Intermediate Sanctions

Private Inurement

Intermediate sanctions apply only to those 501(c)(3) and 501(c)(4) tax exempt organizations defined in Treasury Regulation § 53.4958-2(a). In order for an organization to become and remain tax exempt in accordance with § 501(c), the organization must avoid private inurement. The doctrine of private inurement is at the heart of distinguishing a tax-exempt or nonprofit organization from a for-profit organization.

One of the limitations to obtaining 501(c)(3) tax exempt status is: “no part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual.”

This seemingly narrow concept is much broader in practice. This doctrine covers persons (individuals), other organizations, trusts, etc., that have influence over the tax-exempt organization's operation.

Here's a more accurate definition:

None of the assets or income of a tax-exempt organization subject to the private inurement doctrine may be permitted to directly or indirectly unduly benefit an individual or other person who has some close relationship to the organization, particularly those individuals or persons who are in a position to exercise a significant degree of control over it..¹

Q: What's the purpose of the private inurement rule?

A: To ensure that the organization is serving its public service purpose and not the private interests of one or more individuals associated with the organization.

The operative word in the above definition is "unduly." Clearly, individuals who are part of the organization will have transactions with the organization. But these transactions must meet the standard of being reasonable. Any exchange between the individual and the organization must be an equal exchange of benefits; the individual may not be seen as getting a disproportionate gain from the exchange.

Private Benefit

A further concept in law is that of private benefit. This concept is somewhat broader than the private inurement concept. The impact of this doctrine is to emphasize that nonprofit organizations are to be operated strictly for the purposes that gained them the tax-exempt status. This can go beyond a concern about undue benefits given to insiders and cover any actions of the organization.

Clearly, it's the intent of the legislature and the IRS that the behavior of tax-exempt organizations be directed to public purposes and not to private gain.