Private Benefit, Inurement, Self-Dealing, and Excess Benefit Transactions

One requirement imposed on nonprofits that are recognized as exempt under IRC 501(c)(3) is that no part of the net earnings of the organization inures to the benefit of any private shareholder or individual.

Private Benefit Doctrine

The doctrine of private benefit prescribes that a Section 501(c)(3) organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest.

Even if an organization is engaged in many activities that further its exempt purposes, its exemption may be precluded if the organization benefits private individuals to a degree that is more than insubstantial.

To determine whether a private benefit is beyond insubstantial, the public benefits derived from the organization’s activities will be weighed against the benefits conferred to private individuals.

In weighing such benefits, the public benefits must be greater than the private benefits to qualify for an exemption.

Private Inurement Doctrine

The doctrine of private inurement also involves a private benefit but goes one step further, focusing on whether there is unjust enrichment to a particular party.

Specifically, the prohibition of benefits to “private shareholder or individual”, as worded in the statute, refers to “persons having a personal and private interest in the activities of the organization.”

These individuals often referred to as “insiders,” are those who, by a special relationship with the organization in question, can influence the expenditure of its funds or the use of its assets.

So, while private benefit restricts an exempt organization from benefiting any private person or entity outside of the wide charitable class it is intended to serve, private inurement, on the other hand, strictly prohibits benefits to organizational insiders.

Like private benefit, a finding of private inurement will likewise result in revocation of Tax exempt status. Unlike the limitation on private benefit, however, the prohibition against private inurement is absolute.

This means that even a minimal amount of private inurement could result in revocation.  It may also lead to other adverse consequences such as intermediate sanctions.

Intermediate Sanctions

Under IRC Section 4958(a)(1), the Internal Revenue Service (“IRS”) may impose a tax on excess benefit transactions equal to 25% of the excess benefit on the disqualified person involved.

If the excess benefit transaction is not corrected, to make the organization whole again, the IRS may impose an additional tax on the excess benefit transaction equal to 200% of the excess benefit.

Furthermore, under IRC Section 4958(a)(2), the IRS may additionally impose a tax equal to 10% of the excess benefit on any “organization manager” who approved the transaction which created the excess benefit, unless such participation is proven to not be willful and is due to reasonable cause.

Tovella Dowling counsels its clients on avoiding, reporting, and curing excess benefit transactions and navigating other considerations relating to conflicts of interest that arise in a nonprofit context.