Private Inurement and Private Benefit rules exist to ensure that any and all section 501(c)(3) organizations operating in the United States are truly worthy of the tax exemption that their status affords them. In order to be eligible for tax exempt status under section 501(c)(3) of the Tax Code, organizations must demonstrate that they exclusively “serve a public rather than private interest.” No organization whose donations or assets are directly or indirectly used to benefit an individual or for-profit entity is eligible for section 501(c)(3) tax exempt status.
What is the difference between Private Inurement and Private Benefit?
The main difference between the two is the distinction of who is benefitting from the tax exempt status of a section 501(c)(3) organization.
The insider rule. It is illegal for a tax “exempt organization’s income or assets” to disproportionately benefit an individual or for-profit entity that has “significant influence over the organization” or is otherwise “closely related” to it. No party who has any control over the organization, or those closely related to them, may monetarily benefit from operations or transactions with the exempt organization. If an organization violates the private inurement rule, there is no leeway: its tax-exempt status under section 501(c)(3) will be revoked.
This rule relates to benefits granted to private parties, meaning individuals and entities that do not fall within the organization’s charitable class(es) and do not have “significant influence over” or are not “closely related” to the exempt organization in question. The private benefit rule does allow for a minimal amount of private benefit to outsiders, but only so far that the benefit is “incidental” to the proposed charitable purposes of the organization. How do you know if the benefit is incidental?
1) It is the only way to accomplish an activity that is necessary to fulfill the organization’s charitable mission.
2) The private benefit must not be substantial in relation to the “overall public benefit conferred by the activity.”
If an organization violates the private benefit rule, there is no leeway: its tax-exempt status under Section 501(c)(3) will be revoked.
As a nonprofit, you MAY NOT:
Offer ownership of any kind to any individual or company.
All assets are owned by, and remain with, the nonprofit.
Transfer, give or grant charitable donations back to a for-profit institution.Note: Paying for reasonable, budgeted costs for overhead for mission-related purposes is allowed.
Take in charitable funds that are not exclusively used for charitable purposes which serves the donor intent.
Complete transactions or engage in activities in which any of the following parties (insiders) financially or personally benefit from the resources of your tax-exempt organization as a result of their relationship to it:
Board members (unless they fall within your charitable class)
Family members (unless they fall within your charitable class)
Any type of stakeholder
Provide any monetary or material benefit to any private entity or individual that does not directly fulfill the purpose of your organization.
Here Are Some Examples:
Private Inurement (applies to all aforementioned parties):
Paying excessive compensation to the organization’s CEO in the form of bonuses, fringe benefits, housing for below-market rent, low-interest or interest-free loans, etc.
Paying rent greater than market value for office space in a building owned by the organization’s CFO.
Using an interested party’s privately-owned entity for an activity over another and failing to pay fair or below market value.
Hiring a firm to provide consulting services at a rate that is greater than their standard hourly rate when one of the firm’s executives is related to a board member.
Spending more money than fair market value to pay for the food at a fundraising event.
Buying in excess from a privately owned company to conduct a program that satisfies the nonprofit’s mission.
Spending a significantly higher percentage of the nonprofit’s budget on overhead expenses than on the public benefit for which the organization was granted tax-exempt status.