Who Are Disqualified Persons? Understanding Self-dealing Rules


The IRS strictly prohibits self-dealing between private foundations and so-called “disqualified persons.” Potential penalties for the disqualified person and foundation staff are stiff. Here’s what you need to know to avoid liability.

Stiff penalties

The Internal Revenue Code imposes a minimum 10% excise tax on disqualified persons on the amount involved in a self-dealing transaction. “Foundation managers” — that is, officers, directors or trustees — who knowingly participate in acts of self-dealing face a 5% tax on the amount involved. Notably, participation on the part of foundation managers includes not only affirmative acts, but also silence or inaction where there’s a duty to speak or act.

If not corrected, the tax on a self-dealing transaction on disqualified persons other than foundation managers soars to 200%. When this extra tax is imposed, an excise tax of 50% of the amount involved is also imposed on any foundation manager who refuses to agree to part or all of the correction of the self-dealing act.

Important definitions

Who exactly are disqualified persons? The IRS defines them as:

  • Substantial contributors (donors who give in excess of prescribed limits),
  • Foundation managers,
  • Owners of more than 20% of certain organizations that are substantial contributors,
  • Family members of the above,
  • Corporations or partnerships in which any of the above hold more than 35% voting power,
  • Trusts or estates in which persons above hold more than a 35% beneficial interest,
  • Certain private foundations effectively controlled by the person or persons in control of the foundation at issue, and
  • Governmental officials.

And what exactly is an act of self-dealing? According to the IRS, it includes the:

  • Sale, exchange or leasing of property,
  • Lending of money or other extension of credit,
  • Furnishing of goods, services or facilities,
  • Payment of compensation or expenses to a disqualified person, and
  • Transfer or use of the foundation’s income or assets by or for the benefit of a disqualified person.

Certain payments to government officials and transactions between organizations controlled by a private foundation may also be taxable self-dealing.


The IRS recognizes an exception to self-dealing if the benefit to a disqualified person is only “incidental or tenuous.” The exception is narrowly interpreted, but it has been granted in a variety of circumstances.

For example, the exception was triggered by a scholarship awarded under a private foundation’s scholarship program for the children of employees of a substantial contributor. And the exception permitted a disqualified person’s participation “to a wholly incidental degree” in the fruits of a charitable program of broad public interest.

Additionally, compensation paid to disqualified persons is not an act of self-dealing if the payments are for reasonable and necessary services to carry on the foundation’s exempt purposes.

Signs of self-dealing

IRS auditors looking for evidence of self-dealing won’t simply rely on a private foundation’s tax return. For example, they’ll review grants to determine if any disqualified person has any connection to the recipient. Auditors also will review all transactions between the foundation and disqualified persons to determine if any merit further review. Relevant evidence might include contracts, meeting minutes, bank documents, interviews, facility tours, and personnel and payroll records.

The IRS will establish the location of all of a foundation’s assets, too — including those that have fully depreciated. They’ll look at whether a disqualified person is using foundation property, how the organization disposes of depreciated assets, and if any assets have been given to disqualified persons.

Proceed with caution

The costs of self-dealing run high, and they extend beyond the monetary penalties. Reputational harm could prove even more painful in the long run. When in doubt, run transactions involving disqualified persons past your professional advisors.