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The director of our 501(c)(3) dance organization is also a paid teacher of the dance studio where our practices are held.  The studio owner and the director have decided to hold auditions for the nonprofit organization and the studio teams at the same time and charge a fee to each girl trying out. They have also required that to be a member of the nonprofit program you must also be a team member of the studio, which benefits the studio owner and the teacher/director.  Does this jeopardize our charitable status?

It certainly could.  This is the kind of tie that could cause you a lot of problems.  A charitable organization may not be used for private inurement (private profit of an insider like the director) or private benefit for a third person like the studio owner.  (See Ready Reference Page: “Charities May Not Confer Private Benefits”)  It is one thing to provide an incidental benefit to the studio owner who might get some extra business from girls who want to use the facility at other hours.  It is quite another thing to require the girls to pay the owner for more time in order to join the nonprofit team.  Whether or not you would actually lose your exempt status would probably depend in part on the magnitude of the benefit, but it would definitely be a bright red flag for the IRS.

If there is a direct economic benefit to the director, it might also be an excess benefit transaction if it is not treated as compensation.  Not only the director, but anyone on the board who approves the plan could be liable.  (See Ready Reference Page:  “Charities Must Avoid Excess Benefit Transactions”) 

Which raises the question that usually arises after the scandal hits the newspapers:  Where was the board?  It is time to break the tie-in or find a new studio.