Question: I sit on the board of Directors of a public charity which is planning to purchase a real estate property owned by one of the board member’s companies. Should I be concerned if the board approves this transaction and will I have any liability?
Answer: The Internal Revenue Code imposes restrictions designed to prevent public charities from engaging in what are called “private inurement transactions”. The private inurement rules prohibit board members, trustees, officers, key employees and other insiders of public charities from unreasonably benefitting from the activities of their organization. Private inurement often arises in connection with remuneration paid to insiders which are deemed to be excessive. Private inurement issues also exist where an organization might potentially be paying above market value consideration for the purchase of property owned in part by a member of the organization’s Board of Directors.
If a public charity is deemed to have engaged in a private inurement transaction with an insider by receiving an excess benefit, then certain consequences result. A tax of 25% is imposed as an intermediate sanction on the excess benefit received by an insider who participates in a private inurement transaction. In addition, an insider will need to repay the excess benefit to the organization. If repayment is not timely made, then an additional tax of 200% of the excess benefit is imposed on the insider. The IRS could also revoke the tax-exempt status of the public charity.
Of greater concern to you, a tax of 10% is imposed on the excess benefit of any other person, including board members, who approve an excess benefit transaction. Any board member who opposes the transaction will not be considered to have participated in the transaction and will not be subject to the 10% excess benefits tax. Silence, however, will not exonerate a board member from the tax imposition.
The IRS has established a rebuttal presumption that payments to insiders are presumed to be reasonable and not excessive if the organization’s Board of Directors relied on appropriate data from independent third parties prior to making its determination, the arrangement and transaction is approved by the board and no individual who had an actual or potential conflict of interest with respect to the transaction participated in the negotiations and discussions. If your organization wishes to proceed with this transaction, then an appraisal should be obtained substantiating the fair market value of the real estate property proposed to be purchased. Assuming the appraisal was conducted by an independent third party appraiser and is otherwise reasonable, reliance on this appraisal may permit you to avoid being subject to these tax impositions. The board member whose company owns the property should neither vote on your organization’s decision to purchase the property nor participate in any discussion on this matter by the Board of Directors. If for whatever reason the board refuses to obtain an appraisal or otherwise fails to follow these procedures, you should object to the transaction and be certain that your dissent is noted in the meeting minutes so as not to create personal liability for you in the future.
While being a member of a public charity’s Board of Directors is often desirable, board membership carries exposure with it. Being a member of a Board of Directors can impose liability on a board member where the board acts improperly in one or more circumstances. Being a member of the Board of Directors of a public charity carries additional exposure due to the potential tax impositions and, therefore, special caution should be exercised if membership on a governing body is accepted.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to [email protected].
