The self-dealing rules under IRC Section 4941 prohibit almost every financial transaction between a private foundation and its insiders, called “disqualified persons,” and a deal is banned even when the price is fair or the foundation comes out ahead. Violations trigger a 10% excise tax on the disqualified person that jumps to 200% if the transaction isn’t unwound in time. The rule surprises many foundation operators who assume an arm’s-length price makes a transaction safe. It doesn’t.
Who Counts as a Disqualified Person
Section 4941 turns on who’s on the other side of the transaction. IRC Section 4946 defines “disqualified person” more broadly than most people expect.1Office of the Law Revision Counsel. 26 USC 4946 – Definitions and Special Rules The category includes:
- Substantial contributors, meaning anyone who has given more than $5,000 to the foundation if that amount also exceeds 2% of total contributions the foundation has ever received.
- Foundation managers, including officers, directors, and trustees with authority over foundation decisions.
- Anyone owning more than 20% of the voting stock, profits interest, or beneficial interest of a corporation, partnership, or trust that is itself a substantial contributor.
- Family members of anyone in the categories above: spouse, ancestors, children, grandchildren, great-grandchildren, and the spouses of those descendants. Siblings are not included.
- Corporations, partnerships, and trusts in which disqualified persons collectively hold more than 35% of the voting power, profits interest, or beneficial interest.
- Certain government officials, but only for purposes of the self-dealing rules.
The Six Prohibited Transaction Categories
Section 4941 bans six kinds of transactions between a private foundation and a disqualified person, whether direct or indirect. It doesn’t matter who initiates the deal, and it doesn’t matter whether the foundation profits.2Office of the Law Revision Counsel. 26 USC 4941 – Taxes on Self-Dealing
- Selling, exchanging, or leasing property in either direction.
- Lending money or extending credit in either direction, with one narrow exception noted below.
- Providing goods, services, or facilities: a disqualified person cannot furnish them to the foundation for a fee, and the foundation cannot furnish them to a disqualified person on preferential terms.
- Paying compensation or reimbursing expenses to a disqualified person, unless the personal-services exception applies.
- Transferring foundation income or assets to or for the benefit of a disqualified person, even indirectly.
- Agreeing to pay a government official, with a limited exception for hiring someone within 90 days of leaving government service.
Indirect Self-Dealing
The rules reach past face-to-face deals. If the foundation controls another entity, a transaction between that entity and a disqualified person can still be self-dealing. “Control” can involve aggregating the stakes of multiple disqualified persons. If a foundation owns 20% of a company and two family members own another 31% between them, the IRS can treat the company as foundation-controlled because those parties could vote together to elect the board.3eCFR. 26 CFR 53.4941(d)-1 – Definition of Self-Dealing
What Is Actually Allowed
A short list of transactions is carved out because they genuinely help the foundation operate. The exceptions are narrow.
Reasonable Compensation for Personal Services
The most-used exception lets the foundation pay a disqualified person for personal services that are reasonable and necessary to carry out the foundation’s charitable mission, as long as the compensation isn’t excessive. “Personal services” has a specific meaning: it covers professional and managerial work such as legal advice, investment management, accounting, and commercial banking. It does not cover manufacturing goods or other non-professional work.4Internal Revenue Service. IRC Section 4941(d)(2)(E) – Taxes on Self-Dealing, Special Rules If compensation is excessive, only the excess portion counts as the “amount involved” for penalty purposes.
Other Permitted Transactions
- A disqualified person can furnish goods, services, or facilities to the foundation at no charge, as long as the foundation uses them exclusively for charitable purposes.
- The foundation can provide goods, services, or facilities to a disqualified person if they’re made available to the general public on equally favorable terms.
- A disqualified person can lend money to the foundation without interest, as long as the foundation uses the proceeds exclusively for charitable purposes. A loan at any interest rate, even below market, is self-dealing.
Each exception carries a strict purpose limitation. If a disqualified person donates office space but the foundation lets the donor use part of it for personal storage, the exception fails.
How the Amount Involved Is Calculated
Every penalty is driven by the “amount involved.” The general rule is that it equals the greater of the money or fair market value of property given, or the money or fair market value received. For leases or other uses of property, it’s the greater of the actual payment or the fair rental value for the period used. Treasury regulations give a plain example: if a disqualified person uses a foundation-owned airplane for two days and pays $500, but the fair rental value for those two days is $3,000, the amount involved is $3,000.5eCFR. 26 CFR 53.4941(e)-1 Definitions
For the initial tax, fair market value is measured as of the date the self-dealing occurred. For the second-tier tax, the calculation shifts to the highest fair market value at any point during the taxable period. Appreciation while the parties argue about whether a violation occurred raises the penalty.
The Two-Tier Excise Tax
Penalties fall on the people involved, not on the foundation itself, and they’re structured to force fast correction.
First-Tier Tax
The disqualified person who took part in the self-dealing act owes 10% of the amount involved for each year (or partial year) the act stays uncorrected. A foundation manager who knowingly participated owes 5% of the amount involved per year, capped at $20,000 per act. The first-tier tax accumulates annually, so a transaction that stays open for three years generates three years of 10% penalties.
IRC Section 4962 lets the IRS abate first-tier taxes for some foundation violations if the failure was due to reasonable cause and corrected promptly. Self-dealing is explicitly excluded from that relief. Even an innocent mistake triggers the first-tier tax with no statutory escape valve.
Second-Tier Tax
If the act isn’t corrected within the “taxable period,” the disqualified person owes an additional 200% of the amount involved. A foundation manager who refuses to agree to correction owes a separate 50% tax, capped at $20,000. The taxable period runs from the date of the self-dealing until the earliest of three events: the IRS mails a notice of deficiency, the IRS assesses the first-tier tax, or the correction is completed.
When Foundation Managers Face Personal Liability
The manager tax isn’t automatic. It applies only if the manager “knowingly” participated and the participation was “willful.” Under Treasury regulations, “knowing” means the manager had actual knowledge of facts that would make the transaction self-dealing, was aware it might violate the law, and either negligently failed to check or actually knew it was prohibited. Merely having “reason to know” is not enough. “Willful” means voluntary and intentional participation, though no specific intent to break the law is required.6eCFR. Subpart B – Taxes on Self-Dealing
In practice, the strongest protection is a reasoned written opinion from legal counsel before approving any transaction involving a disqualified person. A manager who relies in good faith on professional advice has a strong argument that participation wasn’t knowing or willful.
Correcting a Self-Dealing Act
Correction means undoing the transaction so the foundation ends up in at least as good a financial position as if the deal had never happened. The statute goes further and requires placing the foundation in the position it would hold if the disqualified person had been acting under the highest fiduciary standards.
What that looks like depends on the transaction. A sale to the foundation must be rescinded, with the property returned and the money refunded. A loan from the foundation must be repaid with the interest the foundation would have earned. If the property has appreciated since the self-dealing occurred, the correction has to account for that appreciation. The disqualified person doesn’t get to correct at the original price when the asset is now worth more.
Speed matters. The first-tier tax keeps accruing every year the act stays open, and missing the taxable-period deadline triggers the 200% second-tier penalty. Once the IRS mails a notice of deficiency or formally assesses the first-tier tax, the window for voluntary correction closes.
Reporting on Form 990-PF and Form 4720
Self-dealing creates reporting obligations for both the foundation and the individuals involved. The foundation must disclose each self-dealing act in Part VI-B of Form 990-PF, which asks specifically about each category of prohibited transaction.7Internal Revenue Service. 2025 Instructions for Form 990-PF
If an excise tax is owed, the disqualified person and any liable foundation manager each file Form 4720, the return used to calculate and pay excise taxes under Chapter 42 of the Internal Revenue Code.8Internal Revenue Service. 2025 Instructions for Form 4720 The IRS cross-references Form 990-PF disclosures with Form 4720 filings, and a mismatch between the two is one of the more reliable audit triggers in the private foundation world. Foundations that find a self-dealing violation should correct it and report it promptly rather than hoping it goes unnoticed.