Posted on Wednesday, September 26, 2012
There are certain things a nonprofit organization is restricted from doing in order to keep its exempt status. One of which is private inurement.
The IRS specifically states that a section 501(c)(3) organization must not be organized or operated for the benefit of private interests. No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual.
Private inurement occurs when an insider receives benefits from the nonprofit in excess of what he or she provides in return. The IRS refers to insiders as “disqualified persons”. These can be board members, trustees, officers, managers, highest paid employees, founders, major donors or family members of any of the above.
The most common example of private inurement is excessive compensation paid to insiders. Excessive compensation includes all forms of compensation including bonuses, fringe benefits, retirement, insurance, etc. Other forms of private inurement include the sale or purchase of an asset to or from an insider, renting property to or from an insider, lending money to an insider or the use of the organization’s facilities to an insider. The key to determining whether private inurement has occurred is whether the transaction is fair and reasonable under the circumstances. For example, a $100,000 salary to the executive director of Organization A may not be reasonable while the same salary to the executive director of Organization B may be reasonable given the specific circumstances. The executive director of Organization B may have more education and experience or Organization B may be more complex than Organization A. In order to avoid the possibility of private inurement, Organization B needs to maintain documentation as to how the executive director’s salary was determined (i.e. comparable salaries paid by similar organizations), a description of the entire compensation package, the executive director’s responsibilities, and that the salary was approved by the board of directors.
Sometimes findings of private inurement do not warrant the revocation of the organization’s exempt status. Instead, the IRS will impose intermediate sanctions where the insider is required to pay a tax equal to 25% of the excess benefit received. In addition, the insider is required to make the organization whole again within a specified period of time. If the insider fails to make the organization whole within the time frame, the IRS imposes an additional tax equal to 200% of the excess benefit. The IRS also imposes a tax equal to 10% of the excess benefit on any board member who knowingly approves the excess benefit transaction.
It is important to note that there is no de minimis restriction for private inurement. In order to prevent your organization from losing its exempt status and avoid intermediate sanctions, make sure all transactions with insiders are reviewed to ensure the organization is serving public interests, not private interests.
Posted by: Carrie Minnich, CPA
Posted in Mission Minded Nonprofits
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