Reconciling Nonprofit Self-Dealing Rules
ABA Real Property Trust and Estate Law Journal, Forthcoming
52 Pages Posted: 20 Sep 2013
Date Written: September 18, 2013
Charities must serve public rather than private interests. Much of the enforcement effort in this area of the law tries to ensure that such organizations do not engage in impermissible self-dealing, that is, in providing unreasonable benefits to insiders. That is, limits on self-dealing are crucial to regulation of this section. Both state law and federal tax law include provisions designed to prevent such behavior. These laws, however, often exhibit inefficiencies and differences that impose unnecessary burden on organization seeking to comply with applicable law.
State law regulates both trusts and nonprofit corporations. If the organization is formed as a trust, the “no further inquiry rule” of common law applies. Under this rule, a trustee, whether of a charitable trust or a private trust, is per se liable so long as a beneficiary shows that the trustee had a personal interest in the transaction; harm to the trust is irrelevant. If the organization is formed as a corporation, nonprofit corporation statutes generally include requirements as to the procedures for board approval of self-dealing transactions, procedures that, in practice, are usually easy to meet.
Tax law supplies self-dealing rules for organizations exempt under section 501(c)(3) of the Internal Revenue Code. Under federal tax law, public charities must satisfy the so-called intermediate sanction rules, which impose excise taxes on transfers between the organization and an insider that confer an “excess benefit” on the insider. Private foundations, which are section 501(c)(3) organizations that, in general, receive their support from a single individual or corporate source or family group and make grants to other charitable organizations, face stricter rules than public charities regarding self-dealing. They face two-tier excise taxes that in practice prohibit transactions between the private foundation and certain specified insiders, even when the transaction would benefit the organization.
This article uses both the economic theory of deterrence and norms theory to argue for a change to both state law and federal tax law. Using the California nonprofit corporation statute and the availability of individual exemptions from the prohibited transactions rules of ERISA, it argues for advance approval procedures. Making state and federal self-dealing rules as similar as possible would best carry out the rules’ shared purpose. Reconciling these rules would aid nonprofit charitable organizations in adopting a set of operating procedures to ensure compliance with the various laws applicable to them. Similar rules would also render state and federal enforcement easier and more efficient.
Part I describes why self-dealing rules are so important in the nonprofit context. Part II details and evaluates the various self-dealing regimes in which nonprofit tax-exempt entities operate. Part III considers how these various approaches could be reconciled with use of administrative advance approval.
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