Disqualified Persons 

The key element in self-dealing is identifying the Foundation's "disqualified persons," who include the following categories, each of which is more specifically defined in the Internal Revenue Code:

• A "substantial contributor" to the foundation;
• A "foundation manager";
• Certain family members, corporations, partnerships, trusts, or other enterprises that are related to the foundation's substantial contributors and managers; and
• A "government official."

Definition of Self-Dealing. 

The Internal Revenue Code defines "self-dealing" generally as any direct or indirect transaction between a foundation and a disqualified person, including, but not limited to:

• Sale, exchange, or leasing of property;
• Lending of money or other extension of credit;
• Furnishing of goods, services, or facilities;
• Payment of compensation or reimbursement of expenses by a foundation to a disqualified person (but note the important exception below);
• Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a foundation; or
• Agreement by a foundation to make any payment of money or other property to a "government official", other than an agreement to employ such individual for any period after the termination of the individual's government service if the termination is within 90 days.

The Code then establishes several exceptions to the definition of self-dealing, the most important of which for many foundations is that, except in the case of a government official, the payment of reasonable and necessary compensation by a private foundation to a disqualified person is generally excluded from the definition of self-dealing.  The Code also removes no-interest loans from disqualified persons to private foundations, free office space provided by disqualified persons to private foundations, certain grants, awards, or payment of limited travel expenses to government officials, and other specified acts from the definition of self-dealing.

Application of Rules

A disqualified person may not sell property to a private foundation, even if the foundation pays substantially less than fair market value.  While a disqualified person may donate property to a private foundation, the property may generally not be subject to a mortgage or other liability.

A disqualified person may not lease office space to a foundation, even though the rent is set well below fair market value.  However, a disqualified person may provide a foundation with free office space.

A disqualified person may not lend money to a foundation unless the loan is interest-free.  Although an interest-free loan will not constitute an act of self-dealing, in some cases the lender may be forced to recognize imputed interest income from the loan due to the provisions of Code Section 7872.

A foundation engages in self-dealing when it donates funds to another charitable organization in satisfaction of a disqualified person's personal obligation.

A foundation engages in self-dealing when it purchases tickets to a fundraising dinner and the tickets are used by disqualified persons who are not foundation officials.

Penalty Taxes. 

If a foundation and a disqualified person engage in an act of self-dealing, a series of excises taxes will be applied.  An initial tax of 10% of the amount involved in the act of self-dealing is imposed upon the disqualified person who participated in the act.  It is important to note that this penalty tax may not be avoided even if the act of self-dealing was due to reasonable cause.  An additional tax of 5% of the amount involved may be imposed on the foundation's managers who participated in the act, unless the participation was not knowing or willful and was due to reasonable cause.  An additional tax of 200% is then imposed on the disqualified person if the act of self-dealing is not "corrected" within the taxable period, and an excise 50% is imposed on any foundation manager who refused to agree to part or all of the correction of the act of self-dealing.

Willful repeated violations or a willful and flagrant violation of the self-dealing rules will result in involuntary termination of the foundation's tax-exempt status and the imposition of significant additional taxes.

This article provides information of a general nature, and none of the information is intended as legal advice relative to specific matters.  You should consult with an attorney about your particular circumstances before acting on any of this information.