An introduction to the incidental and tenuous exception to self-dealing under Treas. Reg. 53.4941(d)-2(f)(2). IRC Section and Treasury Regulations IRC 4941 Taxes on self-dealing IRC 4941(d)(1) Self-dealing, in general IRC 4941(d)(1)(E) Transfer or use of the foundation’s income or assets by or for the benefit of a disqualified person IRC 4946 Disqualified person, definitions and special rules Treas. Reg. 53.4941(d)-1, Definition of self-dealing Treas. Reg. 53.4941(d)-2(f)(1), Specific acts of self-dealing, transfer or use of the income or assets of a private foundation, in general Treas. Reg. 53.4941(d)-2(f)(2), Specific acts of self-dealing, certain incidental benefits Treas. Reg. 53.4941(d)-2(f)(9), Examples Resources (court cases, Chief Counsel Advice, Revenue Rulings, internal resources) Rev. Rul. 73-407, 1973-2 C.B. 383 held that a contribution by a private foundation to a public charity made on the condition that the public charity change its name to that of a substantial contributor to the foundation and agree not to change the name again for 100 years does not constitute an act of self-dealing under Section 4941(d)(1)(E). The public recognition the disqualified person receives from the charitable act of the private foundation is an incidental and tenuous benefit within the meaning of the regulations. Rev. Rul. 75-42, 1975-1 C.B. 359, clarified by Rev. Rul. 82-136, 1982-2 C.B. 300, held that a grant authorized by an exempt private foundation to a hospital exempt from federal income tax under Section 501(c)(3) and described in Sections 170(b)(1)(A)(iii) and 509(a)(1) for modernization, replacement, and expansion does not constitute an act of self-dealing within the meaning of Section 4941 even though two individuals serve as trustees of both organizations. Any benefit received by the disqualified persons is merely incidental to the private foundation’s use of its funds for a charitable purpose. Rev. Rul. 82-136 similarly involved a grant from one private foundation to another for charitable purposes and clarified that the benefit to the trustee (a banking institution) is incidental even though the same trustee controls both foundations. Rev. Rul. 77-6, 1977-1 C.B. 350 held that the purchase of a portion of a bond issue on behalf of an exempt hospital by a disqualified person with respect to a private foundation that guaranteed the bonds except for those sold to the disqualified person is not an act of self-dealing. Because the guarantee does not apply to bonds purchased by a disqualified person, the arrangement does not result in any use of the foundation's assets for the economic benefit of the disqualified person. Moreover, any benefit derived by the disqualified person by virtue of that person's position as an officer of the hospital is incidental or tenuous within the meaning of Treas. Reg. 53.4941(d)-2(f)(2). Rev. Rul. 77-331, 1977-2 C.B. 388 involved a private foundation’s grant to a public charity that used the grant to guarantee student loans made by financial institutions to the children of employees of the foundation. The ruling held that the guarantee of loans made to disqualified persons would constitute acts of self-dealing under Section 4941(d)(1)(E). Although the grant made by the private foundation to the public charity is not used to provide loans directly to disqualified persons, the public charity can still use the grant to guarantee loans made to disqualified persons and, if a disqualified person defaults, to repay his loan. Each time a loan made to a disqualified person is guaranteed with funds granted by the private foundation, the income or assets of the foundation are being used indirectly to satisfy the legal obligation of a disqualified person. See Treas. Reg. 53.4941(d)-2(f)(1). Such use of the foundation's income or assets confers more than an incidental or tenuous benefit upon the disqualified persons involved. Rev. Rul. 80-310, 1980-2 C.B. 319 held that a private foundation’s grant to a university to establish an educational program in manufacturing engineering was not an act of self-dealing. Any benefit to a corporation that is a disqualified person which intended to hire graduates of the new program and encourage its employees to enroll in the program, where the corporation would not receive preferential treatment in recruiting graduates or enrolling its employees, was incidental and tenuous. Rev. Rul. 85-162, 1985-2 C.B. 275 held that a loan program of a private foundation that provides financing to publicly supported organizations described in Section 170(b)(1)(A)(vi) for construction projects in disadvantaged areas does not result in acts of self-dealing within the meaning of Section 4941 merely because contractors and subcontractors involved in the construction projects, their suppliers, and employees of those involved may have ordinary banking and business relationships with a bank that is a disqualified person with respect to such foundation. The publicly supported organizations have sole control over the selection of such persons for their projects and no preferential treatment is accorded by reason of such ordinary banking and business relationships with the bank. General Counsel Memorandum (GCM) 39107 (1983) discusses the history of the incidental and tenuous benefits standard under Treas. Reg. 53.4941(d)-2(f)(2) and concludes that strict limits to the scope of the exception for incidental and tenuous benefits have been established. Please note that GCMs are not considered precedential guidance and cannot be cited as such. Analysis Self-dealing Section 4941 imposes an excise tax on each act of self-dealing between a private foundation and a disqualified person (within the meaning of Section 4946). Section 4941(d)(1) provides that the following direct or indirect acts constitute self-dealing: (A) Sale, exchange or leasing of property between a private foundation and a disqualified person; (B) Lending of money or other extension of credit between a private foundation and a disqualified person; (C) Furnishing of goods, services or facilities between a private foundation and a disqualified person; (D) Payment of compensation (or payment or reimbursement of expenses) by a private foundation to a disqualified person (unless such compensation or reimbursement is for personal services and is reasonable and not excessive); (E) Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation; and (F) Agreement by a private foundation to make any payment of money or other property to a government official (as defined in IRC 4946(c)), other than an agreement to employ such individual for any period after the termination of his or her government service if such individual is terminating his or her government service within a 90-day period. Incidental and tenuous exception Treas. Reg. 53.4941(d)-2(f)(1) provides that, generally, the transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation shall constitute an act of self-dealing. An exception applies if the benefit to a disqualified person from the foundation’s use of its income or assets is only incidental or tenuous. Treas. Reg. 53.4941(d)-2(f)(2). The history of the incidental and tenuous benefits standard under Treas. Reg. 53.4941(d)-2(f)(2) is discussed in GCM 39107 (1983). The GCM concludes that under the facts presented in the GCM, strict limits to the scope of the exception for incidental and tenuous benefits have been established. It states that the factors leading to that conclusion include congressional reasoning on the enactment of the self-dealing prohibition in Section 4941, noting that the committee's decision, generally in accord with the House bill, was based on the belief that the highest fiduciary standards require that self-dealing not be engaged in, rather than that arm's-length standards be observed. See S. Rep. No. 91-552, 91st Cong., 1st Sess. 28-29 (1969), 1969-3 CB 442-443. The GCM expressed the view that "the highest fiduciary standards" do not allow for the use of the assets of a private foundation in the business of a disqualified person to facilitate financial transactions with other clients. However, the fact that a disqualified person receives an incidental or tenuous benefit from the use by a foundation of its income or assets will not, by itself, make such use an act of self-dealing. Thus, the public recognition a person may receive, arising from the charitable activities of a private foundation to which such person is a substantial contributor, does not by itself result in an act of self-dealing since generally the benefit is incidental and tenuous. For example, a grant by a private foundation to a Section 509(a) (1), (2), or (3) organization will not be an act of self-dealing merely because such organization is located in the same area as a corporation which is a substantial contributor to the foundation, or merely because one of the Section 509(a) (1), (2), or (3) organization's officers, directors or trustees is also a manager of or a substantial contributor to the foundation. See Treas. Reg. 53.4941(d)-2(f)(2). Similarly, a scholarship or a fellowship grant to a person other than a disqualified person, which is paid or incurred by a private foundation in accordance with a program consistent with: The requirements of the foundation's exempt status under Section 501(c)(3), The requirements for the allowance of deductions under Section 170 for contributions made to the foundation, and The requirements of Section 4945(g)(1), will not be an act of self-dealing under Section 4941(d)(1) merely because a disqualified person indirectly receives an incidental benefit from such grant. Thus, a scholarship or a fellowship grant made by a private foundation in accordance with a program to award scholarships or fellowship grants to the children of employees of a substantial contributor shall not constitute an act of self-dealing if the requirements of the preceding sentence are satisfied. For an example of the kind of scholarship program with an employment nexus that meets the above requirements, see Treas. Reg. 53.4945-4(b)(5) (example 1). See also Rev. Rul. 80-310, 1980-2 C.B. 319. Treas. Reg. 53.4941(d)-2(f)(2) states that the fact that a disqualified person receives an incidental or tenuous benefit from the use by a private foundation of its income or assets will not, by itself, make such use an act of self-dealing. Rev. Rul. 77-331, 1977-2 C.B. 388 reasoned that an incidental or tenuous benefit occurs when the general reputation or prestige of a disqualified person is enhanced by public acknowledgement of some specific donation by such person, when a disqualified person receives some other relatively minor benefit of an indirect nature, or when such a person merely participates to a wholly incidental degree in the fruits of some charitable program that is of broad public interest to the community. A foundation’s provision of proxy voting rights, for voting at the annual shareholder meeting, to the corporation in which the foundation owns stock and whose management includes disqualified persons, is not an act of self-dealing. See Example 3 of Treas. Reg. 53.4941(d)-2(f)(9). A foundation’s naming of a recreation center after a substantial contributor as a condition of the substantial contributor’s gift is considered an incidental benefit. See Example 4 of Treas. Reg. 53.4941(d)-2(f)(9). See also Rev. Rul. 73-407, 1973-2 C.B. 383 (a contribution by a private foundation to a public charity made on the condition that the public charity change its name to that of a substantial contributor to the foundation and agree not to change the name again for 100 years does not constitute an act of self-dealing). Issue indicators or audit tips Issue indicators: Review Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation, Part VI-B (Statements Regarding Activities for Which Form 4720 May Be Required) to determine whether there is any initial excise tax due under Section 4941. Analyze any possible self-dealing transactions to determine if the benefit to the disqualified person might meet the exception to self-dealing as being incidental and tenuous, taking into consideration that the exception should be narrowly construed. Review grants to determine if any disqualified person with respect to the private foundation has any connection with the organization receiving the grants. Review the foundation’s website to see if there are any benefits that might possibly be obtained by a disqualified person by the use of the foundation’s assets. Audit tips: Review all transactions undertaken between the foundation and its disqualified persons. Examiners will need to investigate and identify the disqualified persons with respect to the private foundation and determine if any transactions have occurred between the disqualified persons and the foundation that might warrant further review. Evidence can be obtained from contracts, meeting minutes, bank statements and cancelled checks, interviews, tours of the facility, personnel and payroll records. Review other Chapter 42 excise taxes to ensure no other Chapter 42 violations occurred. These potential violations include Section 4942 (Mandatory Distributions), Section 4943 (Excess Business Holdings), Section 4944 (Jeopardizing Investments), and Section 4945 (Taxable Expenditures). For instance, an act of self-dealing that violates Section 4941 might also be a taxable expenditure pursuant to Section 4945(d)(5). Tour the foundation’s facility to observe all property (real or personal) owned by the foundation. Review balance sheet listing of assets, including depreciation schedules. Establish location of all assets, even fully depreciated ones, and identify who is using them. For instance: real property owned by the private foundation might be used by disqualified persons for hunting or other personal uses. See Treas. Reg. 53.4941(d)-4(e) for an exception for certain property jointly owned as of Oct. 9, 1969. a fully depreciated vehicle may be driven by a disqualified person. artwork owned by the private foundation may be listed in the books as in “storage” but in fact is displayed in a disqualified person’s residence or business. How were fully depreciated assets (which still may have value) disposed of? Were they just given to a disqualified person? Review rental agreements, sales contracts, agreements, side deals. Examine the income stream of the foundation to ensure the income is not being derived from any activity involving a disqualified person. If so, determine if the activity falls within one of the exceptions to self-dealing pursuant to Section 4941.
