I wrote a white paper about compensation considerations for foundation insiders. It is a topic that should not be overlooked while working with foundation insiders, such as family members. If the member’s compensation does not correlate with the IRS’ regulations, heavy penalties ensue, and in the long run, leads to a loss of money. This is why it is important to consider the risk and rewards of compensating an insider. If you decide to move forward with an insider, pay close attention to the rules and regulations.
Many foundations have family members serve on their board, however sometimes foundations have trouble deciding whether or how much to pay those family members. Careful consideration must be taken when deciding these factors to avoid the foundation using a family member’s seat on the board as a vehicle for making a tax-exempt transfer of assets. The risk of this occurrence can be avoided by following the regulations imposed by the IRS.
The regulatory law on the matter of family compensation within foundations is very clear in that any financial transaction between a foundation and an “insider,” or a disqualified person,1 is considered self-dealing, and therefore not allowed. An insider could be a foundation manager (i.e. officer, director or trustee), a foundation contributor with a 20% or greater business interest, owners and family members of any of those individuals. Certain entities owned or controlled by disqualified persons may also fall under this category. The only exceptions to this rule would be payment for personal services and payments deemed necessary, which the guidelines for this differs based on things such as other charities compensations, location and size of the organization.
There are penalties for charities that neglect the IRS guidelines and proceed to compensate their insiders in an unreasonable manner.
Some of the penalties include paying fees to the IRS. For example, if an organization spends funds unreasonably for a cause that does not assist the organization’s charitable duties, the organization will be penalized. In this case, the foundation must collect the excess compensation spent on an insider, and pay a fee of 20% of that amount to the IRS. The director of the foundation then also must pay a 5% fee of the excessive amount spent to the IRS.
It all comes down to whether or not a compensation is seen to be reasonable by the IRS’ standards.
Excessive compensation for insiders is a problem foundations can easily avoid. It is possible, and even a fairly common practice, to pay insiders for their work on a foundation, as long as they are compensated according to IRS rules. Correcting a penalty for excessive compensation is expensive and stressful. Taking the extra steps to ensure the foundation is following regulations for the personal services and reasonable and necessary compensation standards is key to remaining in compliance and avoiding the IRS penalties.
It is easier to abide by the regulations of the IRS than it is to try and get around them.
Susan Hartley-Moss is conscious creator and a trusted wealth advisor with decades of experience. She is passionate about helping family businesses reach their potential through establishing Private Trust Companies (PTCs) and developing family office governance and operating structures. She is also known as a financial author and speaker, publishing her work in mainstream financial magazines such as Estates magazine. She currently serves as a partner at Cerity Partners.
Compensation Considerations for Foundation Insiders - Susan Hartley Moss
Many foundations have family members serve on their board, however sometimes foundations have trouble deciding whether…