Private Inurement: What You Need to Know

Nonprofit organizations simply can't operate to benefit private individuals. Not even a little bit.

Any private inurement may place an organization's 501(c)(3) nonprofit status at risk.

That's why it's so important that everyone on your team understands the rules.

What Is Private Inurement?

Simply put: Private inurement is the use of nonprofit funds or assets for personal means.

Or, as the IRS puts it ...

"A section 501(c)(3) organization must not be organized or operated for the benefit of private interests, such as the creator or the creator's family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests. No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization."

So what does the ban on private inurement for 501(c)(3) organizations mean in practice?

Let's consider a few cases:

• An executive director stays an extra night at a hotel after a conference and pays with the nonprofit organization’s credit card.
• A nonprofit organization hires a board member’s company to conduct a computer security audit.
• An executive director hires their daughter for an administrative support role with hourly pay.
• A nonprofit organizations waives rental fees for use of the organization’s facilities by board members.

Each of the above issues could serve as an example of private inurement. But in each case, staff and board leaders also could take some of the steps that follow to prevent problems.

How to Avoid Private Inurement Problems

1. Pay for personal expenses with personal funds

An organization’s financial management practices should include routine review of detailed expense reports. These days, such systems are often online and offer sophisticated approval, search, and analysis tools. Where a personal expense might be paid for on the organization’s card, staff should rapidly reimburse any personal portion of the expense. Make sure your policies and procedures reflect that this practice should be rare, rapid, and well-documented.

Be aware that sometimes board and staff may disagree about expenses. For example, in the case mentioned above of the extra hotel night paid for on the organization’s card, the executive director felt that such an expense was reasonable and justified. The board believed otherwise. After a board-initiated investigation, the executive director reimbursed several personal expenses and resigned.

2. Seek competitive bids

It isn’t necessarily a problem that a board member’s company provides services for a fee to a nonprofit organization. But if the organization excludes competitors and simply contracts with a board member, that should cause concern.

For most projects, such as the computer security review project mentioned above, a nonprofit organization’s leaders (board and/or staff) should seek a reasonable number of competitive bids. A public request for proposals may be appropriate in some circumstances, while a request for a quote might suffice in others.

Document both the process of seeking alternatives and deliberations. Anyone in the organization with connections to the people or companies involved should recuse themselves entirely from the process. In desirable circumstances, I’ve seen a board member instruct their company to offer more goods and services than competitors — and at a lower price. That’s an excellent outcome for the nonprofit organization. And it’s a much better result than a no-competition contract awarded above market price that places the organization’s tax status at risk!

3. Compensate appropriately

As with projects, post positions publicly and consider qualified candidates. Many organizations appropriately prohibit situations where one family member might hire or supervise a relative, as in the example case of an executive director who hired their daughter.

Unjust compensation occurs when a person receives benefits beyond what might be reasonably expected in the marketplace. Compare compensation arrangements at your organization to those of similar jobs at similar organizations. The National Council of Nonprofit Organization offers useful suggestions and links to resources. Some state nonprofit associations release salary studies you can consider as you determine compensation levels. (As a side note: be sure to set policies and document if, and, or how any of an organization’s equipment — such as cars, laptops, or smartphones — may or may not be used for personal purposes along with reimbursement policies. Make sure to appropriately consider and include this compensation as part of the organization’s W2 and/or 1099 reporting.)

Of course, with an hourly position both the rate of pay and hours worked matter. And, yes, even though you’re reading this at the ClickTime blog, I’ll mention that a solution like ClickTime can help people in organizations accurately track, review, and report time. Hours paid, but not worked, present a problem.

4. No special benefits

Make sure no special benefits accrue to board members. For example, one organization I worked with allowed board members to rent event space at a discounted rate. We changed the policy. Instead, we made rental discounts a major donor benefit. Any board members who were also major donors received the discount. But no longer were board members in a position to receive special benefits solely as result of their board role.

Besides, the board members a nonprofit organization really wants are board members who pay more than full price: They cover the organization’s costs and then some.

And that’s true for staff, too. The best organizations need well-compensated staff who place stewardship of the organization’s resources for the public good over a personal pursuit of private benefit.

Private Inurement Penalties

In short, they are bad. Very bad. Your organization could even lose its tax-exempt status.

Again, that's why it's critical you put sound policies and governance into place, and educate your team about how — and how not — to use company funds and assets.

For more information, check out our guide to in-kind donations!