Private foundations:
Private foundations that violate self-dealing rules often do so unknowingly. One of the pitfalls to avoid is fulfilling personal charitable commitments with private foundation funds. If a private foundation makes an expenditure (i.e., payment of fees, dues, pledge, etc.), that satisfies the legal obligation of a disqualified person, the expenditure will ordinarily constitute an act of self-dealing.1 Such an expenditure is tantamount to using foundation funds to pay off an individual's debt. Private foundations should never make such payments. Note that this prohibition not only applies to pledges, but also to expenses such as membership fees or dues that have already been assessed, and are then paid by a private foundation on behalf of the individual. The benefit conferred on the individual is not incidental or tenuous, but is direct and economic in nature because that individual would have been expected to pay those membership fees or dues. In the case of payments made on behalf of a disqualified person, that payment constitutes an act of self-dealing which can result in punitive penalties on both the individual and the private foundation as described below.2 And even if the individual is not a "disqualified person" in the technical sense of the Internal Revenue Code, the payment undoubtedly constitutes private inurement which can result in sanctions against the private foundation.
Donor Advised Funds:
IRS regulations pertaining to Donor Advised Funds ("DAFs") require that all final decisions about distributions from a DAF be made by the managing charity's board (e.g., the community foundation board). Grants from DAFs may only be made to other §501(c)(3) federal tax-exempt organizations.3 Grants may not be made to satisfy any individual's legally binding pledge, nor may they be made to a charity that will provide goods or services to an individual in return for the grant. The grants also cannot be used to pay tuition assessed, membership fees or dues, benefit tickets, sporting events tickets, alumni fees, goods bought at charitable auctions, etc.
Penalties Imposed by the Pension Protection Act of 2006:
If a DAF or private foundation makes distributions providing a "more than incidental benefit" to a donor, donor advisor, or related party, a tax equal to 125% of the amount of the benefit is imposed on the benefited party under the Pension Protection Act of 2006. In addition, in the case of a private foundation in particular, the foundation's tax exempt status can be jeopardized.
Alternatively, in the case of a DAF, penalties may be imposed on donor advisors and the administering charity's staff and board. A tax equal to 10% of the amount of the benefit is imposed on any "fund manager" (e.g., board member, advisory staff, etc.) at the administering charity who agrees to make a distribution knowing that the distribution would confer a "more than incidental" benefit. The maximum amount of tax imposed on a fund manager as to any distribution is $10,000.
Solution - Suggest a Contribution rather than Commit to a Pledge:
The prudent advice to potential donors is: Don't make a pledge. Instead, respond to a request for a pledge by giving an indication of intent, such as "we have suggested [or we will be suggesting] that a grant be made from [name of donor's DAF or private foundation] to the [name of requesting organization]. Pending approval by the [managing foundation or private foundation board], a check will be issued from the [managing foundation or private foundation] to the requesting organization".
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1 IRC §4941(d)(1)(E); Regs.53.4941(d)-2(f)(1). Self-dealing laws prohibit financial transactions between a private foundation and its "disqualified persons." The definition of a disqualified person includes the foundation's officers, directors, trustees, key employees, substantial contributors, their family members, corporations, partnerships, trusts or estates in which any of the foregoing has more than 35% of the voting power, profits or beneficial interest, and any owner of more than 20% of a corporation, partnership or trust that is a substantial contributor.
2 See Rev. Rul. 77-160, 1977-1 C.B. 351.
3 DAF grants also cannot be made to private foundations or used for political contributions, lobbying, or to support political campaign activities.
