Nonprofit Law Jargon Buster – Private Inurement v. Private Benefit

Nonprofit Law Jargon Buster – Private Inurement v. Private Benefit

Private Inurement vs. Private BenefitThe 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 benefitting. 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.

Comments (5)

  • Avis Williams

    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?

  • Rick

    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.

  • Charity Boss

    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?

  • Louis Drace

    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?

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