It may not be the responsibility of an HR manager in the nonprofit sector to be aware of all of the laws that apply to nonprofits. However, there are some laws that have impact specifically on matters within the purview of the HR department that are worth being aware of. Here, we will briefly discuss a few of the laws that might most frequently apply to the work of an HR manager at a Section 501(c)(3) public charity.
Prohibitions Against Private Inurement, Private Benefit, and Excess Benefit Transactions
Private Benefit Doctrine
To qualify as exempt under Internal Revenue Code (“IRC”) Section 501(c)(3), an organization must be operated for the benefit of the public and cannot serve a private interest—a requirement referred to as the private benefit doctrine. The concern behind the doctrine is that, by providing more than an incidental private benefit to an individual or entity, the organization may not be operated primarily for an exempt purpose, as Section 501(c)(3) requires.
The private benefit doctrine does not entirely prohibit an organization from conferring benefits on individuals; rather, it requires that such benefits to individuals must be incidental, both quantitatively (i.e., the private benefit is not excessive in amount) and qualitatively (i.e., the private benefit is a mere byproduct of the public benefit), to furthering of the organization’s exempt purposes. The doctrine is the broadest of the private benefit rules that apply to IRC Section 501(c)(3) organizations in that it covers any individual on whom the organization may confer a benefit and includes both monetary payments and other benefits.
Facts and circumstances that may raise a concern regarding the provision of a prohibited private benefit include entering into transactions or providing payments on unreasonable or unfavorable terms to the nonprofit; conferring benefits on private parties beyond what is necessary to further the nonprofit’s exempt purposes; establishing exclusive business dealings with a particular for-profit business; failing to consider alternative sources or comparable prices when purchasing goods or services; and serving too small of a class of beneficiaries.
A 501(c)(3) exempt organization is similarly prohibited from allowing any part of its net earnings to inure to the benefit of any private shareholder or individual, a rule known as the private inurement doctrine. The private inurement doctrine generally prohibits a nonprofit from using its assets to provide an unjust enrichment to a person having a personal and private interest in the organization’s activities.
The private inurement doctrine is narrower than the private benefit doctrine in that it applies only to insiders of the organization (i.e., a director, officer, or key employee or other person in a position to influence or control use of the organization’s assets), rather than any individual receiving an impermissible benefit. However, the restriction on private inurement is absolute, meaning there is no such thing as incidental private inurement, and the penalty for an organization that engages in a private inurement transaction is much stiffer: the potential revocation of its exempt status.
The private inurement doctrine does not bar a nonprofit from entering into any and all transactions with insiders. Rather, it requires the nonprofit to ensure that it is not providing such insiders with a disproportionate share of benefits based on what the organization is receiving in return.
From an HR perspective, concerns regarding the private benefit and private inurement doctrines are most likely to arise around issues involving compensation. Some examples of situations in which private inurement violations may be found include:
- Compensation arrangements with an insider that do not include an upper limit or cap;
- Compensation arrangements based on factors extrinsic to performance at and benefit provided to the organization; and
- Payment of more than fair market value for goods or services provided by an insider.
Nonprofits should also be careful when considering entering into transactions that, due to their complexity or uniqueness, may be more difficult to analyze for potential private inurement violations, such as:
- Compensation arrangements that include considerations such as deferred compensation, bonuses, fringe benefits, or retirement or severance packages;
- Arrangements that involve assigning rights to intellectual property developed by insiders and funded, in whole or in part, with organizational assets; or
- Use of organizational assets to support, fund, or otherwise invest in an insider’s business.
Nonprofits may be able to help mitigate against the risk of providing a prohibited private benefit or entering into a transaction involving private inurement by having and using a well-drafted conflict of interest policy and obtaining the assistance of experienced counsel. (more…)