Private foundations may be used to accomplish a number of philanthropic goals such as charitable giving, creating a legacy for a family name, and estate planning. However, when private foundations and their managers make distributions, they need to consider some common practices that have generated confusion over the years. This article deals with three specific areas of self-dealing: payment of personal pledges, compensation to employees and board members, and paying or reimbursing expenses of disqualified persons or family members.
To begin, self-dealing may be broadly defined as any financial transaction between a private foundation and a disqualified person. A disqualified person includes a manager, trustee, officer, or substantial contributor with respect to the private foundation. In addition, friends or family of the aforementioned disqualified persons along with employees, suppliers, customers, or other business associates of for-profit businesses owned more than 35 percent by these disqualified persons may also be considered themselves disqualified persons by attribution.
Payment of personal pledges
A private foundation may make grants to specific charities or receive requests from charities for grants. The criteria used by the private foundation will determine which charities will receive grants. Typically, the criteria will be determined by the person or entity which established the private foundation and incorporated into the organizational documents of the private foundation. When pledges are made to specific charities, these can be considered legal obligations of the taxpayer that makes the pledge; therefore, the taxpayer who makes the pledge must be the same person who fulfills the pledge. It may be considered an act of self-dealing for a disqualified person of a private foundation to make a pledge as an individual to a charity and subsequently fulfill that pledge with assets from the private foundation. If the disqualified person wants the private foundation to support a specific charity, it is imperative the appropriate steps are followed to make the private foundation the taxpayer that makes the pledge to the charity.
Compensation to employees and board members
Just as any organization is allowed to compensate its employees, a private foundation is also allowed to provide compensation which is reasonable and necessary for the performance of personal services by disqualified persons. Although specific dollar amounts or percentages are not provided by the IRS, a comparison of compensation for a similar position in another not-for-profit entity or consulting available reference sources which provide this information would be useful guidelines. The service provided must also be necessary to fulfill the charitable purpose of the private foundation. In general, personal services are defined to include general banking services, accounting services, investment management, and legal services. Compensation may be paid to family members or other disqualified person as long as all the above criteria are met.
Payment of reimbursement of expenses of disqualified persons or family members
Finally, the payment or reimbursement of expenses by a private foundation to a disqualified person must be carefully evaluated before the reimbursement takes place. The main consideration in these situations is to determine if the expense was reasonable and necessary for the charitable purpose of the private foundation. One common pitfall in this area is when a board member or other disqualified person is required to travel to further the private foundation’s tax-exempt mission and the private foundation pays the travel expenses of the board member’s or disqualified person’s spouse or significant other. This reimbursement of the spouse’s expense may be considered an act of self-dealing unless one of the exceptions is met. The exceptions to this rule include instances when the spouse is performing duties of the private foundation or the expense of the travel for a family member is considered compensation to the board member or disqualified person and the compensation meets the aforementioned compensation criteria.
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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.