In the course of ordinary business as a nonprofit organization or charity, a related entity or individual (such as a board member) may want to provide services or goods to be used by the company; however, while this may seem like a simple and beneficial way to provide easy and inexpensive opportunities for the organization, these types of transactions can actually bring about a variety of issues and may even be prohibited by law.
What is a related-party transaction?
A related-party transaction, often referred to as self-dealing, is an event that occurs between the nonprofit organization and another entity or individual that has significant influence or control of the nonprofit. This can be in either a direct or an indirect fashion. The materiality of the transaction is not a factor in determining whether or not a transaction is considered self-dealing, and every transaction carries reporting requirements from a tax perspective.
Reporting a related-party transaction.
Whether the organization is a private foundation or a public charity, all related-party transactions must be reported on their income tax returns filed with the IRS and state Attorney General. In addition to this, a transaction with a related-party should not be settled by the organization until the governing board and executive staff have been notified and reviewed the transaction. The board of directors and executives should meet to discuss the transaction, without the related-party’s presence. This meeting should determine whether the organization needs the transaction, whether the transaction is reasonably priced (as verified by competitive bids or market rates), and that the necessary disclosures can be made to ensure the organization is not subject to penalties or legal ramifications. One of the key questions that should be asked with every transaction, whether with a related-party or not, is if the transaction has the organization’s overall interest and goals in mind.
What can we do to mitigate any problems?
The IRS has included a sample conflict of interest policy that can be found on their website or in the instructions when applying for exemption status. Whether or not this specific language is used can be established by the board members; however, a conflict of interest policy should be included in every company’s organizational documents. This will help to mitigate risks involved in any related-party transactions, establish repercussions if the policy is not followed, and ensure that the company retains its exemption status through the eyes of the IRS. Additionally, the audit committee should review transactions that have potential conflicts of interest. If a CPA is not on this committee, it is recommended to seek the advice of an outside CPA (or the CPA who prepares the income tax return) to verify reasonableness of the transactions. Lastly, all decisions regarding any related-party transactions should be documented along with the evidence to support the transaction. This is just another reason why Board of Director’s minutes should be kept up-to-date and are crucial to every nonprofit organization.
Related or not related, we can help resolve your problem.
It is usually best to avoid related-party transactions; however, these transactions can be necessary and beneficial, sometimes even unavoidable, to the nonprofit organization. In these cases, it is essential to keep good records and follow specific guidelines, such as the conflict of interest policy, to ensure that the IRS guidelines are followed and the entity’s exempt status is not jeopardized.
The rules regarding related-party transactions can be complex and intimidating. If you have any questions or concerns regarding these transactions, please contact your L&B professional at (858) 558-9200.