be handled with care as it may be construed as self-dealing. Both direct and indirect transactions from a wide range of arrangements and contexts can trigger the self-dealing provisions. Foundations should be particularly vigilant with transactions with businesses that are owned and controlled by disqualified persons as the likelihood of tripping the self-dealing rules is very high. Strangely, even if a given transaction is favorable to the foundation it can still be considered self-dealing. A clear conflict-of-interest policy may help foundations navigate the unstable ground relating to self-dealing.
The IRS provides a precise definition of self-dealing as well as a lengthy discourse on certain exceptions—unfortunately, the IRS writing on the subject can be difficult to penetrate. Regardless, here is a link to the official IRS definition of self-dealing as well as a link to IRS examples of self-dealing.
Below we streamline the explanation of self-dealing to get to the core ideas—please note that this summarized description is not comprehensive.
Common Self-Dealing Transactions
The following transactions are generally considered acts of self-dealing between a foundation and a disqualified person.
- Sale, exchange, or rental of property between the private foundation and a foundation insider.
- Provision of goods, services, or facilities between the private foundation and a foundation insider.
- Lending of money or other extension of credit between the private foundation and a foundation insider.
- Compensation or payment of expenses by the private foundation to a foundation insider.
- Use of, or any benefit from, assets belonging to the private foundation by a foundation insider.
An indirect example of self-dealing:
A private foundation and the foundation’s president both contract the same investment advisor. The foundation pays investment management fees of 1% while the president pays a discounted rate of only .35%. The investment advisor allows the discounted rate because he also manages the foundation’s investments at his standard rate. This is self-dealing.
Exceptions to the Self-Dealing Rules
The Internal Revenue Code does provide for a few explicit carve-outs to the general self-dealing rules. These exceptions include:
- Free services, free physical goods, or rent-free office space provided to the foundation.
- Reasonable compensation to directors, officers and managers of the foundation.
- Reimbursement of reasonable and legitimate foundation expenses paid for out-of-pocket by a foundation insider.
- Reasonable compensation for legitimate and necessary personal services. Personal services are narrowly defined and have a pointed white collar bias. Personal services include general management, accounting services, legal services, and general banking and investing services. Non-managerial and non-white collar work are generally not considered to be personal services and therefore are likely to be in violation of self-dealing rules.
- Lending of funds to the foundation at zero interest.
Penalties for Self-Dealing
The IRS punishes self-dealing with monetary sanctions in the form of excise taxes. The first-tier penalty is a 10% excise tax of the transaction amount. If the prohibited transaction is not unwound and corrected, the excise taxes escalate in severity up to a potential 200% tax. The taxes are imposed on the self-dealer as well as the foundation managers. If the transaction is unwound in a timely manner the financial penalty can be reduced and stay at the first-tier penalty of 10%. Extreme and flagrant cases of self-dealing can also lead to the dissolution of the foundation itself. Before passing judment the IRS considers all facts and circumstances including the degree of the offense as well as any repeat allegations and controls put in place to prevent the issue.
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