July 13, 2022
IRS TE/GE 'Issue Snapshot' identifies issue indicators and audit tips related to self-dealing exceptions
- A new Issue Snapshot, written for IRS agents conducting examinations of private foundations, highlights the agency's focus on self-dealing rules.
- The Snapshot’s lists of "issue indicators" and "audit tips" can help private foundations identify the issues on which the IRS is focused and better understand how audits will be conducted.
- Any benefit conveyed to a disqualified person that is incidental or tenuous should be carefully documented by the private foundation.
In a recent "Issue Snapshot" posted to the IRS website on June 28, 2022, the IRS Tax Exempt and Government Entities division (TE/GE) reviews the incidental and tenuous exception to the self-dealing rules for private foundations and provides pertinent "Issue Indicators" and "Audit Tips" highlighting the areas of self-dealing on which IRS agents should focus during reviews of Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation.
Incidental and tenuous exception to self-dealing
Disqualified persons generally are prohibited from receiving financial or other benefits through their relationships with private foundations. An exception to the prohibition against self-dealing applies if the benefit received is merely incidental or tenuous (Reg. Section 53.4941(d)-2(f)(2)). Benefits included under this exception generally include:
- An incidental or tenuous benefit that a disqualified person receives from the use of the private foundation's income or assets
- An incidental or tenuous benefit of public recognition that a disqualified person may receive based on substantial contributions to the private foundation, including the naming of a building after the disqualified person as a condition of his or her gift
- An incidental benefit of a scholarship or fellowship grant made by a private foundation to the children of employees of a substantial contributor, so long as the scholarship or fellowship grant is consistent with the requirements of (1) the private foundation's exempt status under IRC Section 501(c)(3), (2) the allowance of deductions under IRC Section 170 for contributions made to the private foundation, and (3) IRC Section 4945(g)(1).
The Issue Snapshot recommends actions that will help IRS agents determine whether the incidental and tenuous exception applies. These include:
- Review Form 990-PF, Part VI-B (Statements Regarding Activities for Which Form 4720 May Be Required) to determine if excise tax is due under IRC Section 4941
- Analyze potential self-dealing transactions to determine if the incidental and tenuous exception might apply, taking into consideration that the exception should be narrowly construed
- Review each of the private foundation's grants to determine if a disqualified person has any connection with the organization receiving the grant
- Review the private foundation's website to potentially identify any benefits that a disqualified person could obtain by using the private foundation's assets
The Issue Snapshot concludes with a list of audit tips for IRS agents conducting audits of private foundations. These include:
- Review all transactions between the private foundation and its disqualified persons, obtaining evidence from contracts, meeting minutes, bank statements, cancelled checks, interviews, tours of the facility, personnel and payroll records
- Review other Chapter 42 excise taxes to ensure no other violations occurred — e.g., of IRC Section 4942 (Mandatory Distributions), IRC Section 4943 (Excess Business Holdings), IRC Section 4944 (Jeopardizing Investments), and/or IRC Section 4945 (Taxable Expenditures)
- Tour the private foundation's facilities to observe the foundation's real and personal property
- Review balance sheet listing of assets, including depreciation schedules
- Locate all assets, even if fully depreciated, and identify who is using them
- Determine how the private foundation disposes of fully depreciated assets (e.g., by giving them to disqualified persons)
- Review rental agreements, sales contracts, agreements and side deals involving the private foundation and disqualified persons
- Examine the private foundation's income stream to ensure income is not being derived from any activity involving a disqualified person
IRS TE/GE continues to focus on and refine its data-driven approach to identifying exempt organizations for examination and conducting those examinations. Among its examination priorities is private foundations that engage in self-dealing with disqualified persons. Accordingly, private foundations should review the issue indicators and audit tips provided in the Issue Snapshot, evaluate their transactions that could potentially involve self-dealing, and document how any benefit to disqualified persons in those transactions is incidental or tenuous, as described in the examples above.
Please contact your Ernst & Young LLP professional for further information.
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