Thursday April 25, 2024

7.2.2 Self-Dealing

Self-Dealing

Disqualified Person:  A disqualified person, for purposes of applying self-dealing rules, is a substantial contributor to the foundation.

Penalty for Self-Dealing:  Self-dealing transactions are penalized by an excise tax imposed upon the disqualified person that engages in the self-dealing transaction with the private foundation.

Exceptions to Self-Dealing Penalty:  There are a number of exceptions to the self-dealing rules.
Nearly all direct or indirect transactions between a private foundation and a disqualified person are prohibited as an act of self-dealing. Sec. 4941. Self-dealing most often occurs in the form of the following types of transactions between a private foundation and disqualified person:

  1. the sale or exchange of property;


  2. leasing of property (unless from a disqualified person to a private foundation without charge);


  3. lending of money (unless by disqualified person to a foundation if the loan is without interest and the loan proceeds are used exclusively for charitable purposes);


  4. furnishing of goods, services or facilities (other than (i) furnishing goods, services or facilities without charge and (ii) if from the foundation to disqualified person, on a basis no more favorable than made available to the general public);


  5. payment of compensation or reimbursement of expenses (other than reasonable salary);


  6. transfer or use of assets or income of the foundation by or for the benefit of a disqualified person (e.g., satisfaction of charitable pledges or purchase of tickets and tables at charitable functions).


Reg. 53.4941(d)-2, Reg. 53.4941(d)-3.

The absolute prohibition on self-dealing, with the limited carve outs noted above - such as payment of a reasonable salary from a private foundation to a disqualified person - applies even if the transaction between the private foundation and disqualified person is reasonable and at arms-length.

Disqualified Person
A disqualified person, for purposes of applying self-dealing rules, is a substantial contributor to the foundation, a foundation manager, a lineal descendant, children, grandchildren and spouses of a disqualified person, and certain entities that have an interest in a disqualified person or are owned by a disqualified person. Sec. 4946. Whether a person is in a position to exercise substantial influence is determined by the facts and circumstances of the situation. Reg. 53.4946-1.

Penalty for Self-Dealing
Self-dealing transactions are penalized by an excise tax imposed upon the disqualified person that engages in the self-dealing transaction with the private foundation and, in some cases, upon managers of the private foundation (such as officers, directors or trustees) who knowingly participate in the self-dealing transaction. The excise tax is calculated based upon the amount involved in the transaction. The initial excise tax imposed upon the disqualified person is 10% of the amount involved and the initial excise tax imposed upon a manager of the private foundation who knowingly participated is 5% with a maximum of $20,000 per person. If the self-dealing transaction is not subsequently corrected, or undone to the extent possible, an excise tax of 200% of the amount of the excess benefit is imposed upon the participating disqualified person and an excise tax of 50% with a maximum of $20,000 per person is imposed upon foundation managers who knowingly participated. Sec. 4941, Reg. 53.4941(b)-1.

Example 7.2.2A Self-Dealing for Foundation to Satisfy Personal Pledge

Donor pledged to pay his favorite Charity $1,000,000 per year for the next five years. When Donor's first payment was due, he directed his private foundation to write a $1,000,000 check and send it to Charity in satisfaction of his first year pledge obligation. The Trustee of Donor's private foundation did not write the check to Charity and told Donor that he had to use his own money, rather than money previously contributed to his private foundation, to satisfy the pledge. Donor did not understand why Trustee refused to make the payment. Trustee explained that a private foundation engages in prohibited self-dealing if it makes a payment to satisfy the pledge of a disqualified person - such as a substantial contributor to the foundation like Donor. Reg. 53.4941(d)-2(f)(1).

Exceptions to Self-Dealing Penalty
There are a number of exceptions to the self-dealing rules. For example, a disqualified person may lease property to a private foundation without engaging in an act of self-dealing. The self-dealing rules do not apply to an interest-free loan made by a disqualified person to a private foundation used for exclusively charitable purposes. Goods and services furnished free of charge by a disqualified person to a private foundation for an exclusively charitable purpose will also not constitute self-dealing.

The private foundation may furnish goods or services to a disqualified person on the same basis that such goods and services are made available to the general public and not run up against the self-dealing rules. Reasonable and necessary compensation by a private foundation to a disqualified person is also not self-dealing. Any incidental benefit received by a disqualified person from a private foundation's act will not in and of itself disqualify the transaction as self-dealing.

Example 7.2.2B

Charity A awards scholarships to all students at Hemphill high school with a 3.8 GPA. Trustee of Charity A's daughter has a 3.9 average and automatically qualifies for a scholarship. Trustee A is a disqualified person who receives an incidental benefit by virtue of his daughter qualifying for a scholarship. This incidental benefit will not in and of itself disqualify the transaction as a self-dealing transaction.

Case Studies on Self-Dealing

Lucky Lucy Lindstrom's "No Self-Dealing" Charity:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. Lucy had invested $1,000,000 in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 in stock to a charitable foundation to help those in need.

Lucy discussed several options with her attorney and her favorite charity. One of the options that Lucy was very interested in was a private foundation (PF). She asked her attorney for reasons to select a private foundation. Her attorney noted that private foundations are more expensive to operate, appreciated gifts are deductible only to 20% of AGI, deductions for gifts of real estate to a PF are limited to basis, there is usually a 2% excise tax on investment income and the PF is subject to various rules on self-dealing, minimum distributions and excess business holdings. However, a private foundation would give Lucy full control.

Private Letter Rulings

PLR 200005027 Non-Prorata Distribution To Private Foundation Approved:   A passed away and his wife B and children are beneficiaries to his estate. In addition, a portion of the estate is intended to be transferred to a family private foundation.

PLR 200007039 Incidental Exception to Self-Dealing For Compensation:   A private foundation is currently operated by children and grandchildren of the founder. Previously, the private foundation did not pay compensation to the family, even though they served as directors of the foundation and as grant managers. However, the endowment has now grown sevenfold, and the family desires to receive compensation. The compensation is deemed necessary, since the responsibilities for both management and grant-making have increased also.

PLR 200111051 Corporate Pledge of Stock Options to PF is not Self-Dealing:   Corporation C recently pledged to Private Foundation X an option to purchase shares of its common stock. C's business purpose for the pledge is to further the charitable purposes of X and other charitable organizations. The options pledged are transferable by X only to charities described in Sections 170(c) and 501(c)(3). However, these charities must not be related to X or be controlled by a disqualified person under Sec. 4946. Of importance is the fact that C is a substantial contributor to X and therefore is a disqualified person with respect to X.

TAM 200114035 Disqualified Person Avoids Self-Dealing Penalties by Invoking Statute of Limitations:   D is a disqualified person with respect to Private Foundation (PF) under Sec. 4946. Based on the recommendation of D, trustees of PF elected to make an unrestricted grant to Public Charity (PC). D is not a trustee of PF nor does he have any grant-making authority. Once the grant was made, PC used the funds to repay a debt owed to X organization.

PLR 200129041 PF Grant May Benefit Disqualified Persons However No Self-Dealing Found:   PF wishes to make a grant to a community trust, which is exempt under 501(c)(3), for the construction and expansion of a public library. The library project involves purchasing buildings and land in the surrounding area. In particular, land is needed for the new library and parking garage structure. However, X and Y, both disqualified persons with respect to PF under Sec. 4946, have property interests in the area where the library and parking garage will be constructed.

PLR 200132037 No Self-Dealing When PF and Heirs Enter Into Settlement Agreement:   Taxpayer created during his life Private Foundation ("PF"), whose purpose was to make educational grants to students pursuing graduate studies overseas. Taxpayer planned to further fund PF at his death with assets from his estate. Taxpayer's estate consisted primarily of shares of stock in a publicly traded corporation and a personal holding company, which owned shares of stock in the same corporation.

PLR 200134033 No Self-Dealing Where Estate Makes Loan to Executor's Employer:   Taxpayer created a testamentary Charitable Remainder Trust (CRT), which at his death would be funded with the residue of his estate. Taxpayer passed away, and, according to his instructions, Taxpayer's wife, W, was named co-executor of his estate and co-trustee of his CRT.

PLR 200135047 Trustee Fees Charged to Charitable Trust Are Not Self-Dealing:   B is a charitable trust and a private foundation. B supports and promotes the arts by making grants to public charities, private operating foundations, and other 501(c)(3) organizations. The grants are made at the discretion of B's trustees.

PLR 200217056 Private Foundations Payment for Financial Services Not Self-Dealing:   Private Foundation (PF) provides assistance to people with respect to financial, personal and family matters. PF established N, a support office, to help PF accomplish its exempt purposes. Specifically, N provides financial services to PF.

PLR 200219038 Termination of Trusts with Remainder to Charity Not Self-Dealing:   X is a private foundation, which was funded by Donor. Afterwards, two of Donor's sisters created testamentary trusts with income to E and F (the children of Donor) and remainder to X. Both testamentary trusts provided for income and principal distributions to E and F pursuant to the sole discretion of the trustees.

PLR 200225045 Early Termination of CLAT is Not an Act of Self-Dealing:   Taxpayer created a charitable lead annuity trust pursuant to Sec. 4947(a)(2). The CLAT term was 12 years and 9 months and had a 12% annuity payout. For the duration of the trust, C, a private foundation, was the sole charitable income beneficiary.

PLR 200232036 Foundation May Own and Pay Premiums on Life Insurance Policy Contributed by Donor:   Donor created a private foundation and an irrevocable trust during his life. Donor now wishes to have his trust transfer a term life insurance policy to his foundation. The term life insurance policy requires annual premiums, is convertible into a whole life policy, has no cash value and is not subject to a policy loan. Because the policy has no cash value, no one can possibly borrow against it.

PLR 200247051 Foundation's Matching Gift Program Will Not Result in Self-Dealing:   Big Company is a public utility that provides electricity to citizens of State. As a benefit to its employees, officers, directors and retirees, Big Company offers an educational matching gifts program. Specifically, Big Company will match gifts made to accredited educational institutions. To qualify, the educational institutions must be Section 501(c)(3) public charities.

PLR 200315031 Son's Disqualified LLC May Provide Property Management Services to Foundation:   Mayflower is a private foundation that was created by Husband, Wife and Son. Son also created Oasis Property Management (Oasis), a limited liability company which provides full-service, real estate management services to its clients. Typical services include property management, billing and collection of rent, leasing activity and negotiations, risk management and supervision of outside professionals and contractors.

PLR 200319009 Grant to Charity and Simultaneous Lease to DQ Person Not Indirect Self-Dealing:   Private Foundation (PF) supports Christian missionary activities and awards scholarship grants. Public Charity (PC) operates a training facility for pastors and preserves an historic home. PF wishes to make annual grants to PC. During this time of grant making, PC desires to lease property from LLC at the fair market rental value. The property includes an historic home and a training facility for pastors. However, LLC is a disqualified person with respect to PF. Specifically, LLC's owners are substantial contributors to PF.

PLR 200324056 Foundation May Reimburse Its Conference Participants' Travel Expenses:   The Teach Democracy Foundation is a private foundation that encourages the study, teaching and research of the fundamental principles of democracy. To accomplish its purpose, the foundation supports programs and activities that will result in an increased understanding of the benefits of individual freedom and civic responsibility. For example, the foundation achieves its charitable purpose by granting scholarships to students who are interested in the areas of law, history and political science.

PLR 200429016 Foundation's Sale of Partnership Interest Not Self-Dealing:   Private Foundation's (PF) primary assets consist of an interest in Partnership 1, an interest in Partnership 2 and various publicly traded stocks and bonds. PF wants to sell its interest in Partnership 1 because the sale will provide PF with greater liquidity. In particular, the greater liquidity would allow PF to more effectively meet its charitable goals and purposes.

PLR 200432026 No Self-Dealing When Foundation Pays Service's PLR User Fee:   At the death of Donor, Foundation received apartment buildings and three partnership interests. The three partnerships owned apartment buildings as well. Foundation and two of the partnerships wanted to borrow against their respective property from an independent lender. The loans would be approximately 60% of each property's fair market value.

PLR 200433028 Foundation May Compensate Disqualified Person If Services Reasonable and Necessary:   Foundation was funded primarily with publicly traded stock in a national bank. After the gift of the bank stock, 90% of Foundation's assets consisted of the bank stock. However, Foundation owned less than 1% of the outstanding stock in the bank.

PLR 200501021 Incidental Self-Dealing Exception for Investment Trustee:   When Mary Donor passed away, her estate assets flowed into her existing private foundation. During life, she had held the roles of both administrative trustee and investment trustee. When she passed away, four individuals became administrative trustee and a financial services entity(A) became the investment trustee.

PLR 200517031 Private Foundations May Create Real Estate:   Donor has created a private foundation M. Since Donor is a very successful real estate developer, he would like his private foundation to create an LLC to purchase land and then lease land to a second LLC to develop the property. His intent is for his private foundation M to use cash to purchase the land and then to lease it on a fixed payment lease to the Development LLC.

PLR 200521028 Redemption Qualifies for Self-Dealing Exception:   Private Foundation owns stock of C corporation. C corporation wishes to redeem Private Foundation's shares of C corporation stock. However, Private Foundation and other disqualified persons effectively control C corporation. Thus, C corporation requests a ruling that the redemption of Private Foundation's stock will not be an act of self-dealing under Sec. 4941. Self-dealing includes any direct or indirect sale of property between a private foundation and a disqualified person.

PLR 200530007 Pledge of Corporate Stock Option Not Self-Dealing:   Corporation, a major contributor to Private Foundation, planned to make a gift of stock options to Private Foundation. Corporation and Private Foundation separately requested private letter rulings that the gift of options would not violate the self-dealing rules of Sec. 4941, that the exercise of the options would not constitute self-dealing and that the gain on the exercise by Private Foundation would not result in unrelated business income tax (UBIT).

PLR 200530008 Corporation's Stock Option Pledge to Foundation Not Self-Dealing:   Corporation is a for-profit corporation traded on the New York Stock Exchange (NYSE). Foundation is a tax-exempt private organization founded to provide a vehicle for Corporation's charitable giving. As such, Corporation is a disqualified person with respect to the Foundation under Sec. 4946(a).

PLR 200532053 Sale of Land to Grandchild of Private Foundation Creator not Self-Dealing:   Beatrice Benefactor established a private foundation during her life. At her death, the private foundation was to receive the residue of her living trust. At Beatrice's death, the living trust held parcels of real estate, which according to the trust document, would be distributed to the private foundation.

PLR 200532057 Sale of Land Will Not Affect Tax-Exempt Status:   Magnanimous (M), a tax-exempt religious organization owned two parcels of land. Parcel one contained M's worship buildings, a house, recreation facilities and offices. The second parcel, consisting of two single-family homes, was M's original facilities, which were no longer used.

PLR 200542037 Foundation's Payments to Board Member Not Self-Dealing:   K is a private foundation classified under Sec. 509(a) of the Code. M is a publicly elected district court judge who receives annual compensation in excess of $20,000. M has served as an officer and director of K for eight years and receives compensation for his services.

PLR 200620029 Financial Return to Trustee of Private Foundation is not Self-Dealing:   B is a for-profit bank and serves as the trustee of P, a private foundation. B invested a small portion of P's assets in two accounts managed by B. B charged P a reasonable fee for the investment services on the two Y accounts. B subsequently sold the Y account division to C, a separate for-profit bank.

PLR 200628038 No Self-Dealing When Foundation Engages in Real Estate Sale:   E, the estate of Decedent, proposed to sell land to D, the son of Decedent. Decedent was the founder of Private Foundation. Private Foundation was left the property in Decedent's will.

PLR 200637041 Private Foundation's Real Estate Holdings Permitted:   A was formed as a private foundation as described in Sec. 509(a). A will hold a real estate portfolio consisting of commercial and residential rental properties.

PLR 200649030 Foundation's Purchase of Insurance For Managers Not Self-Dealing:   Z created Foundation and subsequently passed away. Z's will created a number of charitable remainder trusts naming his family as the income recipients and Foundation as the remainder beneficiary. Each CRT had three co-trustees, which Foundation appointed. After several of the original trustees resigned, Foundation decided to acquire error and omission (E&O) insurance and other coverage to indemnify the trustees from suits filed by the income beneficiaries.

PLR 200715014 Reorganization of Private Foundation Not Self-Dealing or Subject to Tax:   M is a private foundation (PF). M was established to provide support for "religious and charitable, scientific or literary education purposes." Many years into M's existence, the directors disagreed on how to use M's required expenditures and how best to manage M's affairs.

PLR 200802032 Cashing Out Charitable Remainder Trust Not Self-Dealing:   M's will directed the creation of a charitable remainder annuity trust (CRAT). The CRAT was to be funded with all of M's assets less her personal property. M's daughter, D, was to receive a 6% income interest for he life from CRAT with the remainder passing to two public charities, C1 and C2.

PLR 200806015 Asset Transfer Not Self-Dealing:   A and B are both 501(c)(3) organizations classified as private foundations under 509(a) that are controlled by the same directors/trustees. A intends to transfer real estate partnership interests to B worth approximately 25% of A's net assets for no consideration.

PLR 200809044 Early Termination of NICRUT Not Self-Dealing:   B and C are equal partners in N, a family limited partnership (FLP). N created a net income only charitable remainder unitrust (NICRUT) on date X. On date Y, N decided to terminate the NICRUT by selling its income interest back to the listed charitable remainder beneficiary.

PLR 200811003 Judicial Reformation of Trust is Not Self-Dealing:   A and B created a trust with the intent that it qualify as a fixed percentage irrevocable charitable remainder trust (CRUT) under Sec. 664(d)(2). The trust paid income to A and B with remainder to Charity. The trust first paragraph described a fixed percentage CRUT, but a scrivener's error stated the trust's payout as a net income makeup charitable remainder trust (NIMCRUT) instead of a fixed percentage (standard) CRUT.

PLR 200816032 Early Termination Not Self-Dealing; No Termination Tax:   A and B established C, a charitable remainder unitrust as described in Sec. 664(d)3) of the Code. C was created as a net income plus makeup unitrust (NIMCRUT) to pay A and B the lesser of net income or 10% of the trust's net fair market value, with the possibility for recouping lost payments in future years.

PLR 200817039 Early Termination of CRT Not Self-Dealing:   B and C established A, a charitable remainder unitrust under Sec. 664(d)(3). B and C served as trustee of A and D served as an independent special trustee. D resigned and an appointment of a successor was not required under the trust terms.

PLR 200833012 Early CRT Termination Not Self-Dealing:   A created a charitable remainder unitrust (Trust) naming A and A's spouse, B, as income beneficiaries. The trust was established as a net income plus makeup trust and the trustee was directed to make lifetime payments to the beneficiaries at the lesser of trust net income or a percent of the net fair market value of trust assets as valued annually.

PLR 200841040 Termination of CRUT Not Self-Dealing:   Grantor created Trust on Date X, a grantor trust upon which Grantor paid the tax each year. At Grantor's death, Trust was split into CRUT A and CRUT B, charitable remainder unitrusts within the meaning of Reg. 1.664-4. CRUT A was to pay 5% of its net income as determined annually to A for life and then to B if then living.

PLR 201206019 Sale of Building, Transfer of Note not Self-Dealing:   W was a substantial contributor to Private Foundation (PF). She left a gift to PF in her will of $5 million, less the asset value of PF. The remaining assets of W's estate include cash, promissory notes, a home and an office building.
PLR 201221031 Payments Not Self-Dealing:   Foundation is a private, non-operating foundation formed to receive charitable contributions and to use them for charitable, educational, religious, scientific and literary purposes. Foundation proposes to hire Company to manage its investments and to provide tax and other professional financial services.
PLR 201243015 IRS Rules on Foundation's Proposed Transfer of Property:   Foundation was organized as a Sec. 501(c)(3) organization and classified as a private foundation under Sec. 509(a). Foundation's charitable purpose was to receive and administer funds for religious, charitable, scientific and educational purposes.

PLR 201301015 Foundation's Lease of Parking Spaces Not Self-Dealing:   Foundation is classified as a tax-exempt organization under Sec. 501(c)(3) and as a non-operating private foundation within the meaning of Sec. 509(a). Foundation derives income from a portfolio that, among other holdings, consists of investment real property located in City 1 and City 2.
PLR 201311034 Foundation's Grants to Orgs Not Self-Dealing:   Foundation is a tax-exempt private foundation organized for the purpose of making charitable grants to exempt organizations. Both University and Healthcare are exempt organizations. Healthcare has requested a grant from Foundation to build a research center for children's health issues on the grounds of University.
PLR 201317018 Settlement Agreement Won't Result in Self-Dealing:   A and B are the surviving children of decedent C. D is a limited partnership in which A, B and C held partnership interests at the time of C's death. E is a private foundation and the two executors of C's estate also serve as the co-trustees of E.
PLR 201325018 Early Termination of NIMCRUT Not Self-Dealing:   Husband and Wife (Trustors) created a net income plus makeup charitable remainder unitrust (NIMCRUT). Disappointed with Trust's investment returns, Trustors seek to terminate it and cash out their interest.

PLR 201407021 Distribution to Fdn. Won't Result in Self-Dealing or Excess Business Holdings:   Founder's estate plan provides that after the death of the survivor of Founder and Founder's wife, an ownership interest in an LLC will pass to Foundation. Founder owns all membership units, voting and nonvoting, in LLC.

PLR 201415010 Foundation's Museum Expansion Won't Result in Self-Dealing:   Foundation is a tax-exempt private foundation. Foundation operates Museum. Museum occupies the same parcel of land as the personal residence of Foundation’s founder, a disqualified person with respect to Foundation.

PLR 201421023 Payments by Lead Trusts Won’t Result in Self-Dealing:   H and W are husband and wife. Each had separate trusts, H Trust and W Trust, that made arrangements for testamentary charitable lead annuity trusts (“CLATs”) to be created upon each of their deaths.

PLR 201427019 Transfer of Assets Not Self-Dealing:   Trust 1 and Trust 2 are irrevocable charitable trusts classified as private foundations under Sec. 509(a) and are exempt under Sec. 501(c)(3).

PLR 201432025 No Self-Dealing upon Reformation of Trust:   Foundation is a charitable trust under Section 501(c)(3) and classified as a private foundation under Section 509(a). Settlor 1 and 2 (the Settlors) are married and Settlor 2 is a substantial contributor to Foundation.

PLR 201606030 Foundation's Asset Transfer is Not Self-Dealing:   Foundation 1 is classified as an exempt 501(c)(3) organization and a private foundation under section 509(a). Its directors are B, C and D. After a disagreement regarding how to carry out Foundation 1’s exempt purpose, B created Foundation 2 (which was recognized by the IRS as a 501(c)(3) private non-operating foundation).

PLR 201609001 No Self-Dealing for Foundation’s Transfer of Assets:   Founder created Foundation to make payments or distributions for charitable purposes to, or for the use of, charitable organizations. Foundation’s board of directors is made up of Founder’s five children and four grandchildren. The directors have decided to divide Foundation into three separate private foundations.

PLR 201624013 Stock Redemption Not Self-Dealing:   Foundation, a private foundation under Sec. 509(a), was funded by members of X family. X family members are current or former shareholders of Company, a closely-held corporation and a disqualified person under Sec. 4946(a) with respect to Foundation.

PLR 201642001 Foundation's Grant Not Self-Dealing :   Taxpayer, a tax-exempt private foundation, plans to make a grant to Supporting Organization for the purpose of constructing a new performing arts venue for Supported Organization.

Related Topics on Self-Dealing

7.1.1  Types of Public Charities:    There are three main ways to qualify as a public charity. The first is to operate as a traditional public charity, the second is to have broad public financial support and the third is to actively function in a supporting relationship to another public charity. Sec. 509(a).

Ziegenhals:    In United States v. James L. Ziegenhals et al.; No. 3:11-cv-00464 (21 Mar 2014), a former attorney was found liable for a very substantial self-dealing tax.

      Quiz-Basic



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