9 Ways Private Foundations Can Avoid the Compliance Pitfalls of Fundraisers and Galas

#1: Self-Dealing
Many foundation managers, staff and board members understand that the self-dealing rules1 generally prohibit a disqualified person2 from entering into a financial transaction with the foundation. What is often not well understood is that, with few and narrow exceptions, they forbid the flow of any tangible economic benefits from the foundation to a disqualified person. Specifically, section 4941(d)(1) lists six prohibited acts of self-dealing between a private foundation and its disqualified persons. One of these prohibited acts is the “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation” (emphasis added). When a foundation obtains tickets to an event, those tickets become assets of the foundation. Therefore, the personal use of those tickets by disqualified persons or their family members will ordinarily constitute an act of self-dealing.

If tickets are obtained for personal use by or on behalf of a disqualified person, the IRS can impose a penalty tax on the disqualified persons who engage in the act of self-dealing. The penalty, payable by the disqualified person who used the tickets (not by the foundation), will be equal to 10% of the amount involved.3 Further, the disqualified person must pay the foundation back for the ticket or otherwise correct the self-dealing violation. If the self-dealing act is not undone or “corrected” within a certain period of time known as the “taxable period,”4 the IRS may impose confiscatory second-tier taxes, currently 200% of the amount involved. Finally, the IRS may impose an additional 5% penalty on any foundation manager who “participated” in the self-dealing transaction “knowing” that the act was self-dealing.

#2: Taxable Expenditures
In addition to the prohibition on financial transactions with disqualified persons, the Code also imposes penalties on a foundation’s “taxable expenditures” (i.e., any expenditure that does not further charitable purposes5). So, even if the foundation’s use of an event ticket confers a benefit on someone who is not a disqualified person, that use may still violate the law if it does not further a charitable purpose. If the use of a ticket is a taxable expenditure, it carries a penalty, payable by the foundation, in the amount of 20% of the expenditure. In addition to the penalty, the IRS rules and regulations governing taxable expenditure violations require that the violation be corrected (which could include having the funds returned to the foundation), as is the case with self-dealing violations.

#3: The “Reasonable and Necessary” Exception
Foundation board members often have excellent reasons to attend a charity fundraising event, such as a need to monitor the use of foundation grants, interact with other donors, or meet the grantee’s board and staff so they can learn more about the charity and its programs. Sometimes, a charity desires the presence of foundation representatives because they might attract other influential donors. If the economic benefit received by the disqualified person is reasonable and necessary, and in furtherance of the foundation’s charitable purposes, using the foundation tickets is allowable. Accordingly, it will not constitute self-dealing if, for example, a board member attends an event to represent the foundation in an official capacity and to carry out work that is reasonable and necessary for fulfilling the exempt purposes of the foundation.

It is important to note that the above exception to the self-dealing rules only applies to, and tickets should only used by, foundation staff, officers, directors, and others who have an official role on the foundation and attend events for foundation purposes, not for personal reasons. Spouses or other family members who do not serve the foundation in an official capacity, and would attend the events purely for personal reasons, are not covered by this exception to the self-dealing rules and may not use foundation tickets. Because such family members likely are disqualified persons, they could be personally liable for self-dealing penalties if they were to receive the foundation’s tickets.

Want to see the rest of the list?
Check out the complete article to learn more about navigating the legal issues from the improper use of foundation tickets.

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1 Section 4941(a)(1) of the Internal Revenue Code of 1986, as amended (the “Code”), imposes a tax on each act of self-dealing between a disqualified person and a private foundation.
2 The term “disqualified person” includes directors, officers, trustees, substantial contributors, persons with a 20% or greater interest in an entity that is a substantial contributor, the family members of all such individuals, and certain entities partially or wholly owned, directly or indirectly, by disqualified persons.
3 The calculation of the “amount involved” for an act of self dealing varies depending on the type of transaction that triggered the self dealing violation. See section 4941(e)(2) of the Code and the section 53.4941(e)-1(b) of the Treasury Regulations.
4 Section 4941(e)(1) defines the taxable period as the period beginning with the date on which the act of self-dealing occurs and ending on the earliest of: (i) the date of mailing a notice of deficiency regarding the initial self-dealing tax, (ii) the date on which the initial self-dealing tax is assessed, or (iii) the date on which correction of the act of self-dealing is completed.
5 Among other transactions defined as “taxable expenditures,” section 4945(d)(5) includes within the definition “any amount paid or incurred by a private foundation for any purpose other than one specified in section 170 (c)(2)(B)”.