How Private Foundations Get Into Trouble – Top Ten List
Article featured in Private Foundation News. Sources used from various publications by the Council of Foundation.
Private foundations are subject to more stringent tax laws and regulations than public charities. Know as the “private foundation rules”, these additional rules and regulations are often counter-intuitive. Transactions which are entirely proper for a public charity often may be illegal for a private foundation. Both family foundations and corporate foundations should keep these rules in mind to avoid legal traps.
- What is self-dealing? Transactions between the private foundation and specific insiders, known as “disqualified persons,” are prohibited. Disqualified persons who enter into self-dealing transactions are subject to personally excise taxes of 10% until the self-dealing transactions are reversed.
- Who are disqualified persons? Directors – officers – trustees – foundation managers – substantial contributors to the private foundation – family members of this list.
- What are some examples of prohibited self-dealing transactions? The foundation pays rent to a disqualified person (even below-cost rent). The foundation loans money, or furnishes goods or services to a disqualified person. The foundation pays excessive compensation to a disqualified person. A foundation trustee uses the foundation offices for meetings unrelated to a foundation business.
- What about the extension of credit between the private foundation and a disqualified person? The lending of money between a private foundation and a disqualified person is prohibited except in the case of a loan to the foundation if the loan is without interest and the proceeds are used exclusively for Section 501(c)(3) purposes.
2. Satisfying Personal or Corporation Pledges
In either the family or corporate foundation context, if a charitable grant will satisfy a legally blinding personal pledge of a disqualified person or the corporation, the grant will constitute an act of prohibited self-dealing.
- What is a pledge? A pledge is a promise to pay. It is self-dealing for the foundation to pay a legally enforceable promise to pay because that is a personal debt of the disqualified person or of the corporation.
3. Attending Fundraisers
If the private foundation receives goods and services from a charity in exchange for a grant, e.g., tickets for an event including dinner and entertainment, lunch and a national speaker, etc., the tickets cannot be used by a disqualified person except if it is part of that person’s oversight responsibility.
- What if I pay the foundation back for the cost of the dinner? Dividing the ticket value into “charitable” and “non-charitable” components doesn’t work. For the purpose of the self-dealing rule, the IRS takes the position that it is not possible to separate the price of a ticket anyway.
- What should I do with tickets received by the foundation? The safest thing to do is give them back to the organization or to another charity.
4. Hiring Family Members as Staff
A private foundation may not pay compensation to a disqualified person, nor reimburse the expenses of a disqualified person, unless two conditions are met. First, the compensation must be fore specific “personal services” which are reasonable and necessary for carrying out the foundation’s exempt purposes. Second, the amount of compensation must be reasonable and not excessive under the circumstances.
5. Board Compensation
Most private foundations do not compensate board members or trustees. There is no prohibition against it, however, so long as the fees are reasonable.
6. Paying Travel Expenses
- Can I take my family on foundation travel at the foundation’s expense? Generally, no. Paying for family travel using foundation assets is self-dealing, unless the person has legitimate foundation duties.
7. Providing Scholarships
- Are there special rules for grants to individuals? Yes. Scholarships to benefit disqualified persons are prohibited. For example, a private foundation cannot provide a scholarship for the grandchildren of the foundation’s substantial donor.
- Can we avoid these rules if we make the grant to a public charity or directly to the educational institution? Generally, yes. The foundation could grant directly to the institution and have it make the selection if the charitable class is large enough and the institution is agreeable. If the foundation does not want to limit the recipients to one institution, it also could establish a companion fund for scholarships at CICF.
8. Jeopardizing Investments and Excess Business Holdings
Private foundation trustees and managers must be attentive to rules affecting its investments. Imprudent and risky investments can result in imposition of an excise tax of 10% of the amount invested. The rules also regulate how much of a business enterprise a foundation and its disqualified people may hold.
9. International Grantmaking
- Can we make grants outside the U.S.? Private foundations can grant to non-501(c)(3) organizations outside the U.S. as long as they follow the rules for either “expenditure responsibility” or “equivalency determination”.
- What are the Expenditure Responsibility rules? 1) Pre-grant inquiry; 2) written agreement; 3) separate account; 4) regular reports; 5) reports to IRS on 990-PF.
10. Lobbying or Other Transactions with Government Officials
A private foundation may not make, or agree to make, any payment of money or transfer of property to a government official. Moreover, the Tax Code imposes punitive taxes on private foundations and their managers if the foundation engages in lobbying and requires the foundation to correct the situation. Although there are types of non-lobbying advocacy that fall outside the technical statutory definition of lobbying, foundations that wish to become involved in public policy must follow the lobbying rules established by IRS regulation.
Sources used in compiling this article: various publications by the Council on Foundation’s legal staff.
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