Are you planning to set up a private foundation? If so, you need to be very familiar with the concept of self dealing. If you aren’t, you can quickly get into very hot water. Read on to find out what self dealing is all about and how to avoid getting your foundation — or yourself — in trouble.

What is self dealing?

Self dealing is a term that refers to situations where people who are connected with the private foundation derive personal benefits from interacting with the foundation. There are laws against that and serious problems can result both for the donors and other parties as well as for the foundation.

Rules against benefitting personally from a charity have existed in some form for as long as there have been foundations. However, in 1969, Congress established strict official rules against what became self dealing. This happened in response to perceived abuses of foundation insiders.

Among the first things you need to know about this subject is that there are two possible parties to a self dealing situation: the foundation and what is referred to as a disqualified party, or specifically, a disqualified person (“DP”).

What is a disqualified person?

Basically, the term “disqualified person” refers to any person who is not permitted to benefit directly from dealing with the foundation. This includes founders, donors, officers, board members and other insiders of the foundation, along with any person or business who can be classified as a “substantial contributor” to the foundation.

What happens if there is self-dealing?

You may wonder what will happen if the rules are violated. There are penalties, which can be severe, and can range all the way from a 7 ½% tax, to a possible 200% tax, to the loss of the foundation’s tax-exempt status.

So how do you avoid self-dealing?

You basically refrain from engaging in any activities that are not allowed. Unfortunately, this is easier said than done. However, it helps to understand that basically all financial transactions between private foundations and disqualified persons are prohibited. Still, the rules are so numerous that it would be almost impossible to keep track of them all. However, there’s an easier way to manage — by focusing on the exceptions.

What are the main exceptions?

There are two different categories of exceptions, statutory and regulatory exception.

Statutory exceptions are exceptions that are formally included in the statute. Those tend to be “special rules” that were created primarily to allow for transactions that benefit the foundation. Regulatory exceptions are those that are basically accepted by the IRS without being formally included in the statute.

Examples of statutory exceptions include the contributions of indebted property under certain conditions. They also include loans made to the foundation as long as no interest is charged and the money is used to further the foundations tax exempt purpose.

The foundation may also provide a disqualified person with any services, property use, or goods that it also provides the general public.

Are there exceptions that could benefit the donor or the founder?

There are indeed. They include exceptions for payments related to travel, and also reimbursement and “reasonable” compensation for services that are necessary to carry out the foundation’s charitable work.

The latter, of course, provide an opening that allows for targeted travel and activities to be reimbursed — and if the foundation has been created with the right mission, it can allow the founders to pursue a wide range of their interests — and get reimbursed by the foundation.

However, as you can see, with rules that are this complex, it’s generally a very good idea to consult an expert on private foundations before setting up your own foundation. That way, you can ensure that you have the greatest possible access to exceptions, while not running afoul of the many complex rules against self dealing.

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