When individuals devote time to foundation matters—whether as officers, directors, trustees, executive directors, employees, or professional service providers—they may expect to be fairly compensated for their time and effort. Unfortunately, because of a few bad actors, the issue of compensating insiders for their work on the foundation has become something of a lightning rod for controversy.
No one wants foundations to use compensation as a pretext for the transfer of tax-exempt funds to family members. Private foundations, after all, are organized expressly for charitable purposes. Federal and state laws discourage abuse, but some foundations have charter documents that prohibit compensation outright, requiring that those who serve on the foundation do so strictly as volunteers. For those foundations that do compensate insiders— and many do—attention must be paid to make sure compensation is both “reasonable and necessary.” Failure to do so could expose the foundation, and possibly the compensated individual, to federal tax penalties—not to mention humiliating press coverage and public derision.
Generally speaking, as spelled out in Section 4941, the IRS prohibits all financial transactions between a private foundation and its “disqualified persons” (insiders). All such transactions are considered self-dealing, and such violations can result in tax penalties and even the loss of the foundation’s exempt status.