Understanding and Avoiding Conflicts of Interest in Private Foundations

Conflicts of interest can arise in any nonprofit organization, but they carry unique implications for private foundations. While many people assume private foundations have more flexibility than other charitable organizations, the reality is quite the opposite. The Internal Revenue Code holds private foundations to stricter standards, particularly when it comes to conflicts of interest, compensation, and self-dealing.

Understanding these differences is essential for anyone involved in managing, governing, or advising a private foundation.

What makes private foundations different

Private foundations differ from public charities in structure and oversight. They often have a smaller donor base, closer family or business ties, and more control concentrated among a few individuals. These same characteristics that make private foundations efficient also create a higher risk for conflicts of interest.

The IRS regulates private foundation transactions under Section 4941, which prohibits acts of self-dealing between the foundation and any disqualified person. A disqualified person includes substantial contributors, foundation managers, officers, directors, trustees, and the family members of those individuals, plus entities in which any of the above hold significant ownership or control.

This definition is intentionally broad. It means that a foundation’s president, executive director, or even a board member’s spouse can fall under the rule, and conflicts do not have to involve money changing hands to be problematic. Any use of foundation assets for personal benefit, even temporarily, can qualify as self-dealing.

Common examples of conflicts and self-dealing

The rules for private foundations cover a wide range of activities.

Common examples include:

• Sale or exchange of property between a foundation and a disqualified person, even at fair market value

• Leasing or lending foundation property for personal use, such as borrowing artwork or using event space

• Purchasing event tickets or sponsoring a table with foundation funds and having disqualified persons attend at no charge

• Paying personal expenses or providing compensation that exceeds what is considered reasonable

Even well-intentioned acts can trigger violations. In one historical example, Winthrop Rockefeller, the son of a substantial foundation contributor, attempted to purchase land from the family foundation at above-market value. The IRS still considered it an act of self-dealing.

More recent cases have drawn attention to foundation boards that approved luxury travel or accommodations at the foundation’s expense. These actions, regardless of motive, represent private benefit and must be reported and corrected.

Compensation and reasonable payment

Private foundations are permitted to pay staff and board members for legitimate services, but compensation must be reasonable. Treasury regulations define reasonable compensation as “only such amount as would ordinarily be paid for like services by like enterprises under like circumstances.”

To support this standard, the Council on Foundations’ Grantmaker Salary and Benefits Report provides national benchmarking data for private foundation salaries. Foundations can use such surveys to demonstrate that pay is appropriate for the role and market.

Best practice also requires that any decisions related to compensating a board member or other disqualified person are made by disinterested board members — meaning anyone with a conflict of interest in the decision recuses themselves from the discussion and the vote. The meeting minutes should clearly document the potential conflict of interest and the board’s due diligence in determining fair market value of the services.

Excessive compensation can trigger excise-tax penalties under Section 4941 and may need to be disclosed on the foundation’s Form 990-PF.

Penalties and correction

Acts of self-dealing can carry significant penalties for both the foundation and individuals involved. The IRS may impose:

• A 20 percent excise tax on the disqualified person for the amount involved in the transaction

• A 5 percent excise tax on any foundation manager who knowingly participated

• Additional taxes of up to 200 percent for the individual and 50 percent for the manager if the transaction is not corrected

Correction typically means reversing the transaction and restoring the foundation’s position as if the act had not occurred. The foundation must report these actions on Form 4720 and maintain detailed records to demonstrate compliance.

Avoiding conflicts of interest

Private foundations should take a proactive approach in preventing conflicts of interest. Every private foundation should have a written conflict-of-interest policy that is reviewed and signed annually by board members, officers, and key employees.

That policy should:

• Define who qualifies as a disqualified person

• Outline procedures for disclosing and managing conflicts

• Require recusal from decision-making when a conflict arises

• Emphasize that any use of foundation assets must directly support charitable purposes

Private foundations should also ensure that board members and staff understand how these rules appear on the Form 990-PF. Reviewing the return each year provides valuable insight into the IRS’s expectations and helps identify potential issues early.

Why diligence matters

Private foundations play a critical role in philanthropy, but their close governance structure means the margin for error is small. The IRS expects these organizations to operate with a higher degree of transparency and accountability than public charities.

Board members and managers cannot rely on “I didn’t know” as a defense. Every individual in a position of authority has a responsibility to understand the rules and ensure that foundation assets are used appropriately.

Conflicts of interest, even when unintended, can jeopardize a foundation’s reputation, funding, and tax-exempt status. Awareness and proactive governance are key to avoiding those risks.

Supporting compliance and best practices

At Nonprofit Solutions Law, we help private foundations interpret IRS rules, establish compliant policies, and correct potential self-dealing issues before they escalate. Our team advises foundation boards and managers on how to maintain transparency, document decisions, and ensure charitable dollars are used as intended.

For guidance on managing conflicts of interest in private foundations or reviewing your existing policies, contact our team to learn more.