Self-dealing is any transaction between a private foundation and a “disqualified person” (foundation insider), except for a few narrow exceptions.

Disqualified persons include:

  • A substantial contributor to the foundation, which is the founder of a foundation formed as a trust, or any person who has contributed in aggregate more than $5,000 to the foundation, where that amount represents more than 2% of total contributions made to that foundation since its inception, as of the close of any given year.
  • Foundation managers, which include a foundation’s officers, directors, trustees, and individuals having similar powers or responsibilities.
  • Owners of more than 20% interest of an organization that is a substantial contributor to the foundation.
  • Family members of those listed above, which include an individual’s spouse, ancestors, lineal descendants, and the spouses of his or her lineal descendants.
  • Organizations in which any of those listed above collectively hold, directly or indirectly, more than a 35% interest.

Generally, foundations and their insiders must avoid the following six activities. This is true even if the terms of transaction are favorable to the foundation.

  1. Sale, exchange, or lease of property between the private foundation and a disqualified person.
  2. Loan of money or other extension of credit between the private foundation and a disqualified person.
  3. Furnishing of goods, services, or facilities by a disqualified person to the private foundation and vice versa.
  4. Payment of compensation and/or reimbursement of expenses by the private foundation (see exception below).
  5. Use of, or any benefit from, income or assets belonging to the private foundation. This includes retaining foundation assets, such as a painting, on private premises.
  6. Agreement by the private foundation to pay a government official.

Exceptions to these rules are provided by the Internal Revenue Code for certain transactions, which include:

  • Rent-free office space provided to the foundation by the foundation’s creator.
  • Reasonable salaries for directors and officers, and reimbursement of reasonable expenses.
  • Loan of funds to the foundation at no interest.

If self-dealing occurs, the prohibited transaction must be “unwound” or corrected, and the disqualified person is subject to a 5% excise tax. This is true even if the transaction is favorable to the foundation. If the self-dealing transaction is not corrected, the self-dealer is subject to a second tier 200% excise tax.

Unlike certain other penalties assessed by the IRS, here the IRS lacks the authority to abate (forgive) the taxes imposed upon a self-dealer—even if he or she didn’t realize that the self-dealing act was prohibited.

An Ounce of Prevention…

When you become a Foundation Source client, you get more than convenience, comprehensive services, and access to private foundation experts—you also get peace of mind. Our daily involvement and active compliance monitoring of foundation transactions helps us spot potential self-dealing issues before they become problems.

Resource: 21 Terms Every Private Foundation Should Know