The self-dealing rules for private foundations can—and do—trip up even the most seasoned and well-intentioned funders. Do you make it a point to review the self-dealing rules each year and seek out expert advice?
The general rule is this: Certain insiders known as “disqualified persons” are prohibited from engaging in a specific list of transactions with a private foundation, unless there exists a stated exception. If you are a board member, officer, or substantial contributor to a private foundation, you, your family members, and entities controlled by you must be cautious about any financial transactions with the foundation—even if they seem like a good deal for the foundation.
We asked attorneys at Adler & Colvin what self-dealing scenarios they encounter most, and we added additional ones based on the calls we field from our member foundations. The six examples that follow highlight specific self-dealing issues and suggest how to resolve them. Other self-dealing issues can be triggered in these scenarios that are not addressed here.
A trustee encourages the foundation to move its assets to the trustee’s high-performing personal money manager. When the foundation transfers its assets, the trustee’s personal management fees are cut in half, due to the increase in total assets under management.
Why self-dealing? Foundations cannot make their income or assets available for the benefit or use of a disqualified person.
How to avoid self-dealing? Ensure the money manager understands the foundation’s assets are separate and that any fee reduction must be given to the private foundation, not the trustee.
A foundation hosts a board retreat in Florida where two board members live. The foundation pays all travel expenses for board members, including two additional hotel nights for those who want to extend their stay.
Why self-dealing? Foundations cannot make their income or assets available for the benefit or use of a disqualified person.
How to avoid self-dealing? Ensure the foundation pays only for room nights necessary to attend the board retreat. All other expenses should be paid by the disqualified person directly to the hotel rather than reimbursing the foundation, which would necessitate a loan to a disqualified person.
A foundation’s donor decides she can most effectively run the foundation from the family office, and the foundation pays the family office for space and services, including maintenance, accounting, and tax preparation.
Why self-dealing? Foundations cannot engage in the purchase, sale, lease, or exchange of property with a disqualified person, even at below market rates. In addition, foundations cannot compensate a disqualified person, except for personal services. Payments for personal services should be necessary and reasonable, covering only those services that directly benefit the foundation. Accounting and tax preparation are personal services, but compensating the family office for maintenance is self-dealing.
How to avoid self-dealing? The family office may provide space to the foundation at no cost, and the foundation may pay its portion of maintenance costs directly to the maintenance company. The foundation could draw up a compensation contract for the personal services offered.
A business owner dies and bequests the business to his children and the real estate on which the business operates to the foundation. The business then leases property from the foundation.
Why self-dealing? Foundations cannot engage in the purchase, sale, lease, or exchange of property with a disqualified person.
How to avoid self-dealing? If the business wants to continue the lease, take advantage of rules that permit assets bequeathed to a foundation to be exchanged with other assets before the assets have been distributed from the estate.
A foundation makes a grant to a local nonprofit for a film project in which a foundation board member’s son is being paid for services.
Why self-dealing? Foundations cannot make their income or assets available for the benefit or use of a disqualified person, unless for a reasonable and necessary personal service. Personal services are narrowly defined, and it is not clear if the film project services would fit the exception.
How to avoid self-dealing? The foundation may make a grant to the nonprofit, but should include a clause in the grant agreement that the grant may not be used for the film project. We recommend general operating grants to all nonprofits that employ disqualified persons, even if the services qualify as personal services.
A foundation buys iPads for each of its trustees so they can easily access the foundation’s online grants system. Trustees use the iPads an average of 10 hours per week for foundation work.
Why self-dealing? Foundations cannot make their income or assets available for the benefit or use of a disqualified person. In this case, the iPad is typically used for personal use as much or more than for foundation business.
How to avoid self-dealing? The foundation may consider the iPad compensation to the trustee and should report its cost on appropriate tax forms.
We encourage you to review the self-dealing rules annually, document the full list of disqualified persons (including entities), and create guidelines or policies for those areas you encounter regularly so as to avoid any missteps.
Get our 50-page publication How to Avoid Self-Dealing
Legal review by Ingrid Mittermaier, Adler & Colvin
This article is provided for informational purposes only and not as part of an attorney-client relationship. The information is not a substitute for expert legal, tax, or other professional advice tailored to your specific circumstances, and may not be relied upon for the purposes of avoiding any penalties that may be imposed under the Internal Revenue Code.
Senior Program Director Sara Beggs focuses her time and energy on Exponent Philanthropy’s Getting to Impact Initiative, an effort to equip philanthropists with the information and inspiration to achieve greater impact over time. Her greatest philanthropic joy is participation in Blooming Kids for Kindness, a group of ten families who encourage their children to care about their communities and recognize that each can make a difference through local and international volunteer and fundraising activities.