The Weird World of Nonprofit Terminology

You think you’re pretty well versed in the English language, right?  If you grew up in an English-speaking country, you’re pretty sure you have this thing down pat.  Maybe you do, and maybe you don’t!

It’s been said that the English language can be difficult for some people whose native language is something other than English.  Our mother tongue has a lot of weird rules and exceptions, plus the lexicon grows every single year.  My sister-in-law was raised in a Baltic country, where they don’t use articles (a, an, the, etc.).  After nearly 30 years in this country, she still drops her articles!

The nonprofit world sometimes seems like it uses a language all its own.  It’s not so much strange grammar, punctuation, or verb tense.  Instead, it is (mostly) normal English words or phrases that are easy enough to read, but not very clear in their meaning.  If you are not emersed in all-things-nonprofit, you may be completely unfamiliar with these terms.  Even if you’ve heard them a hundred times, people are still often confused about what they really mean.

Here a 7 common words and phrases used in nonprofit circles that are not well understood:

We’ll start things off with a two-fer:  inurement and private benefit.  I say two-fer because they are both strange words/phrases, and they are often used interchangeably.

Inurement in a nonprofit setting means that an insider is unfairly benefiting themselves by misappropriating a nonprofit’s assets to their own benefit.  According to IRS.gov,

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 by or indirectly by such private interests.

An example of this might be a board member who uses company assets for her own personal use.  Another example could be a key employee paid an exorbitantly high salary.  Yet another might be a founder using the nonprofit as a platform for steering customers into his commercial business.

Key point:  Inurement is NOT a good word in the nonprofit world.

Since we’re coming off the topic of inurement, our next phrase is intermediate sanctions.  I’d bet $1 that 99% of the people reading this post have never used that phrase in a sentence.  So what does it mean?

Intermediate sanctions are essentially financial penalties levied by the IRS against a nonprofit that has been determined to have impermissible inurement going on.  For example, let’s say that an Executive Director makes a reasonable salary.  But, the board decides to pay the Director a bonus equal to a 20% commission on the amount of donations raised by the Director personally.  There’s no cap on the potential commission, and John, the ED, wrangles in $500,000 through his fundraising efforts.

In a situation like this, should it get scrutinized, the IRS may very well decide that the $100,000 commission is excessive and is, in fact, not reasonable.  If they determine that inurement has taken place, the IRS could levy intermediate sanctions penalties equal to 25% of the excess amount against the board members individually, not against the nonprofit itself.  That’s a certain way to discourage inurement.  Should the nonprofit not correct the situation, the penalty can jump to 200% per person deemed liable.

Are intermediate sanctions levied very often?  Fortunately, no.  It almost always results from an IRS audit, and those are not very common.  It’s also quite subjective.  What is considered bad enough to trigger intermediate sanctions in one organization might not raise an eyebrow in another.  It’s all very relative.

This is another strange sounding phrase:  disqualified person.  What is a disqualified person, and what are they disqualified from?

A disqualified person, particularly within the context of a private foundation 501(c)(3), is a person who is an insider or a significant contributor.  Specifically the IRS says that the following people are disqualified persons:

1. Substantial contributors
2. Foundation managers (officers, directors, key employees)
3. Owners of more than 20% interest of certain organizations that are substantial contributors
4. Family members of persons described in 1-3
5. Corporations in which persons described in 1-4 hold more than 35% voting power
6. Partnerships in which persons described in 1-4 hold more than 35% profit interest
7. Trusts or estates in which persons described in 1-4 hold more than 35% beneficial interest
8. Certain private foundations which are effectively controlled by the person or persons in control of the foundation in question
9. Governmental officials

So, that’s the list, but what does “disqualified” mean?  Basically, it means they have a significant control function in a private foundation.  As such, conflict-of-interest rules are strictly enforced against these individuals.  In most settings, a disqualified person cannot be employed by the foundation.  There are exceptions, but they are narrow.  Inurement thresholds are also much lower with regard to disqualified persons.

Shifting gears away from people, let’s look at restricted funds.  Now this is a topic we’ve covered a lot, so follow the links to the specific articles that deal with this topic in depth.  But in summary, here’s what it means:

Restricted funds describe a donation that has been restricted to a specific purpose by the donor.  This can be the result of a direct solicitation by the charity to give to a specific cause.  It can just as well be an unsolicited designation by the donor that the charity chooses to honor.

In either case, restricted means restricted.  It must be segregated from the general fund, and its use restricted to the intended purpose.  Only the donor can release a restriction after the money has been set aside.

An endowment is similar to restricted funds, in that the use of those funds is limited.  An endowment is different, however, in that the funds are generally meant to generate income, not be used for operating expenses.  It’s the endowment earnings from investments that are earmarked for operations or other specific purposes.

Any nonprofit can establish an endowment fund.  But for it to truly operate as an endowment, the money it contains comes from restricted donations designated specifically for endowment purposes.  You often see endowments with educational organizations, such as colleges and universities.  An endowment may be established by a wealthy alumnus, the earnings of which are designated to be used for providing scholarships, for example.

Endowments are more often permanent, but you’ll sometimes see a donor put a sunset date on the principle amount, after which time the funds can be used for operational or other purposes.

Program related investments, or PRIs, are primarily the domain of private foundations.  A PRI is when the foundation makes an investment in a private, commercial business that has a business model that is closely related to the foundation’s charitable mission.

At first glance, many people’s reaction to this idea is, “Wait, what?  A private foundation can do that?”  Actually, yes they can.  But there are several caveats to that.  A PRI must:

1. Advance the primary exempt purpose of the organization
2. Have no concern of the production of income or appreciation of property
3. Not be used directly or indirectly to lobby for political purposes, and
4. Should not jeopardize the foundation’s mission

An example of this might be a foundation making an investment in a for-profit utility company to develop power grids in developing countries.  Potential examples are endless.

One more thing that needs to be said about program related investments, however.  They are complex and heavily-scrutinized by the IRS.  They are not for the novice foundation manager.

Our final weird word/phrase is social welfare.  We’ve talked a lot about this subject, primarily when discussing 501(c)(4) nonprofits.  501(c)(4)s have as their primary purpose the “social welfare” of a community.  However, that term can mean a lot of different things.

In general, social welfare describes an activity that benefits the public in a nonprofit, noncommercial manner, yet that public benefit isn’t charitable in nature.  Here’s some examples:

1. Homeowner’s associations
2. Advocacy/cause groups
3. Some political groups
4. A free community newspaper

There are so many possibilities to this.  But I think you can see where this is going.  Social welfare means there is a beneficiary group, but that benefit isn’t a commercial activity, nor is it considered charity.  Again, see our post on 501(c)(4) organizations to get more on this.