The biggest trap that most private foundations fall into is self-dealing. Self-dealing is very broadly defined, but the general definition is officers and directors using foundation funds to enrich themselves or their business. Blatant examples include directly taking foundation funds or donations and putting them into personal accounts. However, there are also less obvious forms of self-dealing. This post will detail them here and how to avoid them. And if certain self-dealing actions are unavoidable, how to avoid being penalized by the IRS.
One form of self-dealing is steering foundation work and contracts to businesses owned by family. For example, your foundation might need a CPA or attorney. You just so happen to have a brother who owns his own firm, so you pay him to handle your legal or tax affairs. This is an example of self-dealing. A related example is when a director or officer owns – say a printing business – and the foundation contracts with that person's business to print tshirts and mugs. This is an example of self-dealing in that you are using foundation funds that can indirectly benefit you. By itself, this can draw IRS penalties that can be financial, and in the worst case scenario, result in revocation of tax-exempt status. There are ways to avoid this however.
First, you should have a policy to deal with instances of self-dealing in your bylaws. This is not mandatory but is very helpful to refer to. The policy should dictate that when deciding on having that brother work on your taxes, or have the officer's business print your merchandise, that you solicit quotes and selected the lowest quotes possible. Next, it is important to show that the interested person – the one who's brother owns the business, or the officer – is removed from the decision making process. To the IRS, a group of disinterested parties – those who wouldn't financially benefit – making the decision will make the choice look more credible. This takes me to my final point, which is to keep copious notes of all meetings, so in the event that the IRS does audit you for self-dealing, you can show that you have taken all the right steps and avoid penalizing.