Don’t let insiders profit
First, it’s important to understand the concept of 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 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 “insiders” or “disqualified persons” — generally any officer, director, individual or organization who is in a position to exert significant influence over your nonprofit’s activities and finances. The rule also covers their family members and organizations they control. A violation occurs when a transaction that ultimately benefits the insider is approved.
Remember your “purpose”
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.
Violators of the rule face excise taxes and the loss of exempt status — although the latter is rare. Bad PR and loss of community support are also major risks. Contact us if you’re unsure about a pending transaction or want us to help educate your stakeholders.