By law, the money and assets obtained by a 501(c)(3) nonprofit must be used only for its stated charitable purposes and cannot be used to benefit or enrich “insiders,” including the persons who founded it, run or work for it, contribute to it, or are related to it in any way. Tax-exempt status is conferred and maintained only if a 501(c)(3) nonprofit is organized and operated for religious, charitable and scientific purposes and its money is used to further those purposes.
Use by a 501(c)(3) nonprofit of its money to benefit insiders instead of to further the charitable purposes it was intended to support is called “private inurement.” It is a broad term that encompasses a wide range of uses beyond the permitted purposes of furthering the organization’s charitable purposes.
Examples of Private Inurement
- Compensation to insiders that exceeds a typically fair salary for comparable positions, like an allowance for monthly living expenses.
- Payments to insiders for goods or services that exceed the fair market value of such goods or services.
- Use of the organization’s money to pay the personal expenses of the nonprofit’s board members or executives, like a spouse’s automobile lease, country club membership, a vacation rental, a child’s tuition, a wedding, or personal credit card expenses.
- Offering free services to insiders that non-insiders must pay for.
Consequences of Private Inurement
The IRS will usually impose monetary sanctions. In more serious cases, an organization could lose its nonprofit status, and the IRS can revoke the nonprofit’s tax exemption. There is no coming back for a nonprofit whose tax-exempt status is revoked.
Policies and Procedures to Guard Against Private Inurement
Because the consequences of private inurement can be severe or even fatal, a 501(c)(3) nonprofit should thoroughly review its operations to identify all opportunities for private inurement and should establish adequate policies and procedures to prevent it. At a minimum, nonprofits should do the following.
- Require detailed expense reports and conduct routine review to make sure that all personal expenses of insiders are paid for with personal funds.
- Compare compensation arrangements for similar positions at similar nonprofit organizations using online tools such as the The National Council of Nonprofit Associations and state nonprofit organizations.
- Seek competitive bids before obtaining goods or services from insiders.
- Develop and implement a conflict of interest policy.
- Do not provide special benefits to insiders that non-insiders are required to pay for.
Questions?
Did you know the Colorado Nonprofit Legal Center can assist with questions you have about private inurement? Reach out today to ensure you don’t accidentally cross the line. You can reach us at katie@conplc.org or 720-323-2720.
By Julia Parker