An introduction to how to determine the amount involved for acts of self-dealing, specifically the lending of money to disqualified persons (DP) IRC Section 4941(d)(1)(B). IRC Section and Treas. Regulation IRC Section 4941 Taxes on Self-Dealing IRC Section 4941(d)(1) Self-Dealing, in general IRC Section 4941(d)(1)(B) Self-Dealing includes lending of money IRC Section 4941(e)(1) Definition of Taxable Period IRC Section 4941(e)(2) Definition of Amount Involved Treas. Reg. Section 53.4941(d)-1 Definitions of self-dealing Treas. Reg. Section 53.4941(d)-2 Specific acts of self-dealing Treas. Reg. Section 53.4941(d)-2(c)(1) Loans, in general Treas. Reg. Section 53.4941(e)-1(b)(1) Amount Involved, in general Treas. Reg. Section 53.4941(e)-1(b)(2)(ii) Definition of Amount Involved Treas. Reg. Section 53.4941(e)-1(b)(3) Time for Determining Fair Market Value Treas. Reg. Section 53.4941(e)-1(b)(4) Examples 2 and 4 – Examples of calculation of the Amount Involved Treas. Reg. Section 53.4941(e)-1(e)(1)(i) Number of acts of self-dealing Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Rollins v. Commissioner, T.C. Memo. 2004-260, held a fiduciary liable for excise taxes on prohibited transactions with a plan under Section 4975. The court described Congress' motivations in enacting Section 4941 with strict standards for use of a private foundation's assets to minimize the need to apply subjective arm's length standards and the close relationship between IRC Sections 4941 and 4975, including language demonstrating that IRC Section 4975 was modeled after IRC Section 4941. Zacky v. Comm'r., T.C. Memo 2004-130, 87 T.C.M. (CCH) 1378 (May 27, 2004) was a court case involving loans to a disqualified person that were determined to be prohibited transactions under IRC Section 4975. The first-tier excise taxes were assessed on the amount involved (which is defined similarly to the amount involved for IRC 4941), which was determined to be the interest amount on the loan balance. Geib v. Comm'r., T.C. Memo 2000-391, 80 T.C.M. (CCH) 931 (Dec. 28, 2000) was a court case involving loans to a disqualified person that were determined to be prohibited transactions under IRC Section 4975. First-tier excise taxes were assessed. Since petitioner did not fully repay the loans, the second-tier excise taxes were also applicable. A prohibited transaction may be corrected by undoing the transaction to the extent possible, but in any case placing the plan in a financial position not worse than that in which it would be if the disqualified person were acting under the highest fiduciary standards. IRC Section 4975(f)(5). Where the prohibited transaction is the lending of money, the disqualified person may correct the transaction by repaying the principal plus reasonable interest. Rev. Rul. 2002-43, 2002-2 C.B. 85, although referring to prohibited transactions under IRC Section 4975, illustrates the calculation of the first tier prohibited transactions excise taxes in the instance of the use of money where there are multiple excise tax rates. The revenue ruling cites the Section 4941 regulations and describes the amount involved for the lending of money to DP as the interest amount for each year where there is an outstanding balance on the loan. In addition, this Revenue Ruling shows how a foundation's self-dealing taxes are calculated in an instance of a loan from a foundation to a disqualified person that spans more than one year and constitutes multiple acts of self-dealing. IRS website Amount Involved Private Foundation Self-Dealing discusses the "amount involved" for IRC Section 4941 self-dealing issues. Analysis Section 4941(d)(1)(B) provides that the lending of money or other extension of credit between a private foundation and a DP constitutes a self-dealing transaction. Sections 4941(a)(1) and (b)(1) impose a tax on each act of self-dealing between a DP and a private foundation. Also, IRC Section 4941(a)(2) and (b)(2) impose a tax on the participation of any foundation manager in an act of self-dealing between a DP and a private foundation. Treas. Reg. Section 53.4941(e)-1(e)(1)(i) provides that if a transaction between a foundation and a DP is determined to be self-dealing, there is generally one act of self-dealing. If, however, such transaction relates to the leasing of property, the lending of money or other extension of credit, other use of money or property, or payment of compensation, the transaction will generally be treated as giving rise to an act of self-dealing on the day the transaction occurs plus an act of self-dealing on the first day of each taxable year or portion of a taxable year within the taxable period and which begins after the taxable year in which the transaction occurs. Revenue Ruling 2002-43, 2002-2 C.B. 85, although it addresses IRC Section 4975, illustrates the same method that would be used to calculate self-dealing taxes under IRC Section 4941 in an instance of a loan from a foundation to a DP that spans more than one year. Under the facts of the Ruling, the loan spanned three separate calendar years before being repaid in full. The first-tier tax is imposed for each year in the taxable period, rather than only the year in which the original loan was made. In addition, there would be an act of self-dealing deemed to have occurred on the first day of each subsequent tax year or portion of a taxable year within the taxable period in which there was an outstanding principal balance remaining on the loan. The excise taxes imposed by IRC Section 4941 in regard to the lending of money between a private foundation and a DP are calculated based on the "amount involved". Treas. Reg. Section 53.4941(e)-1(b)(2)(ii) provides that where the use of money or other property is involved, the amount involved shall be the greater of the amount paid for such use or the fair market value of such use for the period for which the money or other property is used. The calculation of the amount involved for first-tier excise taxes under IRC Sections 4941(a)(1) and (a)(2) is different from the calculation of the amount involved for second-tier excise taxes under IRC Sections 4941(b)(1) and (b)(2), which are imposed for any uncorrected act of self-dealing. Amount involved - First-Tier excise taxes under IRC Sections 4941(a)(1) and (a)(2): The amount involved for the first-tier excise taxes under IRC Sections 4941(a)(1) and (a)(2) when referring to a self-dealing lending of money to a DP is the interest amount. The interest is calculated using a Fair Market Value (FMV) interest rate for the period for which the money is used in accordance with Treas. Reg. Section 53.4941(e)-1(b)(2)(ii) and determined as of the date when the act of self-dealing occurred. IRC Section 4941(e)(2)(A) and Treas. Reg. Section 53.4941(e)-1(b)(3). Example 2 at Treas. Reg. Section 53.4941(e)-1(b)(4) provides an example of the amount involved: Example 2: On April 10, 1970, B, a manager of private foundation P, borrows $100,000 from P at 6 percent interest per annum. Both principal and interest are to be paid 1 year from the date of the loan. The fair market value of the use of the money on April 10, 1970, is 10 percent per annum. Six months later, B and P terminate the loan, and B repays the $100,000 principal plus $3,000 ($100,000 x 6 percent for one-half year) interest. For purposes of Section 4941(a), the amount involved with respect to the act of self-dealing is $5,000 ($100,000 x 10 percent for one-half year) for each year or partial year in the taxable period. Amount involved - Second-Tier excise taxes under IRC Sections 4941(b)(1) and (b)(2): The amount involved for second-tier excise taxes under IRC Sections 4941(b)(1) and (b)(2) is the highest fair market value during the taxable period. See IRC Section 4941(e)(2)(B) and Treas. Reg. Section 53.4941(e)-1(b)(3). This means that the highest FMV rate of interest during the taxable period will be used to determine the amount involved. Issue indicators or audit tips Issue indicators In addition to reviewing IRC Section 4941 self-dealing transactions, review other Chapter 42 excise taxes to determine that no other Chapter 42 violations occurred, such as required distributions under IRC Section 4942, excess business holdings under IRC Section 4943, jeopardizing investments under IRC Section 4944, and taxable expenditures under IRC Section 4945. When self-dealing transactions occur, you will generally encounter a violation of IRC Section 4945 since many self-dealing transactions aren't considered compliant with IRC Section 170(c)(2)(B) purposes, thus becoming taxable expenditures. Audit tips If self-dealing occurred due to a loan, verify whether the self-dealing transaction was properly reported and tax paid on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code. Review Form 990-PF to determine if the foundation reported in its assets any promissory notes. Confirm that an appropriate fair market value interest rate is being used for the loan(s). Verify whether the self-dealing transaction was corrected by repaying the full principal amount plus the appropriate amount of interest. Failure to make a correction can result in the imposition of second-tier taxes. Determine if there were subsequent acts of self-dealing that are deemed to have occurred in subsequent taxable years because the loan balance remained uncorrected.
