May 12, 2014
Authored by: Keith Kehrer
With research and drafting assistance provided by our extern from Washington University School of Law, Rachael Lynch.
Now that we’ve scared you with the potentially high taxes for self-dealing in private foundations, what is self dealing?
Self dealing includes any of the following transactions:
1. sale or exchange, or leasing, of property between a private foundation and a disqualified person (click here for a definition of a disqualified person);
2. lending of money or other extension of credit between a private foundation and a disqualified person;
3. furnishing of goods, services, or facilities between a private foundation and a disqualified person;
4. payment of compensation by a foundation to a disqualified person;
5. transfer of income or assets of a private foundation to a disqualified person; and
6. agreement by a private foundation to make any payment to a government official (other than an agreement to hire the official when their government service ends if the service is scheduled to end within 90 days).
There are some exceptions to the rigid definition of self dealing. A disqualified person may
- Lend money to a foundation without interest or other charge, or
- Furnish the foundation with goods, services, or facilities without charge, if the proceeds or goods are used exclusively for charitable purposes.
- Pay compensation (not excessive) to a disqualified person for personal services which are reasonably necessary to carryout out the charitable purpose of the foundation.
Internal Revenue Code section 4941 imposes an excise tax on acts of self-dealing between disqualified persons and private foundations. The disqualified person is subject to a tax of 10% of the amount involved with respect to each act of self-dealing for each year (or part year) in the taxable period. The taxable period begins on the date of the self-dealing transaction and ends on the earliest of:
- The date of notice of deficiency,
- The date the 10% tax is assessed, or
- The date a correction is completed.
The foundation manager is also subject to a tax of 5% for each year in the taxable period (up to $20,000) if the manager knew that the act constituted self-dealing, unless the manager’s participation was not willful and was due to reasonable cause.
If the self-dealing is not corrected within the taxable period, a second tax equal to 200% (no, that’s not a typo) will be imposed on the disqualified person who participated in the act of self-dealing. The foundation manager is also subject to a second tax of 50% (again, not to exceed $20,000) if the manager refuses to agree to all or part of the correction.
If more than one person participates in the act of self-dealing, they will be jointly and severally liable for the tax (meaning, if one person doesn’t pay his or her tax, the others will have to pay it).