Maintain Tax-Exempt Status

Endangering its tax-exempt status is the last thing any nonprofit organization wants to do. A flood of consequences will come with that change, not the least of which is, of course, having to pay taxes.

One activity to avoid in order to keep that status is ensuring no one reaps any excess benefit from the organization’s transactions. Private inurement – the enriching of anyone associated with the nonprofit, including founders, organizers, members, volunteers, or donors – is something the IRS takes very seriously.

Understand private inurement

A private benefit is any payment or transfer of assets made, directly or indirectly, by your nonprofit that’s:

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

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

The private inurement rules extend the private benefit prohibition to your organization’s “insiders.” The term “insider” or “disqualified person” generally refers to any officer, director, individual or organization (as well as their family members and organizations they control) who’s in a position to exert significant influence over your nonprofit’s activities and finances. A violation occurs when a transaction that ultimately benefits the insider is approved.

Make reasonable payments

Of course, 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 nonprofit’s tax-exempt purpose in mind.

To 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 ensure 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.

Avoid negative consequences

To ensure your nonprofit doesn’t participate in an excess benefit transaction, educate staffers and board members about the types of activities and transactions they must avoid. Stress that individuals involved could face significant excise tax penalties.

For more information, please contact us.