Understanding Self-Dealing: The IRS Rule Every Family Foundation Must Know
What Is Self-Dealing and Why It Matters
Previously, we discussed the 5% spending rule for family foundations. Another equally important regulation governs how foundations operate — it’s called self-dealing.
Self-dealing occurs when a transaction personally benefits someone closely connected to the foundation. In simple terms, it’s when foundation resources are used in a way that serves private interests rather than charitable purposes.
Why so many rules? Because family foundations enjoy substantial tax advantages, and the IRS wants to ensure those benefits aren’t misused. These restrictions — including the 5% spending requirement and the self-dealing prohibition — exist to maintain fairness and public trust.
If the primary goal is simply avoiding taxes without engaging in genuine philanthropy, a family foundation may not be the right choice. These rules are what keep charitable giving legitimate and compliant.
Why the IRS Created the Self-Dealing Rule
Family foundations are recognized as charitable organizations, which grants them significant tax breaks. However, with those advantages comes accountability.
The IRS established self-dealing rules to prevent individuals from using foundations as personal tax shelters. The purpose is simple: protect the integrity of charitable organizations by ensuring that donations and grants benefit the public — not private parties.
Defining Self-Dealing in One Sentence
Self-dealing is any transaction between a family foundation and a disqualified person that results in personal benefit.
Who Counts as a “Disqualified Person”?
The IRS defines several categories of individuals and entities as disqualified persons. These are people or organizations that have significant influence over the foundation.
Here are the main ones:
Major donors: Anyone who has given more than $5,000, if that amount represents over 2% of the foundation’s total contributions.
Foundation managers: Board members, officers, or individuals directly managing foundation activities.
Immediate family members: A spouse, parents, or children of a major donor or foundation manager (but not siblings, cousins, or aunts unless they have separate qualifying influence).
Related businesses: Companies can also be disqualified. For example, if a business donates $5,000 and a family member owns 20% of it, both the business and that individual qualify as disqualified persons.
Key idea: If someone has meaningful influence over foundation decisions, they’re likely considered disqualified. For example, a spouse who participates in decision-making is disqualified; an uninvolved aunt is not.
What Actions Count as Self-Dealing?
Here are the most common types of transactions the IRS considers self-dealing:
Buying or selling: Selling your company’s products to your foundation or purchasing assets from it.
Leasing property: Renting space to or from your foundation.
Loans: Borrowing from or lending to the foundation.
Providing goods or services: Charging the foundation for services or materials you supply.
Paying salaries or fees: Compensating foundation insiders or family members without proper justification.
Exceptions: When It’s Not Self-Dealing
Despite the strict rules, the IRS allows certain reasonable exceptions that make running a foundation practical.
1. Reasonable Salaries
Paying yourself or others can be permitted if the compensation meets three conditions:
It’s based on actual work performed and hours contributed.
It aligns with fair market value (for example, $100,000–$200,000 for roles comparable to financial advisors or board members).
It’s not excessive or beyond industry standards.
You can even hire family members and pay them fair wages for legitimate work. If you’re retired and spend more time managing the foundation, a modest pay increase can also be justified. The IRS focuses on reasonableness and transparency, not punishment.
2. Free Services or Transactions
If no one profits, it’s generally not self-dealing. Examples include:
Allowing your foundation to use your home office rent-free.
Loaning money to your foundation without charging interest.
Because these transactions don’t result in personal gain, they’re fully acceptable under IRS rules. Running a foundation from home or providing voluntary support is perfectly fine — as long as you’re not billing the foundation for it.
Summary: Staying Compliant With Self-Dealing Rules
The IRS provides an extensive list of self-dealing definitions and exceptions, but the fundamentals are straightforward:
Self-dealing is any transaction between a foundation and a disqualified person that provides personal benefit.
Disqualified persons include major donors, foundation managers, immediate family members, and certain related businesses.
Business transactions between disqualified persons and the foundation are prohibited.
Exceptions: Paying reasonable compensation or offering free services is allowed.
By following these principles, family foundations can maintain compliance, protect their tax-exempt status, and continue making a meaningful charitable impact.
Consult A Tax Professional
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This post is to be used for informational purpose only and does not constitute legal, business, or tax advice. Each person should consult his or her own accountant, attorney, or business advisor with respect to matters referenced in this post. Zhou Agency assumes no liability for actions taken in reliance upon the information contained herein.
