Artisan Q&A: Loans to Non-Profits

Dear Rex,
Our arts organization is waiting on some big donations promised to arrive in January of the new year.  But we’ve got some expenses due in December and not enough money in the bank to pay them all.  Can I make a short-term loan to our organization to cover these expenses and have the organization repay me when the donations are made?  If so, how would it affect my personal taxes and the org’s taxes?  And if the org is unable to repay me, would the loan become a donation or just a bad debt loss?
Board President

Dear Board President,

Exempt organizations receive their special tax treatment to promote and encourage public support of the charitable purposes around which they were organized.  To ensure a few private individuals don’t take advantage of something intended to benefit the public, exempt organization are subject to special rules that prohibit selfish activity.

One such rule is the prohibition against “self-dealing” transactions between an exempt organization and a disqualified person.  Self-dealing transactions include the sale, exchange, or leasing of property; the lending of money or other extension of credit; the furnishing of goods, services, or facilities; the payment of compensation (or payment or reimbursement of expenses); and the transfer or use of the income or assets of the organization.  [Internal Revenue Code Sec. 4941 (d)(1)]

Who is a disqualified person?  Simply put, substantial contributors, foundation managers, and family members of both.  If substantial contributors are themselves organizations, then the owners of more than 20 percent interest of that organization are also considered disqualified. A foundation manager is an officer, director, trustee, or a person having similar responsibilities whether specifically so designated on an official document (like the certificate of incorporation, or bylaws) or if he or she regularly exercises general authority to make administrative or policy decisions on behalf of the organization.  [Internal Revenue Manual 7.27.20]

To recap your particular situation, you are an officer of an exempt organization (a disqualified person) who wishes to loan money to that organization (a prohibited self-dealing transaction).

So this transaction is clearly not allowed, right?  Not so fast.

There is a legal exemption that states the prohibition against a self-dealing loan “shall not apply to the lending of money or other extension of credit by a disqualified person to a private foundation if the loan or other extension of credit is without interest or other charge.”  [emphasis added, 26 CFR 53.4941(d)-2(c)(2)]

As long as (a) you are lending money to the organization and not the other way around, and (b) you are charging no interest on your loan, your loan would be allowed.

If you decide to make this loan, you’ll want to put the loan in writing.  I’d have the full board vote on the loan while you abstain from voting.  The board should, of course, record its decision in the meeting minutes.

For accounting purposes, you would show on your personal books a loan due to you (“notes receivable”); the organization would show that it owed a loan (“notes payable”) in the same amount.  Because the transaction is a loan, rather than a donation, and no interest is being charged, there are no tax consequences for either you or the organization.

If the organization is does not repay the loan, the tax treatment becomes trickier.  The IRS will look at the facts and circumstances of the situation—especially the organization’s financial ability to repay the loan—to determine your “charitable intent” in writing off the loan.  Let’s hope for the best and assume, if this happens, you’ll call in a tax professional to guide you through the process.

The rules around self-dealing and disqualified persons are much more complex and nuanced than I’ve described here.  If your situation doesn’t exactly match the one described above, you owe it to yourself and your exempt organization to get good advice that fits your unique situation.