Most non-profit leaders are familiar with the concept of excess benefit transactions and the need to avoid them. However, reminders on excess benefit transactions may be necessary, particularly when you consider that 501(c)(3) organizations determined by the IRS to have violated the rules can be liable for penalties of 25% to 200% of the value of the benefit in question. They may also risk a revocation of their tax-exempt status — and, as a result, the loss of donor and community support.

Private Inurement

To understand excess benefit transactions, you also need to comprehend the concept of private inurement. A private benefit is any payment or transfer of assets made, directly or indirectly, by your non-profit that is either:

• Beyond reasonable compensation for the services provided or goods sold to your organization
• For services or products that don’t further your tax-exempt purpose

If any of your net earnings inure to the private benefit of an individual, the IRS won’t view your non-profit as operating primarily to further its tax-exempt purpose.

Private inurement rules extend the private benefit prohibition to “insiders” or “disqualified persons” — generally any officer, director, individual, or organization (including major donors and donor advised funds) in a position to exert significant influence over your non-profit’s activities and finances. The rules also cover their family members and organizations they control. A violation occurs when a transaction that ultimately benefits the insider is approved.

Be Reasonable

The rules don’t prohibit all payments, such as salaries and wages, to an insider. You simply need to make sure that any payment is reasonable relative to the services or goods provided. In other words, the payment must be made with your non-profit’s tax-exempt purpose in mind.

To help ensure you can later prove that any transaction was reasonable and made for a valid exempt purpose, formally document all payments made to insiders. Also make sure that board members understand their duty of care. This refers to a board member’s responsibility to act in good faith; in your organization’s best interest; and with such care that proper inquiry, skill, and diligence has been exercised in the performance of duties. One best practice is to ask all board members to review and sign a conflict-of-interest policy.

Appearance Matters

Some states prohibit non-profits from making loans to insiders (such as officers and directors) while others allow it. In general, you’re safer to avoid such transactions — regardless of your state’s law — because they often trigger IRS scrutiny. Contact us to discuss the best ways to help avoid both excess benefit transactions and the appearance of them in your organization.