Self-Dealing Considerations for Family Offices & Family Foundations
Author: Jana Kirksey
Family foundations and family offices are common tools employed by wealthy families. The family office allows for centralized family wealth and other family financial matters. Family foundations are key in assisting families in their charitable giving. The private foundation tax rules are complex and prohibit many transactions between the family and its foundation. However, understanding the rules and how they’re applied can allow the family office and family foundation to share costs and investment arrangements.
If a private foundation is involved in an act of self-dealing with a disqualified person, a 10 percent excise tax may be imposed on the disqualified person. Additional taxes—up to 200 percent—are imposed if the act of self-dealing isn’t corrected. A tax on foundation managers also may apply. Individuals are considered a disqualified person to the private foundation if they’re:
- A substantial contributor to the family foundation
- An officer, director or trustee of the foundation (foundation manager)
- A greater than 20 percent owner of a corporation, partnership or trust who is a substantial contributor to the family foundation (20 percent owner)
- A family member of a substantial contributor, foundation manager or 20 percent owner. For purposes of defining a disqualified person, family members include an individual’s spouse, ancestors, children, grandchildren, great-grandchildren and the spouses of children, grandchildren and great-grandchildren.
- A corporation of which substantial contributors, foundation managers, 20 percent owners or family members of such individuals own more than 35 percent of the total combined voting power
- A partnership in which substantial contributors, foundation managers, 20 percent owners or family members of such individuals own more than 35 percent of the profit’s interest
- A trust or estate in which substantial contributors, foundation managers, 20 percent owners or family members of any such individuals hold more than 35 percent of the beneficial interest
In most cases, the family office will be more than 35 percent owned by individuals who are disqualified persons to the private foundation because they’re substantial contributors, foundation managers or family members of these persons. Therefore, in these situations, the family office also would be a disqualified person to the private foundation.
Acts of self-dealing include any of the following direct or indirect transactions between the family foundation and a disqualified person, even if the transaction benefits the private foundation and not the disqualified person:
- Sale, exchange or leasing of property
- Lending of money or other extension of credit
- Furnishing of goods, services or facilities
- Payment of compensation or expense reimbursements
- Transfer to, or use by or for the benefit of, a disqualified person of the family foundation’s income or assets
As with many tax laws, a number of exceptions apply to the self-dealing rules. The following transactions aren’t considered acts of self-dealing:
- The furnishing of goods, services or facilities by a disqualified person to a private foundation if it’s done without charge and the goods, services or facilities are used exclusively for purposes specified in Internal Revenue Code Section 501(c)(3)
- The lending of money by a disqualified person to a private foundation if the loan is without interest or other charge and the loan’s proceeds are used exclusively for purposes specified in §501(c)(3)
- Except for a governmental official, the payment of compensation (and the payment or reimbursement of expenses) by a private foundation to a disqualified person for personal services that are reasonable and necessary to carry out the foundation’s exempt purpose if the compensation (or payment or reimbursement) isn’t excessive
- Leasing of property by the disqualified person to the private foundation without charge. Payments for utilities, janitorial or other maintenance costs that are incurred for the use of the property are allowed if they aren’t paid directly or indirectly to a disqualified person.
With the proper design and forethought, family foundations and family offices can share services and costs without engaging in self-dealing. Below are a few planning opportunities laid out in IRS-issued letter rulings.
The time-sharing of an employee between the family foundation and a family office was determined not to be self-dealing when the compensation paid by the foundation would be based on the amount of time worked and not excessive in relation to the services provided. The shared employee would provide personal services such as general administration or investment management.
In another set of circumstances, the IRS addresses the sharing of office space and office equipment. The foundation was provided the office space free of charge but would pay janitorial services, utilities and other maintenance costs based on its pro-rata portion of the space used. These costs would all be paid directly to the third-party provider. Sharing of office equipment was permitted because the foundation would only pay for its use and would keep detailed records for support.
Key factors in these situations and others not considered self-dealing are:
- Payments are made directly to shared employees or third-party vendors and not to the disqualified persons.
- Compensation is reasonable and for personal services.
- Payments for shared space or office equipment are proportionate to usage and records are kept.
- All actions are exclusively to carry out the foundation’s exempt purpose under §501(c)(3).
By keeping these factors in mind and taking time to plan correctly, the family foundation and family office should be able to share certain costs. For more information and planning guidance, visit BKD’s Foundations page or contact your BKD advisor.