A wide array of transactions between a private foundation and its donors, officers or other affiliated persons (defined as "disqualified persons") are considered to be acts of "self-dealing." These transactions are subject to special rules and may give rise to serious tax consequences.
Payment of compensation to a disqualified person is one common type of self-dealing transaction. There is, however, an important exception to the self-dealing rules if the compensation paid to the disqualified person is for the performance of reasonable and necessary services rendered in carrying out the affairs of the foundation. Services are "necessary" if they are essential to the conduct of foundation activities. The compensation is "reasonable" if it is comparable to that ordinarily paid for similar services by similar enterprises under similar circumstances.
The most appropriate comparisons are to similarly-situated foundations. Since all private foundations and public charities are required to disclose (upon request) the compensation of the five highest paid foundation employees and independent contractors, as well as the compensation of each officer, director, trustee and foundation manager, comparability information may be readily available. A website (http://fdncenter.org) makes the process even easier by providing on-line IRS Forms 990 PF filed by private foundations. The Council on Foundations also publishes a biennial Foundation Management report, which contains private foundation compensation levels by size of foundation, position and area of the country. The Council also provides on-line help to foundations looking to locate similar foundations in their geographical area (http://www.cof.org). Council members can obtain salary tables and administrative expense data via that website.
Non-compliance with these rules (even if inadvertent) may have harsh tax consequences. Any amount of self-dealing (even $1 in a $1,000,000 transaction) can cause a problem. A two-fold excise tax may apply (a 5% tax on the recipient, and a 21/2% tax on every manager who participated in the transaction). The act of self-dealing may result in loss of tax-exempt status since the transaction constitutes private inurement, i.e., the use of foundation funds for private, rather than charitable, purposes.
In short, private foundations may pay appropriate compensation to disqualified persons. But the foundation must proceed carefully in so doing in order to avoid excise tax exposure and the possible loss of tax-exempt status. The foundation should therefore regularly undertake and document sufficient due diligence, with the assistance of its tax attorney, to establish the reasonableness of the compensation paid.
