IRS Issues Guidance on Self-Dealing Rules for Private Foundations

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Cory D. Halliburton

Cory D. Halliburton

Attorney

214.984.3658
challiburton@freemanlaw.com

Cory Halliburton serves as general counsel and business adviser to a nationwide nonprofit / tax-exempt client base, as well as for multi-state professional service companies. He is a results-oriented attorney, with executive-level strategy and an understanding of the intersection of law and business judgment. With a practical upbringing, he pushes for process-driven results in internal governance, strategy and compliance with employment law, and complex or unique contracts and business relationships.

He dedicated the first ten years of his practice to mainly commercial litigation matters in West Texas and the Dallas-Fort Worth Metroplex. During that experience, Mr. Halliburton transitioned his practice to a more general counsel role, with an emphasis on nonprofit and tax-exempt organizations, advising those organizations through formation, dissolution, litigation, governance, leadership succession, employment law, contracts, intellectual property, tax exemption issues, policy creation, mergers and other. He has served as borrower’s counsel for tax-exempt bond and loan transactions near $100 million aggregate; some with complex pre-issue construction, debt payoff and other debt financing challenges.

Mr. Halliburton also serves as outside legal and business advisor for executive professionals in multi-state engineering firms, with a focus on drafting and counsel on significant service agreements, employment law matters, and protection of trade secrets.

IRS Issues Guidance on Self-Dealing Rules for Private Foundations

On March 1, 2022, the IRS published its 128-page Exempt Organizations Technical Guide TG 58 Excise Taxes on Self-Dealing under IRC 4941. While not authoritative, the guidance addresses in great detail the definitions applicable to self-dealing transactions, specific examples of self-dealing transactions and exceptions, taxes imposed for self-dealing transactions, enforcement, examination and audit tips, and concepts around the ever-nebulous “indirect” self-dealing situations.

Below is a basic overview of the self-dealing rules that apply to private foundations and their officers, directors, and managers.

Section 4941 of the Internal Revenue Code (Title 26, the “Code”) imposes an excise tax on any direct or indirect act of self-dealing between a private foundation and a disqualified person and that is not otherwise excepted. See Treas. Reg. 53.4941(d)-1(a). It is immaterial whether the transaction results in a benefit or a detriment to the private foundation. See Treas. Reg. 53.4941(d)-1(a).

Private foundations” are those organizations that are exempt from taxation under Section 501(c)(3) and do not meet the requirements of public charity status under Section 509(a). A “disqualified person” is defined as an individual or organization related to a private foundation as a substantial contributor (or 20% owner of a substantial contributor), a foundation manager, a member of their families, or certain entities 35% owned by the foregoing. See 26 U.S.C. § 4946(a)(1) (defining “disqualified person”). For these purposes, “the family of any individual shall include only his spouse, ancestors, children, grandchildren, great grandchildren, and the spouses of children, grandchildren, and great grandchildren.” Id. at § 4946(d).

In this context, the term “foundation manager” means, with respect to any private foundation—“(1) an officer, director, or trustee of a foundation (or an individual having powers or responsibilities similar to those of officers, directors, or trustees of the foundation), and (2) with respect to any act (or failure to act), the employees of the foundation having authority or responsibility with respect to such act (or failure to act).” Id. at § 4946(b)-(b)(2).

Self-dealing transactions described under and listed in Section 4941(d) are:

26 U.S.C. § 4941(d)(1)-(d)(1)(F); Treas. Reg. 53.4941(d)-2 (listing specific acts of self-dealing).

These types of transactions are qualified by many technical and special rules and exceptions described in the Code and the Treasury Regulations. Some transactions are specifically excepted from the definition of self-dealing, and due care should be taken to ensure that any transaction that may be excepted meets the detailed qualifications required for such beneficial carve-out. See Treas. Reg. 53.4941(d)-3(a) (“In general, a transaction described in section 4941(d)(2) (B), (C), (D), (E), (F), (G), or (H) is not an act of self-dealing.”).

The excise taxes imposed by Section 4941 for engaging in an act of self-dealing are assessed against the self-dealer and, in appropriate cases, the foundation managers. Generally, a disqualified person who participates in an act of self-dealing is liable for the tax even though that person had no knowledge at the time of the act that the act constituted self-dealing. See Treas. Reg. § 53.4941(a)-1(a)(1).

If an act of self-dealing is not corrected within the taxable period, Section 4941(b) imposes additional taxes on self-dealers’ failure to correct and on participating foundation managers’ refusal to agree to correction. See 26 U.S.C. § 4941(b)-(b)(2). A tax of 200% of the amount involved is paid by the self-dealer (or self-dealers if jointly and severally liable). A tax of 50% of the amount involved is paid by any foundation manager (or managers if jointly and severally liable) who has refused to agree to part or all of the correction of the self-dealing act, subject to a $20,000 limitation. Id.

Section 4941(d) prohibits indirect and direct acts of self-dealing. Neither the Code nor the Treasury Regulations comprehensively define indirect self-dealing. Each transaction is reviewed on a case-by-case basis. One form of indirect self-dealing is a transaction between a disqualified person and an organization controlled by a private foundation. See Treas. Reg. § 53.4941(d)-1(b)(5) (defining “control” for these purposes). Basically, an act of indirect self-dealing usually involves the use of the assets or income of a private foundation and the actual or constructive benefit derived by a disqualified person.

The self-dealing rules applicable to private foundations are complex and, if not honored, can result in substantial tax liabilities to the private foundation and its officers, directors, or managers who authorize a transaction that benefits, directly or indirectly, a disqualified person. Private foundations and their managers should remain vigilant of transactions that may involve an indirect benefit to a disqualified person. A carefully-crafted policy on the subject of self-dealing is advisable for adoption and use by the private foundation and its managers.

The IRS’s recently-issued Technical Guide TG 58 Excise Taxes on Self-Dealing is a useful tool, but, as the Guide expressly states on page 1: “This document is not an official pronouncement of the law or the position of the IRS and cannot be used, cited, or relied upon as such.” Thus, the Code, the Treasury Regulations, and judicial authorities on the subject should be carefully consulted with respect to any transaction that will involve the use of income or assets of a private foundation and potential direct or indirect benefit to a disqualified person.