An introduction to self-dealing, specifically IRC 4941(d)(1)(B), the lending of money or other extension of credit.
IRC Section and Treas. Regulation
- IRC 4941 Taxes on Self-Dealing
- IRC 4941(d)(1) Self-Dealing, In general
- IRC 4941(d)(1)(B) Self-Dealing includes lending of money
- Treas. Reg. 53.4941(d)-1 Definitions of self-dealing
- Treas. Reg. 53.4941(d)-2 Specific acts of self-dealing
- Treas. Reg. 53.4941(d)-2(c)(1) Loans, in general
- Treas. Reg. 53.4941(d)-2(c)(2) Loans without interest
- Treas. Reg. 53.4941(d)-2(c)(3) Certain evidences of future gifts
- Treas. Reg. 53.4941(d)-2(c)(4) General banking functions
- Treas. Reg. 53.4941(d)-3 Exceptions to self-dealing
- Treas. Reg. 53.4941(e)-1(e)(1)(i) Acts of self-dealing, Number of acts; use of money or property, In general
Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)
- Rev. Rul. 73-546, 1973-2 CB 384
- Rev. Rul. 73-595, 1973-2 C.B. 384
- Rev. Rul. 77-259; 1977-2 C.B. 387
- Rev. Rul. 2002-43, 2002-2 C.B. 85
- GCM 39066 as modified by GCM 39451
- IRS website: Private Foundation - Loans
IRC 4941 imposes an excise tax on any direct or indirect act of self-dealing between a private foundation and a disqualified person. Self-dealing transactions described under IRC 4941(d)(1)(B) are the lending of money or other extension of credit. For example, an act of self-dealing occurs where a third party purchases property and assumes a mortgage. The mortgagee, a foundation – and the third party – subsequently transfers the property to a disqualified person who either assumes liability under the mortgage or takes the property subject to the mortgage. Similarly, except in the case of the receipt and holding of a note pursuant to a transaction described in Treas. Reg. 53.4941(d)-1(b)(3) – known as the estate administration exception – an act of self-dealing occurs where a note, the obligor of which is a disqualified person, is transferred by a third party to a foundation which becomes the creditor under the note. Lending cannot be direct or indirect, and the rate of interest is better than the foundation could otherwise receive does not eliminate the self-dealing.
A loan by a foundation to an individual, before becoming a foundation manager and thus a disqualified person, may not be an act of self-dealing because the disqualified person status arises only following completion of the compensation package. However, when the loan principal remains outstanding once the individual becomes a disqualified person, an act of self-dealing occurs, and taxes are placed in each year there is an uncorrected extension of credit.
Three exceptions to IRC 4941(d)(1)(B) as contained in Treas. Reg. 53.4941(d)-2(c)
2. Certain evidences of future gifts. Making a promise, pledge, or similar arrangement to a foundation by a disqualified person – whether by an oral or written agreement, a promissory note, or other instrument of indebtedness – to the extent motivated by charitable intent and unsupported by consideration, isn’t an extension of credit (within the meaning of this paragraph) before the date of maturity.
3. General banking functions. The performance by a bank or trust company which is a disqualified person of trust functions and certain general banking services for a foundation isn’t an act of self-dealing:
a. Where the banking services are reasonable and necessary to carrying out the exempt purposes of the foundation
b. If the compensation paid to the bank or trust company. This takes into account the fair interest rate for the use of the funds by the bank or trust company, for such services isn't excessive.
The general banking services allowed by this subparagraph are:
(i) Checking accounts, as long as the bank does not charge interest on any over withdrawals.
(ii) Savings accounts, as long as the foundation may withdraw its funds on no more than 30-days’ notice without subjecting itself to a loss of interest on its money for the time during which the money was on deposit.
(iii) Safekeeping activities.
Three revenue rulings provide guidance in this area.
1. Rev. Rul. 73-546, 1973-2 CB 384 discusses the payment by a foundation to a bank, a disqualified person, of a service fee for an overdrawn checking account in an amount equal to the actual cost of processing the overdraft doesn’t result in an act of self-dealing under IRC 4941. The disqualified person banking institution didn’t charge interest on the amount overdrawn. It did, however, charge a service fee which was the actual expense of processing the amount overdrawn. The ruling held the service fee is part of the compensation paid by the foundation to the bank for the maintenance of its checking account. As the service fee equals the actual expense of processing the amount overdrawn, it isn’t excessive and doesn’t result in an act of self-dealing.
2. Rev. Rul. 73-595, 1973-2 C.B. 384, regards a foundation transaction which deposited funds in a savings account maintained with a disqualified person banking institution. The bank pays interest on funds in deposit during an entire quarter. On the tenth day of a calendar quarter, the foundation deposited funds and in the next quarter it withdrew the funds ten days before the end of the quarter. Thus, the foundation wasn’t entitled to interest on its deposit in either quarter. The transaction was an act of self-dealing because the foundation lost its interest income and the banking exception was inapplicable because the account permitted interest to be lost for a period exceeding 30 days.
3. Rev. Rul. 77-259; 1977-2 C.B. 387, states the purchase by a foundation of a bank mortgage, a disqualified person that in the normal course of its business acquires and sells mortgages, isn’t within the exception for general banking services and is an act of self-dealing under IRC 4941(d)(1).
Subsequent acts of self-dealing arising from initial transaction – lending of money or other extensions of credit
Section 53.4941(e)-1(e)(1)(i) provides that if a transaction between a foundation and a disqualified person is determined to be self-dealing there is generally one act of self-dealing. If, however, such transaction relates to the leasing of property, the lending of money or other extension of credit, other use of money or property, or payment of compensation, the transaction will generally be treated as giving rise to an act of self-dealing on the day the transaction occurs. Also, – it’s an act of self-dealing on the first day of each taxable year or portion of a taxable year which is within the taxable period and which begins after the taxable year in which the transaction occurs. The regulation cited above provides numerous examples.
Example: On August 31, 1970, foundation sells a building to disqualified person. Foundation is on the calendar year basis. Under these circumstances, the transaction between the foundation and disqualified person is one act of self-dealing which is treated for purposes of IRC 4941 as occurring on August 31, 1970.
Example: Assume the facts as stated above except instead of selling the building to foundation, disqualified person leases the building to the foundation for a term of four years beginning July 31, 1970, at an annual rental of $12,000. The annual fair rental value of the building is also $12,000 as of July 31, 1970, and throughout the next four years. This transaction is corrected on September 30, 1973. Under these circumstances, the transaction between disqualified person and foundation constitutes four separate acts of self-dealing, which are treated for purposes of IRC 4941 as occurring on July 31, 1970, January 1, 1971, January 1, 1972, and January 1, 1973. Consequently, there are four taxable periods. The first taxable period is from July 31, 1970, to September 30, 1973; the second is from January 1, 1971, to September 30, 1973; the third is from January 1, 1972, to September 30, 1973; and the fourth is from January 1, 1973 to September 30, 1973. For purposes of the initial taxes in IRC 4941(a), the amount involved is $5,000 for the first taxable period, $12,000 for the second, $12,000 for the third, and $9,000 for the fourth. The initial taxes to be paid by disqualified person are thus $1,000 ($5,000 × 5% × 4 taxable years or partial taxable years in the taxable period) for the first act; $1,800 ($12,000 × 5% × 3) for the second act; $1,200 ($12,000 × 5% × 2) for the third act; and $450 ($9,000 × 5% × 1) for the fourth act.
Rev. Rul. 2002-43, 2002-2 C.B. 85 shows how a foundation’s self-dealing taxes are calculated in an instance of a loan from a foundation to a disqualified person that spans more than one year and constitutes multiple acts of self-dealing. Self-dealing tax is imposed annually rather than merely with respect to the year in which the self-dealing took place. See Treas. Reg. 53.4941-1(a)(1) and GCM 39066 as modified by GCM 39451 (although GCM’s are not considered guidance they are helpful in applying the law to certain facts). Additionally, if a foundation made a multi-year loan to a disqualified person there would be an act of self-dealing with respect to each year there was an outstanding principal balance on the loan.
Issue Indicators or Audit Tips
Look to other Chapter 42 code sections as well. Chapter 42 permits the assessment of excise taxes under different statutes for the same transaction. For instance, a self-dealing transaction, IRC 4941, is frequently also a taxable expenditure, IRC 4945, that may also affect the net investment income, IRC 4940, and the qualifying distributions, IRC 4942. IRC 4941 and IRC 4945 can commonly occur for the same transaction. Many self-dealing transactions are not considered to be for IRC 170(c)(2)(B) purposes, thus becoming taxable expenditures. But a taxable expenditure isn’t necessarily a self-dealing transaction.
Ensure the self-dealing transaction was reported on the Form 4720. Determine if the excise tax was paid and that the self-dealing transaction was corrected. Failure to make correction can result in the imposition of second-tier taxes.
Review and verify balance sheet items on Part II of Form 990-PF, which may indicate loans to and from disqualified persons on line #6 for receivables due from officers, directors, trustees and other disqualified persons and on line #20, loans from officers, directors, trustees and other disqualified persons.