One of the serious mistakes a nonprofit’s management can make is engaging in transactions that tax authorities or donors could construe as self-dealing. A nonprofit’s tax privileges rest in part on the principle that the organization is not operated primarily for the benefit of an individual. In a self-dealing transaction, a nonprofit enters into a deal in which someone in a leadership position (a director, officer, or major donor) or their family members or businesses has a material financial interest.
Bear in mind that not every transaction between a nonprofit and its leadership qualifies as self-dealing. A nonprofit’s director may also run a business that can offer valuable services to the nonprofit at standard market rates without necessarily creating a self-dealing conflict. An organization also can support the development of a community service that will incidentally benefit members of the leadership’s families.
As a general rule, the best approach is to examine each proposed substantial transaction to verify that it won’t constitute self-dealing. Some transactions will fall into a grey area, while others should raise red flags in the board room. Here are a few examples:
- Transactions that are not negotiated at arm’s length. Questions of self-dealing will arise if a deal between the nonprofit and a leader lacks the standard formalities that are usually present in similar deals negotiated between two disinterested parties. For example, a nonprofit that buys real estate from a director without requiring the director to agree to standard seller representations and warranties could be giving the director a substantial personal benefit at the nonprofit’s expense.
- Deals involving unusually high costs. Any potentially self-dealing transaction must be analyzed to verify that the nonprofit is paying market rates. A deal in which the nonprofit pays more than it should creates a strong impression of self-dealing.
- Preferential hiring. A nonprofit can hire qualified individuals in a leader’s family without necessarily appearing to be engaged in self-dealing. But a nonprofit should be sure to complete its customary hiring process, including giving due consideration to outside candidates. Anyone hired under a cloud of self-dealing should not be given preferential compensation.
- Donor gifts that benefit the donor. A donor may attach conditions to its gift that effectively make the donor the beneficiary of the gift. A gift requiring the nonprofit to buy property from the donor, hire the donor’s company, or otherwise provide the donor with a material financial gain may need to be turned down or renegotiated.
The Church Law Center of California supports religious and secular nonprofits in all phases of their development and operation. We help our clients examine their major financial transactions to ensure that potential problems with self-dealing are properly addressed through the governance process. To find out how we can be of help for your nonprofit, call us at (949) 892-1221 or reach out to us through our contact page.