Private Foundations Deeper Dive David Lawson, November 2, 2017 Davis Wright Tremaine Seattle, Washington
What is a private foundation? Can be a nonprofit corporation or a charitable trust Nonprofit corporation • Formed by filing Articles of Incorporation with state • Managed by a board of directors Charitable trust • Formed by executing a trust document • Managed by one or more trustees
What is a private foundation? Has 501(c)(3) tax-exempt status • Must be organized and operated for charitable, educational, scientific, religious, or literary purposes • Assets are irrevocably dedicated to those purposes • No “inurement” or private benefit • Cannot engage in political campaign activity Two types of 501(c)(3) organizations • Public charities : churches, schools, hospitals, organizations meeting a “public support test” • Private foundations : All 501(c)(3) organizations that do not qualify as public charities
Private Foundation Alternatives Donor-advised funds (DAFs) • DAFs are maintained by a public charity “sponsor” • The sponsor has permanent and ultimate control, but will follow donor advice in almost all cases • Can grant to organizations under very similar rules to grantmaking private foundations • Cannot grant to individuals: • Scholarship or fellowship grants • Less administrative overhead and lower costs than an independent private foundation
Private Foundation Alternatives Public charity status • The central challenge is fundraising strategy • Public support tests: • 509(a)(1) + 170(b)(1)(A)(vi) “public support” = contributions and grants alone • 33%, or 10% and pass “facts and circumstances” • • 509(a)(2) • “public support” = contributions, grants, and gross receipts from related activity • 33%, and <33% from investment and unrelated income • 509(a)(3): supporting organizations
Deductions: Individual Deduction Limits Public Charities or Private Private Operating Foundations Foundations Cash or Ordinary Income Cash or Ordinary Income Property: Property: Deduction of up to 50% of Deduction of up to 30% of donor’s contribution base donor’s contribution base Capital Gain Property: Deduction of up to 50% of Capital Gain Property: donor’s contribution base to the Deduction of up to 20% of extent the capital gain property donor’s contribution base does not exceed 30% of the donor's contribution base
Deductions: Corporate Contributions The percentage limitation on charitable contributions by corporations is 10% of the corporation’s taxable income, regardless of whether the recipient is a public charity or a private foundation.
Governing Instrument Section 508(e) requires that an organization have specific provisions in its governing instrument in order to qualify as a private foundation: • prohibit the foundation from engaging in self-dealing subject to tax under § 4941, • require it to make qualifying distributions each year in amounts sufficient to avoid tax under § 4942, • forbid it from retaining excess business holdings taxable under § 4943, • prohibit jeopardizing investments taxable under § 4944, and • bar the foundation from making taxable expenditures within the meaning of § 4945.
Types of Private Foundations Operating “Non-operating” Direct Charitable Grants to Public • • Activities Charities
Types of Private Foundations “Non-operating” • Grantmaking or “Checkbook” Foundation • Primarily makes grants to public charities Operating Foundation • Actively engaged in the conduct of charitable activities • Annual determination • Based on use of income and assets over the most recent four-year period • Reported on Form 990-PF, Part XIV
Private Foundation Excise Taxes Chapter 42 of the Internal Revenue Code Most of these “ taxes ” are punitive in nature; it’s easier to consider these the “ rules ” governing foundations • Section 4940: Investment income excise tax • Section 4941: Self-dealing transactions • Section 4942: Distribution requirements • Section 4943: Excess business holdings • Section 4944: “Jeopardizing” investments • Section 4945: “Taxable expenditures” • Grab bag
Private Foundation Excise Taxes Tax on Investment Income (Section 4940) • 2% on net investment income • May be reduced to 1% if the foundation meets certain distribution requirements • These are slightly different from those in Section 4942 • Does not apply to certain private operating foundations (“exempt operating foundations”) that look like public charities
Self-Dealing Transactions Prohibits certain transactions between foundation and “disqualified persons” (Section 4941) Disqualified persons • Officers and directors • Staff with responsibilities similar to officers/directors • “Substantial contributors” (status for life!) • Spouses, ancestors, descendants of all of the above • Entities 35% controlled by all of the above • Certain government officials
Self-Dealing Transactions Prohibits certain transactions between foundation and “disqualified persons” (Section 4941) Prohibited transactions Sale or leasing of property (in either direction) • Lending (in either direction) • Furnishing of goods, services, or facilities (in either direction) • Payment of compensation to DQP by foundation • “Transfer or use by or for the benefit of” • foundation assets
Self-Dealing Transactions Prohibits certain transactions between foundation and “disqualified persons” (Section 4941) Exceptions: Compensation to DQP for “personal services” • (professional or management services only) Donations by a DQP of goods or services • Interest-free lending by DQP to foundation • Furnishing of goods or services by foundation if DQP • gets them on the same terms as the general public Certain transactions as part of the reorganization • of a DQP
Distribution Requirements “The 5 Percent” (Section 4942) “Qualifying distributions” must exceed “distributable amount.” What is the “Distributable Amount?” 5% of fair market value of all assets, except those used “directly” for exempt purpose A few modifications apply •
Distribution Requirements “The 5 Percent” (Section 4942) “Qualifying distributions” must exceed “distributable amount.” What are “Qualifying Distributions?” Amounts paid to accomplish exempt purposes • Amounds paid to acquire exempt-use assets •
Distribution Requirements Some things that are qualifying distributions: Grants to public charities or governments • Grants to private operating foundations • Permitted scholarship and fellowship grants • Amounts spent directly to operate a charitable • program Administrative expenses (but not investment • management expenses) Program-related investments •
Distribution Requirements Some things that are not qualifying distributions: Grants to organizations controlled by the • foundation or its disqualified persons Grants to other non-operating private • foundations (unless timely redistributed by the grantee foundation and made “out of corpus”) Grants to individuals not permitted under • Section 4945 Investment management expenses •
Distribution Requirements Taxes under Section 4942 Initially, 30% of undistributed income • If uncorrected, 100% of the remaining undistributed • amount Timing Distributions for year 1 must happen by end of year 2 • To avoid 100% tax on income not distributed by the end • of year 2, income must be distributed before either: the return due date for year 2, or • the IRS mails a notice of deficiency. •
Excess Business Holdings Rule (Section 4943) Combined holdings of: • a private foundation, and • all disqualified persons • in any corporation • conducting a business enterprise • which is not substantially related to the exempt purposes • of the foundation are limited to 20% of the voting stock • in such corporation. Special rules apply to nonvoting stock.
Excess Business Holdings: Elements Business Enterprise • The active conduct of a trade or business; and • Any activity that is regularly carried on for production of income from the sale of goods or the performance of services which constitutes UBTI under 513 Not a Business Enterprise • A business that derives 95% of more of its gross income from passive sources (e.g., dividends, interest, royalties, rents) • A business functionally related to the foundation’s exempt purposes
Excess Business Holdings: Elements Increase of Permitted Holdings to 35% Must establish that “effective control” is in one or more • persons who are not disqualified persons with respect to the foundation “Effective Control” Having the power, either directly or indirectly, to direct or • cause the direction of the management and policies of a business enterprise, whether through the ownership of voting stock, the use of voting trusts, or contractual arrangements, or otherwise
Recommend
More recommend
