DONT FORGET THE TAX RULES
profits interact with related parties. If
a New York charity were, for example,
to buy a headquarters building from a
trustee, the old New York law required
that the transaction be fair, but didn’t
have much to say about the process
used to approve the deal.
The new act adds such rules to New
York law for the first time. Federal
tax law, however, has long contained
detailed rules regarding related party
transactions. Unfortunately, the new
New York State rules differ from the tax
rules in a number of important respects,
presenting significant traps for the
unwary. It is important that non-profits
not lose sight of the federal tax law in
complying with the new state rules.
There are two important requirements
under federal tax law to note.
The first are the so-called “excess
benefit” rules, which apply to transactions
between charities and related persons,
such as trustees. Under these rules
all such transactions must be at fair
market value.
While this may sound simple, the
IRS rules apply to a different set of
transactions than the new New York
law. Careful legal analysis is required to
determine whether one or both regimes
apply. As a matter of best practice, it
makes sense to assume that both sets
of rules apply to all transactions.
In addition, the two sets of rules contain
different requirements about how related
party transactions need to be approved.
The IRS rules contain a safe harbor which
presumes that a transaction is fair if it
was properly approved by disinterested
board members after considering data
about similar deals. In the example
involving the trustee selling a building to
the non-profit, the non-profit would need
to obtain an appraisal with comparables
and the trustee could not participate in
consideration of the purchase.
New York does not contain a safe harbor
and a transaction can be questioned even
if all of the applicable requirements are
followed.
In addition, under New York law,
following the federal safe harbor
procedures is not enough. To comply
with New York law, no trustee that
has any business relationship with
the corporation can participate in
consideration of the sale. This includes
any trustees that are employees of the
corporation, who are employed by
companies that do significant business
with the corporation, or have relatives
that fall in these categories.
Another key area of overlap is the
“self-dealing” rules applicable to grantmaking foundations.
These rules contain many specific and
often counterintuitive prohibitions on
transactions between the foundation and
related persons, including transactions
that would benefit the foundation.
For example, these rules would prohibit
the organization in our example from
buying the building from the trustee,
even at, or below, fair market value,
regardless of the procedures that are
followed. (The trustee would be allowed
to donate the building.) Just because
a transaction is allowed under New
York law doesn’t mean that the tax
rules allow it.
Historically, the New
York Attorney General has
had plenary authority to act
on behalf of the people to
ensure that the assets of nonprofits are used to further
their mission. However,
New York law has not had
any specific procedural
requirements with respect
to how non-profits interact
with related parties.”
The revised New York law requires
that non-profits have a policy about
transactions with interested persons
complying with the above rules. The
IRS doesn’t require a policy of this
kind, but it has promulgated a model
policy that many non-profits adopt but
which contains rules that are different
from the New York requirements.
While protecting against abuses in
transactions with related parties may
seem like a matter of common sense,
there are many very specific rules both
under federal tax rules and under the
new New York law. Unfortunately, these
requirements are not always consistent
with each other, presenting many
opportunities for inadvertent missteps.
Non-profits should establish policies
that comply with both sets of rules and
be sure to abide by these policies in
any transactions with their directors,
officers, trustees, or key employees. n
Joshua E. Gewolb, Esq. is a tax attorney at
Harter Secrest & Emery LLP. He can be contacted
at: [email protected]
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