Federal tax law provides that the net earnings of a Hawaii organization qualified under Section 501(c)(3) must not “inure to the benefit” of any private individual. Private inurement occurs when a person who is an “insider” with respect to the organization, such as an officer or director, derives a benefit from the organization without giving something of equal value in return. The IRS may revoke an organization’s tax-exempt status if inurement occurs. Inurement may arise in many ways. Here are some examples.
A Hawaii organization may pay reasonable compensation to employees or others for services rendered. Excessive compensation, however, such as compensation that exceeds payments by other organizations for similar services, may result in inurement.
In addition, as a general rule, a Hawaii tax-exempt nonprofit corporation should not pay any person a salary that is calculated as a percentage of the organization’s net earnings. All incentive compensation arrangements should be reviewed by legal counsel.
If a Hawaii tax-exempt nonprofit corporation purchases property or services for more than adequate consideration or pays rent in excess of fair market value, this may constitute private inurement. Conversely, if a Hawaii tax-exempt nonprofit corporation furnishes property or services without receiving adequate compensation, inurement may result. However, if the organization provides property or services for less than fair market value in the course of fulfilling its tax-exempt purposes (e.g., an orchestra performing free concerts) private inurement should not result.
If a Hawaii tax-exempt nonprofit corporation borrows money from an insider at an above-market rate of interest, or loans money to an insider without receiving adequate security or reasonable interest, this may also create inurement.
As you can see, once a Hawaii nonprofit corporation obtains federal tax-exemption status it enters the realm of the highly regulated and severe sanctions may result for any mistake.
Call or contact our law offices for guidance to avoid losing your tax-exempt status.
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