Q&A #156 – Who is considered a family member under nonprofit conflict of interest rules?
Question: I am a Board member of a 501(c)(3) nonprofit organization that is looking to hire a graphic designer. One of our Board members has a cousin who owns a graphic design business that has offered to do this work for a very reasonable rate. Is this family relationship a conflict of interest and is the related Board member required to abstain from voting on this transaction?
Answer: Extended family members such as aunts, uncles, and cousins generally fall outside of the technical definition of “family members” under the federal tax code provisions governing conflicts of interest involving 501(c)(3) nonprofit organizations. However, these types of relationships can certainly lead to the perception that there is a conflict and should be treated as such to avoid the risk of damaging your organization’s reputation.
The main tax rules governing nonprofit conflicts of interest are the “excess benefit transaction” rules for 501(c)(3) public charities (often referred to as the “intermediate sanctions” rules) and the “self-dealing” rules for 501(c)(3) private foundations. These rules set forth detailed provisions for determining which family members of Board members, officers, and similar insiders of the organization are considered “disqualified persons,” which generally means that compensation paid to a family member of a Board member or officer gets the same scrutiny as if the compensation were paid to the Board member or officer directly.
These rules also include detailed provisions for applying “disqualified person” status to businesses owned or controlled by disqualified persons, so compensation paid to a business that is owned or controlled by a “family member” of a Board member would typically be subject to the same rules as compensation paid to the Board member directly.
Under the excess benefit transaction rules applicable to 501(c)(3) public charities (as well as 501(c)(4) and certain other tax-exempt organizations), a “family member” includes an individual’s:
Spouse;
Brothers or sisters (by whole or half blood);
Spouses of brothers or sisters (by whole or half blood);
Ancestors;
Children;
Grandchildren;
Great grandchildren; and
Spouses of children, grandchildren, and great grandchildren.
See Code § 4958(f)(4); Treas. Reg. § 53.4958-3(b)(1). This same definition applies when determining which Board members are “independent” for purposes of compliance with recommended best practices related to reviewing compensation under the excess benefit transaction rules. See Treas. Reg. § 53.4958-6(c)(iii). Therefore, it is highly recommended (albeit not necessarily legal required) that a Board member avoid taking part in the approval of any compensation to be paid directly or indirectly to a “family member” of the Board member.
Under the self-dealing rules applicable to 501(c)(3) private foundations, a “family member” includes an individual’s:
Spouse;
Ancestors;
Children;
Grandchildren;
Great grandchildren; and
Spouses of children, grandchildren, and great grandchildren.
See Code § 4946(d); Treas. Reg. § 53.4946-1(h). In other words, the private foundation definition of “family members” is the same one that applies under the excess benefit transaction rules, except the definition does not include brothers or sisters, or to spouses of brothers or sisters in the private foundation context.
Your state nonprofit corporation statute may also have provisions defining “family members” for conflict of interest purposes. Most state nonprofit corporation statutes do not explicitly address this issue, but it is important to review your state nonprofit corporate statute to be sure.
Planning Tip – Avoid using a precise definition of “family members” in your organization’s annual conflict of interest disclosure statements that mirrors the narrow and detailed legal definition in the federal tax code. The purpose of these disclosure statements is to surface as much information as possible to enable to the Board to properly manage actual and potential conflicts. In this case, using a broader and less precise definition of “family” will encourage people to use a broader perspective and err on the side of transparency rather than just look for legal loopholes.
As a technical matter, the relevant federal tax code rules do not count extended family members such as aunts, uncles, and cousins as “disqualified persons” for conflicts of interest purposes. Nonetheless, it would be prudent to apply the same conflict of interest review and due diligence processes to extended and immediate family members, regardless of the legal definition. This is because transactions involving family members tend to be highly sensitive and often give rise to the perception of a conflict of interest, which can pose similar risks to public trust and an organization’s reputation.
If you have a question you would like to submit to SE4N, send it to us using the contact form and we will consider answering it in a future post. Please do not send confidential information.
