Transactions involving insiders are one of the most common areas of IRS scrutiny for nonprofit organizations.
While these transactions are not prohibited, they must be carefully structured, properly documented, and fully disclosed. When they are not, they can raise concerns about private benefit, governance, and compliance.
Understanding how the IRS evaluates related party transactions is essential to reducing audit risk.
What Are Related Party Transactions?
Related party transactions generally involve individuals or entities that have a close relationship with the organization.
These may include:
- Officers and directors
- Key employees
- Family members of insiders
- Entities owned or controlled by insiders
These relationships are disclosed on Form 990, including Schedule L, and may also impact other sections of the return.
Why the IRS Focuses on These Transactions
The IRS reviews related party transactions to ensure that the organization is not providing improper private benefit.
Nonprofits must operate for the benefit of the public, not for the financial benefit of insiders.
While transactions with related parties may be permissible, they must meet certain standards:
- Conducted at fair market value
- In the best interest of the organization
- Approved through an appropriate process
- Properly disclosed on Form 990
In many cases, it is the lack of transparency or documentation—rather than the transaction itself—that creates risk.
Common Audit Triggers
Business Transactions with Insiders
Payments to businesses owned or controlled by board members, officers, or key employees are closely reviewed.
Examples include:
- Consulting or advisory agreements
- Vendor contracts
- Professional services
The IRS evaluates whether these transactions are conducted on an arm’s-length basis and supported by appropriate documentation.
Loans to or from Insiders
Loans involving insiders can raise concerns, particularly if:
- Terms are not clearly documented
- Interest rates are below market
- Repayment terms are unclear
These transactions must be properly disclosed and supported by formal agreements.
Leases and Property Arrangements
Leasing arrangements with insiders—such as office space or equipment—are another common area of focus.
The IRS considers whether:
- The terms reflect fair market value
- The arrangement benefits the organization
Informal or undocumented arrangements can increase scrutiny.
Transactions Involving Family Members
Transactions involving family members of insiders are also subject to review.
For example:
- Hiring a relative of a board member
- Contracting with a family-owned business
These relationships must be identified and evaluated to determine whether disclosure is required.
Incomplete or Missing Disclosures
One of the most frequent issues is failing to fully disclose related party transactions.
This may include:
- Omitting required disclosures on Schedule L
- Providing incomplete information
- Inconsistencies across the return
Because Form 990 is a public document, incomplete disclosures can raise concerns even when transactions are appropriate.
The Most Common Challenge: Lack of Process
Many organizations do not have a formal process for identifying and reviewing related party transactions.
As a result:
- Potential conflicts may not be identified early
- Documentation may be incomplete
- Disclosures may be inconsistent
In many cases, the issue is not the transaction itself, but the absence of clear procedures and oversight.
A Practical Approach to Managing Risk
Organizations can reduce risk by implementing structured processes:
- Maintain and update conflict of interest disclosures annually
- Identify related parties before entering into transactions
- Obtain approval from disinterested board members
- Document how terms were determined (including comparability data)
- Ensure accurate and complete reporting on Form 990
Coordination between governance, finance, and leadership is essential.
Why This Matters
Issues related to related party transactions can lead to:
- Increased IRS scrutiny
- Questions about governance practices
- Potential excise taxes in certain situations
- Reputational risk with donors and stakeholders
Because these transactions are publicly disclosed, they are often reviewed beyond the IRS.
Final Thought
Related party transactions are not inherently problematic—but they are highly visible and closely reviewed.
With proper structuring, documentation, and disclosure, organizations can manage these transactions appropriately while maintaining compliance and transparency.
