Nonprofit Tax Risk & Strategy Series (Part 4)
Transactions involving insiders are a common and often necessary part of operating a nonprofit organization.
However, they are also one of the most closely reviewed areas by the IRS.
These transactions are not prohibited—but they must be properly structured, approved, documented, and disclosed. When they are not, they can raise concerns about private benefit, governance, and overall compliance.
Understanding how to manage these transactions is essential to reducing risk.
What Is a Related Party Transaction?
A related party transaction generally involves an individual or entity that has a close relationship with the organization.
This may include:
- Officers and directors
- Key employees
- Family members of insiders
- Businesses owned or controlled by insiders
These relationships are disclosed on Form 990, including Schedule L, and may also affect other areas 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.
Tax-exempt organizations must operate for the benefit of the public—not for the financial benefit of insiders.
While transactions with related parties may be appropriate, the IRS evaluates whether they:
- Are conducted at fair market value
- Serve the organization’s best interest
- Are approved through an independent process
- Are fully disclosed on Form 990
In many cases, the issue is not the transaction itself—but the lack of transparency or documentation.
Common Areas of Risk
Business Transactions with Insiders
Payments to businesses owned or controlled by insiders are common—but highly scrutinized.
Examples include:
- Consulting or advisory services
- Vendor contracts
- Professional services
These transactions must be conducted at arm’s length, meaning they reflect terms that would be agreed upon between unrelated parties.
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
All loan arrangements should be formalized and consistently applied.
Leases and Property Arrangements
Leasing arrangements involving insiders—such as office space or equipment—must reflect fair market value.
Informal or preferential arrangements can create compliance risk.
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 for disclosure purposes.
Incomplete or Missing Disclosures
One of the most common issues is failing to fully disclose related party transactions.
This may include:
- Omitting transactions from Schedule L
- Providing incomplete information
- Inconsistencies across the return
Because Form 990 is a public document, incomplete disclosures can raise questions—even when transactions are appropriate.
The Most Common Issue: Lack of Structure
Many organizations do not have a formal process for identifying and managing related party transactions.
As a result:
- Transactions may not be identified early
- Documentation may be incomplete
- Disclosures may be inconsistent
The issue is often not the transaction itself, but the absence of a clear and consistent process.
How to Structure Related Party Transactions Properly
Organizations can reduce risk by implementing structured procedures:
- Maintain and update conflict of interest disclosures annually
- Identify related parties before entering into transactions
- Evaluate transactions based on fair market value
- Obtain approval from disinterested board members
- Document how terms were determined, including comparability data
- Ensure accurate and complete reporting on Form 990
A proactive approach helps ensure compliance and transparency.
Why This Matters
Related party transactions are visible not only to the IRS, but also to:
- Donors and grantors
- Regulators
- Charity watchdog organizations
Improperly structured or disclosed transactions can lead to:
- Increased IRS scrutiny
- Questions about governance practices
- Potential excise taxes in certain cases
- Reputational risk
Transparency is critical.
Final Thought
Related party transactions are not inherently problematic—but they are highly visible and closely reviewed.
The key is not to avoid these transactions, but to structure them properly, document them thoroughly, and disclose them transparently.
A well-structured approach helps protect both the organization and its mission.
What’s Next
In Part 5, we will focus on:
Governance and internal controls—and what your Form 990 reveals about your organization.
