Can a Nonprofit Loan Money to an Individual: Structure and Risks

A nonprofit can loan money to an individual, but only when the loan actually advances the organization’s tax-exempt purpose and the terms follow IRS rules that prevent insiders from profiting at the charity’s expense. Student loans from an education foundation, microloans from a community development group, and home-repair loans from a housing nonprofit are the kinds of lending programs that typically hold up. A loan to a board member’s friend, or a below-market loan to the executive director, is a different animal — and the IRS treats it that way.

Get the structure wrong and the consequences run in two directions: the organization can lose its 501(c)(3) status, and the individuals involved can face excise taxes reaching 200% of the improper benefit.

The Threshold Question: Does the Loan Serve the Exempt Purpose

Organizations recognized under Section 501(c)(3) must operate exclusively for purposes such as charitable work, education, religion, or science. The IRS reads “charitable” broadly enough to include relieving the poor, advancing education, and combating community deterioration.¹ A loan to an individual fits inside those boundaries only when a clear line connects the lending activity to one of them.

The pattern to look for: does the loan program serve a broad charitable class, or does it move money to a specific person because someone connected to the organization wanted it to? Student loans open to applicants meeting objective criteria are one thing. A “loan” arranged for the founder’s cousin is something else, no matter what the paperwork says.

Who You’re Lending To Changes Everything

The single biggest variable is whether the borrower is an insider. The IRS calls insiders “disqualified persons,” and the definition is wide. It automatically includes voting board members, the CEO or executive director, the CFO, and anyone else with ultimate authority over operations or finances at any point in the five years before the loan.²

It doesn’t stop with those individuals. Their family — spouses, siblings, children, grandchildren, and the spouses of those children and grandchildren — are disqualified persons too. So are entities in which disqualified persons collectively own more than 35% of the voting power, profits interest, or beneficial interest.² Lending to a board member’s daughter, or to a company controlled by the treasurer, triggers the same scrutiny as lending directly to the insider.

Two related doctrines apply. Private inurement is a rule about insiders: any amount of benefit flowing to an insider beyond fair value can destroy tax-exempt status. Private benefit is broader — it applies to anyone, insider or not, and is triggered when the organization’s activities give more than incidental benefit to private interests.¹ A loan program restricted to a narrow group of friends of the staff can violate the private benefit rule even if none of those friends are technically disqualified persons.

Structuring a Loan That Holds Up

There is no single IRS checklist that immunizes a nonprofit loan from challenge. But guidance and reporting requirements make clear what a defensible loan looks like.

Written Terms and Consistent Criteria

IRS Publication 557 tells 501(c)(3) organizations making charitable or educational loans to be prepared to explain the circumstances under which loans are made, the eligibility criteria, how recipients are selected, the repayment terms, any security required, and the interest rate charged.³ In practice, every loan needs a written agreement covering these elements, and the organization should be able to show it applies the same criteria across borrowers rather than deciding case by case.

Board Approval and the Rebuttable Presumption

When the borrower is a disqualified person, the IRS recognizes a “rebuttable presumption of reasonableness” if the organization takes three specific steps:

The transaction is approved in advance by board members or a committee with no financial interest in the deal.
Before voting, that body obtains and relies on data showing the loan terms are comparable to what an arm’s-length lender would offer.
The board records its decision and the basis for it at the time of the vote, not afterward.⁴

Meeting all three doesn’t make the transaction untouchable, but it shifts the burden to the IRS to prove the terms were unreasonable. Skip any one of the three and the protection is gone.

The Interest Rate Floor

For loans to disqualified persons, the interest rate cannot fall below the applicable federal rate (AFR) the IRS publishes each month. Charging less than the AFR means the shortfall counts as an excess benefit.³ Because the AFR changes monthly, check the IRS revenue ruling for the month your loan actually closes rather than relying on a rate you saw earlier.

A Real Conflict of Interest Policy

The IRS expects every nonprofit to have a written conflict of interest policy. Its job is simple: when a board member or officer has a personal stake in a transaction, the policy makes them disclose it and keeps them out of the vote.⁵ A loan to an insider who sat in on the discussion and helped shape the terms is almost impossible to defend later.

Loans to Employees

Employee loans — for relocation, emergencies, or education — are common, and they have their own rulebook. IRC Section 7872 governs below-market loans between employers and employees. If the interest rate falls below the AFR, the IRS treats the shortfall as additional compensation paid to the employee and interest paid back by the employee. That means imputed compensation for the nonprofit to report and income tax for the employee to pay.⁶

There is a useful exception. Loans of $10,000 or less are exempt from Section 7872’s imputed interest rules, provided tax avoidance isn’t a principal purpose.⁶ Once the outstanding balance crosses that threshold, the full rules apply.

Reporting the Loan on Form 990

Any loan between a nonprofit and an “interested person” — a category that overlaps heavily with disqualified persons — must be reported on Schedule L of the annual Form 990. There is no minimum dollar amount; every qualifying loan is listed separately.⁷ Schedule L is also where 501(c)(3) and 501(c)(4) organizations disclose excess benefit transactions.

If a loan goes bad and the loss is large, it may need to be reported as a significant diversion of assets in Part VI of Form 990. The IRS treats a diversion as “significant” when the value exceeds the lesser of 5% of gross receipts, 5% of total assets, or $250,000.⁸ Answering yes triggers an obligation to explain the circumstances and corrective actions on Schedule O.

What Happens When Things Go Wrong

Excise Taxes on Excess Benefit Transactions

When a loan to a disqualified person crosses into an excess benefit transaction, the penalties escalate fast. The disqualified person who received the benefit owes an excise tax of 25% of the excess benefit amount. If the transaction isn’t corrected before the IRS mails a notice of deficiency or assesses the tax, a second tax of 200% of the excess benefit applies on top of the first.⁹

Organization managers who knowingly approve the transaction face their own 10% excise tax on the excess benefit, capped at $20,000 per transaction.⁹ The cap has sat at $20,000 since 2006 without inflation adjustment. This tax applies only when the manager’s participation was willful and not due to reasonable cause, which is exactly why the documentation and board-approval steps carry so much weight.

Loss of Tax-Exempt Status

Beyond excise taxes, the IRS can revoke a 501(c)(3) altogether. Revocation makes future donations nondeductible, subjects the organization’s earnings to income tax, and does reputational damage that usually can’t be undone. The Section 4958 excise taxes are generally the first-line tool, but revocation stays on the table for organizations that show a pattern of abuse.

Default and Forgiveness

A loan that isn’t repaid creates two problems. For the borrower, cancellation of $600 or more in debt generally requires the lender to file Form 1099-C, and the borrower owes income tax on the forgiven amount unless an exception applies (such as insolvency or bankruptcy).

For the nonprofit, forgiving a loan to an insider can itself be an excess benefit transaction: the organization gave away money that was owed back. Even forgiving a loan to a non-insider raises questions. If the “loan” was never realistically expected to be repaid, the IRS may treat it as a grant from the start, which can create its own compliance problems for private foundations that didn’t follow grant-approval procedures. A loan sitting on the books unpaid year after year signals either weak underwriting or a disguised gift, and either reading attracts attention.

Rules Outside the Tax Code

Federal tax rules aren’t the whole picture. Most states regulate consumer lending through licensing, and nonprofit status doesn’t automatically create an exemption. Some states carve out exceptions for bona fide nonprofits lending on favorable terms; others require the same license a commercial lender would need. Check your state’s financial regulation agency before launching a program.

Federal consumer credit law applies based on activity, not entity type. Under the Truth in Lending Act and Regulation Z, a nonprofit that extends consumer credit more than 25 times in a calendar year — or more than five times for loans secured by a dwelling — meets the regulatory definition of a “creditor” and must provide the same disclosures a bank would.¹⁰ Small programs below those thresholds aren’t subject to TILA, but organizations running an active loan portfolio need to budget for compliance.

One worry that usually turns out to be nothing: interest income on charitable loans generally isn’t unrelated business income. Section 512(b)(1) of the Internal Revenue Code excludes interest from unrelated business taxable income.¹¹ Loans funded with borrowed money can pull some of that interest back into UBIT territory under the debt-financed income rules; loans funded from the organization’s own cash or donations are generally clean.

When Not to Lend

Direct lending carries enough regulatory friction that many nonprofits pick a different tool. Grants and scholarships serve the same charitable goals without creating a debtor-creditor relationship or the reporting that follows. Private foundations making grants to individuals need advance IRS approval of their selection procedures, and grants must be awarded on an objective, nondiscriminatory basis.¹²

Direct payment for services is another option. Instead of lending money for medical bills, pay the hospital. Instead of a home-repair loan, pay the contractor. The individual still benefits, and the organization keeps control over how the funds are used without the paperwork, tracking, and default risk that come with running a loan program.

1
Internal Revenue Service. Exempt Purposes – Internal Revenue Code Section 501(c)(3)
2
eCFR. 26 CFR 53.4958-3 – Definition of Disqualified Person
3
Internal Revenue Service. Publication 557 (01/2025), Tax-Exempt Status for Your Organization
4
Internal Revenue Service. Rebuttable Presumption – Intermediate Sanctions
5
Internal Revenue Service. Form 1023: Purpose of Conflict of Interest Policy
6
Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates
7
Internal Revenue Service. Instructions for Schedule L (Form 990)
8
IRS.gov. 2025 Instructions for Form 990 Return of Organization Exempt From Income Tax
9
Office of the Law Revision Counsel. 26 USC 4958 – Taxes on Excess Benefit Transactions
10
eCFR. 12 CFR Part 226 – Truth in Lending (Regulation Z)
11
Office of the Law Revision Counsel. 26 U.S. Code 512 – Unrelated Business Taxable Income
12
Internal Revenue Service. Grants to Individuals