The Legal Answer Book for Private Foundations / Edition 1 available in Paperback
The Legal Answer Book for Private Foundations / Edition 1
- ISBN-10:
- 0471405795
- ISBN-13:
- 9780471405795
- Pub. Date:
- 10/10/2001
- Publisher:
- Wiley
The Legal Answer Book for Private Foundations / Edition 1
Paperback
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Product Details
| ISBN-13: | 9780471405795 |
|---|---|
| Publisher: | Wiley |
| Publication date: | 10/10/2001 |
| Series: | Wiley Nonprofit Law, Finance and Management Series , #164 |
| Pages: | 384 |
| Sales rank: | 1,060,338 |
| Product dimensions: | 7.03(w) x 9.94(h) x 0.98(d) |
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The Legal Answer Book for Private Foundations
By Bruce R. Hopkins Jody Blazek
John Wiley & Sons
ISBN: 0-471-40579-5Chapter One
Basic Legal DefinitionsOne of the most complex bodies of statutory law in the tax-exempt organizations setting is the battery of rules applicable to private foundations. Created over 30 years ago, the private foundation rules are the subject of hundreds of private determinations by the Internal Revenue Service (IRS) (and a few court opinions), and this process continues unabated. New issues constantly arise. This body of law can be onerous and, because of a myriad of penalty excise taxes, can be costly.
If a charitable organization can avoid being a private foundation, it is well advised to do so. If, however, private foundation status is unavoidable, the rules governing private foundations must be faced. Life as a private foundation is by no means impossible, but the organization's management and its advisors should proceed with caution.
Here are the questions most frequently asked (or those that should be asked) about the basic legal definitions in the private foundation rules-and the answers to them.
Q 1:1 What is a private foundation?
There is no affirmative definition of the term private foundation. The statutory definition basically states that a private foundation is a charitable organization that is not a public charity (Q 1:2).
Generically, a private foundation has four characteristics:
1. It is a charitable organization.
2. It is initially funded from one source (usually an individual, a married couple, a family, or a business).
3. Its ongoing income derives from investments (in the nature of an endowment fund).
4. It makes grants to other charitable organizations rather than operate its own program.
The nature of its funding and, sometimes, the nature of its governance (i.e., a closed, family-oriented board of trustees) are the characteristics that make this type of charitable organization private. This entity is sometimes referred to as the standard private foundation (Q 1:34).
NOTE: The Internal Revenue Code is misleading in this regard. The pertinent Code section is styled "Private foundation defined." But, in fact, that section does not define the phrase private foundation at all. Rather, it defines what a private foundation is not, by listing the types of charitable organizations that are not private foundations.
Also, although technically this is not part of a definition of the term private foundation, there are some organizations that, for one or more purposes, are treated as private foundations, such as charitable remainder trusts (Q 17:28).
Q 1:2 What is a public charity?
There are several types of public charities (Chapter 12). One category includes churches, integrated auxiliaries of churches, associations and conventions of churches, universities, colleges, schools, hospitals, medical research organizations, and certain governmental entities. These are sometimes referred to as the institutions (Q 12:2).
Another category of public charity is the publicly supported charity. There are two basic types of publicly supported charity: the donative type (principally supported by gifts and grants) (Q 12:4) and the service provider type (principally supported by exempt function revenue, gifts, and/or grants) (Q 12:8).
The third category of public charity is the supporting organization (Q 12:15).
In applying these definitions of the term public charity, and in deciphering the private foundation rules, it is often critical that the charitable organization know which persons are disqualified persons (Q 1:3) with respect to it.
Q 1:3 What is a disqualified person?
A basic concept of the tax laws relating to private foundations is that of the disqualified person (Chapter 2). Essentially, a disqualified person is a person (including an individual, corporation, partnership, trust, or estate) that has a particular, usually intimate, relationship with respect to a private foundation.
Thus, disqualified persons are commonly trustees, directors, officers, substantial contributors, members of their families, and controlling and controlled entities. The first three of these persons are collectively known as foundation managers. A controlling person is a 20 percent owner, and controlled entities are corporations, partnerships, trusts, and estates.
In the public charity context, this definition generally is inapplicable. (It is used, however, in connection with the computation of public support in the case of service provider publicly supported entities (Q 12:8).) The term disqualified person, however, is used as part of the intermediate sanctions rules. In that context, the term is broader in scope than that in the private foundation setting, in that the concept of member of the family there includes siblings (Q 2:15).
Also, in the public charity context, the private inurement doctrine applies. There, the equivalent to the disqualified person is the insider. There is considerable controversy as to the sweep of this term. Clearly, the idea of the insider embraces trustees, directors, officers, and key employees. The controversy, however, is whether and to what extent it extends to vendors of goods and services, such as fund-raising companies.
Q 1:4 Just what are the private foundation rules?
The federal tax law governing the operations of private foundations is a composite of rules pertaining to self-dealing (Chapter 3), mandatory payout requirements (Chapter 4), business holdings (Chapter 5), investment practices (Chapter 6), various types of expenditures (Chapter 7), and more.
Q 1:5 What are the sanctions for violation of these rules?
The sanctions for violation of these rules are five sets of excise taxes, with each set entailing three tiers of taxation. The three tiers are known as the initial tax, the additional tax, and the involuntary termination tax.
In general, when there is a violation, the initial tax must be paid; the additional tax is levied only when the initial tax is not timely paid and the matter not timely corrected (Q 1:10). The termination tax (Chapter 13)-a third tax-is levied when the other two taxes have been imposed and there continues to be willful, flagrant, or repeated acts or failures to act giving rise to one or more of the initial or additional taxes.
Because of the stringency of these rules, the sanctions are far more than merely taxes; rather they are a system of absolute prohibitions.
Q 1:6 What are the rules concerning self-dealing?
In general, the federal tax law prohibits acts of self-dealing between a private foundation and a disqualified person (Chapter 3). An act of self-dealing may be direct or indirect. The latter generally is a self-dealing transaction between a disqualified person and an organization controlled by a private foundation.
The sale or exchange of property between a private foundation and a disqualified person generally constitutes an act of self-dealing. The transfer of real or personal property by a disqualified person to a private foundation is treated as a sale or exchange if the property is subject to a mortgage or similar lien that the foundation assumes, or if it is subject to a mortgage or similar lien that a disqualified person placed on the property within the 10-year period ending on the date of transfer.
The following generally constitute acts of self-dealing:
The leasing of property between a private foundation and a disqualified person.
The lending of money or other extension of credit between a private foundation and a disqualified person.
The furnishing of goods, services, or facilities between a private foundation and a disqualified person.
The payment of compensation (or payment or reimbursement of expenses) by a private foundation to a disqualified person.
The transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation generally constitutes self-dealing. Unlike the other sets of rules describing specific categories of acts of self-dealing, this one is a catch-all provision designed to sweep into the ambit of self-dealing a variety of transactions that might otherwise technically escape the discrete transactions defined to be those of self-dealing. Benefits to a disqualified person can occur when the foundation's assets are used by one or more parties that are not disqualified persons. There is no requirement that a disqualified person is intended to be benefited.
This is one of the most dangerous aspects of the self-dealing rules, in that self-dealing can occur without the parties realizing it. Part of the problem is that the benefit involved can be intangible, such as increased goodwill, enhanced reputation, and the provision of marketing advantages-all with respect to nondisqualified persons.
TIP: This phraseology is also in the definition of the term excess benefit transaction. As is the case with respect to much of the law defining self-dealing, developments in the private foundation arena can be used to interpret the intermediate sanctions rules. The reverse also is true.
An agreement by a private foundation to make a payment of money or other property to a government official generally constitutes self-dealing, unless the agreement is to employ the individual for a period after termination of his or her government service if the individual is terminating service within a 90-day period.
Q 1:7 Are there any exceptions to the self-dealing rules?
There are many exceptions to the self-dealing rules. For example, in relation to the general prohibition on leasing transactions (Q 1:6), the leasing of property by a disqualified person to a private foundation without charge is not an act of self-dealing. Likewise, in respect to the general prohibition on extensions of credit (Q 1:6), this rule does not apply to an extension of credit by a disqualified person to a private foundation if the transaction is without interest or other charge and the proceeds of the loan are used exclusively for charitable purposes.
Concerning the general ban on furnishing of goods, services, or facilities (Q 1:6), the furnishing of goods, services, or facilities by a disqualified person to a private foundation is not an act of self-dealing if they are furnished without charge and used exclusively for charitable purposes. Moreover, the furnishing of goods, services, or facilities by a private foundation to a disqualified person is not self-dealing if the furnishing is made on a basis no more favorable than that on which the goods, services, or facilities are made available to the general public.
As to the rules in respect to compensation (Q 1:6), except in the case of a governmental official, the payment of compensation (or payment or reimbursement of expenses) by a private foundation to a disqualified person for the performance of personal services that are reasonable and necessary to carrying out the charitable purpose of the foundation is not self-dealing if the compensation (or payment or reimbursement) is not excessive.
CAUTION: This exception is not necessarily as attractive as it might initially appear. A court held that the term personal services is confined to services that are "essentially professional and managerial" in nature. In that case, the services involved were found not to qualify for the exception, being general maintenance, janitorial, and custodial services.
As to the catch-all provision (Q 1:6), the fact that a disqualified person receives an incidental or tenuous benefit from a private foundation's use of its income or assets will not, by itself, make the use an act of self-dealing. In the case of a government official, the self-dealing rules do not apply to the receipt of certain prizes and awards, scholarship and fellowship grants, annuities, gifts, and traveling expenses.
by reason of another exception, a transaction between a private foundation and a corporation that is a disqualified person with respect to the foundation is not an act of self-dealing if the transaction is engaged in pursuant to a liquidation, merger, redemption, recapitalization, or other corporate adjustment, organization, or reorganization. For this exception to apply, all the securities of the same class as those held by the foundation prior to the transfer must be subject to the same terms, and these terms must provide for receipt by the foundation of no less than fair market value.
Q 1:8 When does an act of self-dealing occur?
An act of self-dealing occurs on the date on which all of the terms and conditions of the transaction and the liabilities of the parties have been fixed.
Q 1:9 What is the amount involved?
The amount involved generally is the greater of the amount of money and the fair market value of the other property given or the amount of money and the fair market value of the other property received.
Q 1:10 What does correction mean?
Correction of an act of self-dealing means undoing the transaction that constituted the act to the extent possible, but in no case may the resulting financial position of the private foundation be worse than would be the case if the disqualified person was dealing under the highest fiduciary standards. This means return to the private foundation of the amount involved (Q 1:9), plus another element (usually the payment of a suitable amount of interest), so as to place the parties in the position they were in before the transaction occurred.
NOTE: For example, in the case of excessive compensation (Q 1:6, Q 3:13), correction of the act of self-dealing includes return to the foundation of the excess portion of the compensation paid.
There are special rules in this regard in the context of the additional taxes (Q 1:5):
In the case of the additional tax imposed in connection with the mandatory distribution rules (Q 1:15), the term correct means reducing the amount of undistributed income to zero.
In the case of the additional tax imposed in connection with the excess business holdings rules (Q 1:19), the term means reducing the amount of the excess business holdings to zero.
In the case of the additional tax imposed in connection with the jeopardizing investments rules (Q 1:22), the term means removing the investment from jeopardy.
Continues...
Excerpted from The Legal Answer Book for Private Foundations by Bruce R. Hopkins Jody Blazek Excerpted by permission.
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