Private Operating Foundation’s Loans Found to be Self-DealingPrivate Operating Foundation’s Loans Found to be Self-Dealing

In Chief Counsel Advice (CCA) 202504014 (Jan. 24, 2025), a married couple established a private foundation (PF). The taxpayers, who both served as the PF managers, funded it with stock. Then, over several years, the PF loaned funds to two companies that the taxpayers had also founded and continued to operate or manage in various ways. For example, the taxpayers served as board members of the entities and were majority or significant equity owners. One of the taxpayers was also responsible for managing the day-to-day operations of one of the companies. The loans were interest-only and extended multiple times.

The CCA found that the PF’s unsecured loans to the business entities and the repeated extension of those loans served the private interests of the taxpayers and entities, which meant that the PF was being operated in furtherance of a nonexempt purpose. Under Internal Revenue Code Section 501(c)(3), an organization will lose its tax-exempt status if more than an insubstantial part of its activities further nonexempt purposes. If the exempt organization is a source of credit for its founder, that counts as serving a private interest.

In addition, the loans were indirect self-dealing. Self-dealing includes any direct or indirect lending of money between the PF and a disqualified person. The taxpayers were clearly disqualified persons with respect to the PF, but the transactions were between the PF and the entities, which weren’t disqualified persons because they didn’t own 35% or more of the entities.   Treasury Regulations Section 53.4941(d)-1(b)(4) provides that a transaction between a PF and an organization that’s not controlled by the PF (within the meaning of Treas. Regs. Section 53.4941(d)-1(b)(5)), and of which disqualified persons don’t own more than 35% of the total combined voting power or profits or beneficial interest shall not be treated as an indirect act of self-dealing between the PF and such disqualified persons solely because of the ownership interest of such persons in such organization.

However, indirect self-dealing can still occur as a result of a transaction between a PF and an organization that isn’t a disqualified person but has owners who are disqualified persons if the facts and circumstances show that the PF’s assets are being used to indirectly benefit such owners. Because the taxpayers benefitted from the PF’s loans to the companies they established, owned significant stakes in and even operated, there was indirect self-dealing.

The taxpayers proposed assigning the loans to public charities to “correct” the self-dealing under IRC Section 4941, which requires that the transaction be undone to place the PF in a financial position no worse than it would be in if the disqualified person were dealing under the highest fiduciary standards. However, assigning the notes to public charities didn’t improve the condition of the PF at all, nor did it make it whole.  As a result, it wouldn’t correct the self-dealing.