Nonprofit Law Jargon Buster – Private Inurement v. Private Benefit

The private inurement rule and private benefit rules exist to ensure that charitable assets are preserved for the benefit of the public and not diverted to private use. This is a fundamental concept that distinguishes tax-exempt organizations from for-profits.

The rules originate in the language of Code Section 501(c)(3). Code Section 501(c)(3) contains the specific requirement that:

[N]o part of the net earnings of [the exempt organization] inures to the benefit of any private shareholder or individual . . . .

In addition, under the regulations, an organization is not treated as organized and operated for exclusively exempt purposes “unless it serves a public rather than a private interest,” Based on this provision, tax exempt status is not available to any organization if its net earnings inure to the benefit of private individuals “in whole or in part.”

In practice, the law distinguishes between different degrees of inurement depending upon who is being benefitted. The two types of inurement are referred to as “private inurement” and “public benefit.”

Private Inurement.

The prohibition against private inurement is designed to inhibit what the IRS has called a “disproportionate share of the benefits of the exchange” flowing to an insider when an insider enters into a transaction with an exempt organization.

Under the private inurement rule, none of an exempt organization’s income or assets may unduly benefit a person or company that is closely related to the organization, particularly one who exercises a significant degree of influence over it.  The private inurement rule requires exempt organizations to use a standard of reasonableness to evaluate transactions with insiders (for example, how similar organizations, acting prudently, transact their affairs in similar circumstances) to ensure they are not unduly benefiting the insider in transactions between the insider and the organization.

The most important thing to remember about the private inurement rule is that it lacks any de minimis concept.  Organizations that are found to have violated the private inurement rule face the ultimate penalty of revocation of tax-exempt status.

Private Benefit.

While the private inurement and private benefit rules are based on the same Code provision and policy of preserving charitable assets for the public rather than private parties, they have some important differences.  In contrast to the private inurement rule, the private benefit rule is not limited to circumstances where the benefits accrue to an organization’s insiders.  That is, this prohibition includes benefits conferred on “disinterested” persons and entities, or “outsiders”.

Also unlike the private inurement rule, a “de minimis” amount of private benefit is permissible.   In contrast to the absolute prohibition against inurement, the IRS has traditionally treated the flow of some private benefits to private parties who are “outsiders” as not jeopardizing the organization’s tax exempt status so long as the private benefit is purely “incidental” to the organization’s tax-exempt purposes.  The IRS employs a two-part test for determining whether a private benefit is incidental to an exempt organization’s exempt purpose:

A private benefit is considered incidental only if it is incidental in both a qualitative and a quantitative sense. In order to be incidental in a qualitative sense, the benefit must be a necessary circumstance of the activity that benefits to the public at large, i.e., the activity can be accomplished only by benefiting certain private individuals. To be incidental in a quantitative sense, the private benefit must not be substantial after considering the overall public benefit conferred by the activity.

Like private inurement, the penalty for violating the private benefit rule is revocation of tax-exempt status, a penalty which is often fatal for a tax-exempt organization.

11 Responses to Nonprofit Law Jargon Buster – Private Inurement v. Private Benefit

  1. Thank you for this article! It’s been quite helpful and informative. As a church, are there benevolent limitations as to ‘ what’ we can assist an individual with… for example, paying someone’s signature loan or car note? Unlike, assisting with food, rent, etc, these are interest bearing and would appear that the bank (outsider) would be benefiting. Does that fall under the private benefit rule?

  2. How does a faternal organization give money to people who are considered insiders, officers to attend specific functions that do not benefit the organization members as a whole. i,e giving money to help buy airplane tickets, gas money, hotel expenses. EX: member owns a private company and decides to donate his time to do all the plumbing work for a nonprofit oranization building. The receives expense money (as a member of a frational organization) for gas expense. then turns around and excepts money from the organization to go back to the building for it’s dedicationl. I can’t understand the benefit to the organization as a whole except this person is an officer and the money was voted on the floor of a meeting. Thus has inurement been received. This happens all the time in nonprofit fraternal organizations.. seem fishy to me.

  3. Thanks for putting these concepts in plain English! Where would I go for help to answer the following situation:

    Attorney A operates a law firm that specializes in helping people with a specific injury.

    Attorney A makes charitable contributions to his private foundation, Foundation B.

    Foundation B then makes a restricted donation to Charity C that pays for operation of an information and referral program at a hospital for people with the specific injury.

    Charity C refers all people with the specific injury who need an attorney exclusively to Attorney A.

    Question: Does this situation result in private inurement?

  4. If a person involved with a 501C(3) organization uses his credit card to pay for expenses of the organization in order to get a substantial rebate for his transaction and then gets reimbursed by the organization rather than getting a check from the organization is there jeopardy of private inurement for the organization or private benefit?

  5. I have a question. After my grandfather died a lawyer stepped in and “helped” my grandmother re-write the will. He set up a Private Foundation, of which he is the director. None of my family members are on the board. I am trying to determine if I am able to in some way get a scholarship or grant from the foundation for my daugther who is attending college next year. I was reading about self-dealing, incidental benefits, and private benefits, and seem to be getting conflicting information about this. Can you help with this topic?

  6. Ellis, if an employee uses his/her personal credit card to pay for large business (501c3 organization) expenses such as purchases and travel for subsequent reimbursement by the employer- but does so specifically in order to earn reward miles or points for personal use- could this be deemed private inurement, or at least an abuse?

    A couple of things to note:
    1) There are corporate credit cards that are used by most other employees, but the employee is permitted to use his/her card instead.
    2) The purchases or travel involved are not personal in nature, merely the method of payment that indirectly provides a personal benefit.
    3) There is no benefit available to the employer from its corporate issuer such as miles or points, so that the employee is not getting something personal that would otherwise be obtained by the employer.

  7. Can a church donate to a for-profit business without jeopardizing its tax-exempt status?
    My church has decided to give all cash in next Sunday’s offering to a for-profit startup bagel shop, because the church approves of its hiring and living wage policy and wants to help out. Is this a problem?

  8. I work for a religious NPO as an accountant. I’m quite concerned with the misappropriations of funds. While discussing the general ledger accounts to migrate into our new software system with our CPA, I was informed by the CPA that we will soon be paying the personal mortgage of the President of the foundation (who’s also on the BoD ). His pricey new home is his personal investment and not the Foundation’s asset. The aforementioned mortgage expense is not on the BoD approved proposed budget for 2017.
    Is this not a violation of 501C3 re: personal benefit or inurement?

  9. If it is not treated as taxable compensation it would likely be an excess benefit transaction. They should just raise his compensation which must be reasonable vis a vis similarly situated positions.

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