Exemptions Allow Foundations to Skirt Law Against Self-Dealing

Exemptions Allow Foundations to Skirt Law Against Self-Dealing

Officers and directors at hundreds of private foundations are benefiting from the funds they're tasked with safeguarding by claiming exemptions from a law that prohibits self-dealing, the Wall Street Journal reports.

Enacted in 1969, the law prohibits most kinds of business transactions between private foundations and their officers, directors, and substantial donors — including property deals, loans, and the exchange of goods and services. A review by the Journal of thousands of tax filings found, however, that many foundations have become adept at taking advantage of complex exemptions to conduct business with such "insiders." According to the Journal, more than eighteen hundred foundations indicated in their 2016 tax filings that they had engaged in business transactions with insiders but were not in violation of the self-dealing law.

Federal regulations say foundations may hire an insider to do law, banking, and investment management work — as long as the insider's compensation is "reasonable." The Journal, however, found multiple examples of foundations paying seven-figure sums to insiders' firms. They include the A.R. "Tony" and Maria J. Sanchez Family Foundation, which, according to its tax filings, made charitable donations totaling $1.5 million in 2016 while paying $1.6 million to two Sanchez family-owned companies for investment and accounting services. According to its filings, over a five-year period through 2016 the foundation awarded a total of $14 million in grants and paid $7 million to family-owned companies.

The law also prohibits foundations from doing business with the spouses, parents, grandparents, children, and grandchildren of insiders, but not with siblings — a loophole that enabled Hirair Hovnanian, co-founder of nationally known homebuilder Hovnanian Enterprises, to transfer about five hundred acres of land to the Hirair and Anna Hovnanian Foundation and then sell the property over about a decade to the publicly held company. According to property records, the foundation received gifts of land from Hovnanian and sold it the same day to Hovnanian Enterprises numerous times between 2005 and 2013, although the foundation's tax filings don't disclose the value of the donations or sales.

While a donor can't donate money to his/her foundation, claim a tax deduction, and then have the foundation make a loan to a business s/he owns, s/he can make a loan to his/her business and then make a tax-deductible donation of that loan receivable to the foundation. The result, according to Bruce Hopkins, a Kansas City-based expert in nonprofit and private foundation law, is to simultaneously infuse the business with capital and lower the donor's tax obligation. For example, the Tufenkian Foundation's latest tax filing, from November 2015, reported $9.7 million in outstanding loans to a carpet company owned by the foundation's president. James Tufenkian told the Journal that his foundation never made a loan to his company, which instead is paying interest on promissory notes donated to the foundation.

The Journal's analysis also found that about sixty foundation insiders earned at least $100,000 while working an hour a week or less on foundation business as trustees in 2016. Payments to trustees can be counted toward the 5 percent annual payout requirement for private foundations, and some good-governance groups advise private foundations against paying their board members anything. The risk is that wealthy benefactors could skirt estate taxes by paying children through their foundations, said Dean Zerbe, a former tax advisor to the Senate Finance Committee. For example, the foundation of the late Walter Helmerich III, former president of oil-drilling company Helmerich & Payne, paid $116,000 to each of its trustees — his five sons — in 2016. "It is particularly troubling when trustee payments involve family members of the donor," said Zerbe.

Even if legally defensible, transactions between foundations and insiders may violate the spirit of the law, said William Josephson, a former New York charities regulator. Charitable-foundation assets, he added, are there for "serving a public purpose, and compensating you is not a public purpose."

Andrea Fuller. "Private Charitable Foundations Give Lavish Rewards to Insiders." Wall Street Journal 05/29/2018.