Self Dealing (IRC Section 4941)
Private foundations are prohibited from executing any financial transactions with disqualified persons. These transactions are prohibited even if they are fair and reasonable and benefit the private foundation. A notable exception exists when paying compensation to a disqualified person for personal services (see below). Disqualified persons are defined as:
- Trustees or Directors;
- Foundation managers with similar powers to officers, trustees and directors (such as an Executive Director);
- Substantial contributors (defined as those donors who contributed more than 2% of the foundation's total contributions, if the amount contributed by the donor exceeds $5,000);
- Certain family members of the preceding disqualified persons (spouse, ancestors, children, grandchildren, great grandchildren, and spouses of children, grandchildren, and great grandchildren); and,
- Corporations, partnerships, trusts, estates or unincorporated enterprises where more than 35% of the voting power (for corporations), profits interest (for partnerships), or beneficial interest (for trusts, estates and unincorporated enterprises) is owned by the disqualified persons described above.
Prohibited transactions include the following:
- Sale, exchange, leasing of property;
- Lending of money or extensions of credit; and,
- Furnishing of goods, services or facilities.
Amount of the tax:
- Excise tax of 5% of the amount involved is imposed on the foundation manager who knowingly participated in the act of self-dealing between the foundation and a disqualified person
- Excise tax of 10% of the amount involved is imposed on the disqualified person (other than a foundation manager)
- Additional excise tax of 200% of the amount involved is imposed on the disqualified person if not corrected within the taxable period, and 50% of the amount involved is imposed on the foundation manager
As noted above, private foundations are permitted to compensate disqualified persons for personal services. Such services must be "reasonable and necessary" in carrying out the exempt purposes of the foundation and the compensation provided must not be "excessive". Furthermore, compensation that meets these requirements can be counted towards the foundation's annual distribution requirements.
For more information about self-dealing, refer to the IRS Exempt Organization's CPE Text The Nature of Self-Dealing.