Earlier this year, the IRS released a private letter ruling (PLR 202119002) on a private foundation’s contemplated grants to three foreign organizations that will each regrant the applicable funds to secondary grantees in furtherance of the private foundation’s 501(c)(3) exempt purposes. While a PLR may not be relied on as precedent by other taxpayers or by IRS personnel, it does provide helpful guidance as to how the IRS considers particular issues, including what authorities it relies upon to provide the requested rulings.

Rulings Requested

1. The Grants represent in each case amounts paid for a charitable purpose.
2. The Grants will be qualifying distributions within the meaning of section 4942.
3. The Grants will not be taxable expenditures within the meaning of section 4945.
4. The Grants will not create any acts of self-dealing under section 4941.
5. Rulings 2 and 3 will not be adversely affected by the failure of the Foreign Organizations and Secondary Grantees to comply with notice requirements of section 508.

Authorities

Ruling 1: charitable purpose

Section 501(a) exempts from federal income tax organizations described in section 501(c).

Section 501(c)(3) describes organizations organized and operated exclusively for charitable and other specified exempt purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

Treas. Reg. § 1.501(c)(3)-1(d)(1)(i) includes “charitable” in the list of purposes for which an organization described in section 501(c)(3) may be organized and operated.

Treas. Reg. § 1.501(c)(3)-1(d)(2) provides that the term “charitable” is used in section 501(c)(3) in its generally accepted legal sense, and includes “relief of the poor and distressed or of the underprivileged” and “advancement of education.”

Rev. Rul. 72-124, 1972-1 C.B. 145, considers whether an organization formed for the purpose of establishing and operating a home for the elderly is organized and operated exclusively for charitable purposes. In concluding that the organization is exempt from federal income tax under section 501(c)(3), the Service recognized that the elderly, as a class, are highly susceptible to unique forms of distress due to their special needs in advanced age, and said that satisfaction of these special needs, which contributes to the prevention and elimination of the causes of these unique forms of distress, may, in the proper context, constitute charitable purposes or functions.

Ruling 2: qualifying distributions

Section 4942(a) imposes a tax on the undistributed income of a private foundation for any taxable year.

Section 4942(c) defines “undistributed income” to mean, with respect to any private foundation for any taxable year as of any time, the amount by which (1) the distributable amount for such taxable year exceeds (2) the qualifying distributions made before such time out of such distributable amount.

Section 4942(g)(1)(A) defines “qualifying distribution” to mean, in part, any amount (including that portion of reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in section 170(c)(2)(B), other than any contribution to an organization controlled (directly or indirectly) by the foundation or one or more disqualified persons.

Section 170(c)(2)(B) lists the following purposes: “religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition …, or for the prevention of cruelty to children or animals.” These purposes are the same purposes listed in section 501(c)(3) (excluding testing for public safety).

Treas. Reg. § 53.4942(a)-3(a)(3) states that “an organization is ‘controlled’ by a foundation or one or more disqualified persons with respect to the foundation if any of such persons may, by aggregating their votes or positions of authority, require the donee organization to make an expenditure, or prevent the donee organization from making an expenditure, regardless of the method by which the control is exercised orexercisable.”

Treas. Reg. § 53.4942(a)-3(c)(4) provides that where a donee of a private foundation uses contributed funds to make a subsequent payment to a “secondary donee,” such subsequent payment will not be treated as a contribution by the private foundation to the “secondary donee if the distributing foundation does not earmark the use of the contribution for any named secondary donee and does not retain power to cause the selection of the secondary donee by the [original donee].” Even where the private foundation “has reason to believe” that a secondary donee would benefit from a contribution, the foundation will not be deemed to have made a contribution to such secondary donee “so long as the original donee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of such foundation.”

Ruling 3: taxable expenditures

Section 4945 generally imposes a tax on taxable expenditures made by a private foundation.

Section 4945(d)(4) provides that a grant by a private foundation to an organization (other than a grant to a public charity described in section 509(a)(1) or (2), to a supporting organization described in section 509(a)(3) (other than one described in clause (i) or (ii) of section 4942(g)(4)(A)), or to an exempt operating foundationdescribed in section 4940(d)(2)) will be a “taxable expenditure” unless the private foundation exercises expenditure responsibility over the grant pursuant to section 4945(h). In addition, section 4945(d)(5) provides that a “taxable expenditure” includes any amount paid or incurred by a private foundation for any purpose other than one specified in section 170(c)(2)(B).

Section 4945(h) provides that expenditure responsibility referred to in section 4945(d)(4)(B) means that the private foundation is responsible to exert all reasonable efforts and to establish adequate procedures (1) to see that the grant is spent solely for the purpose for which made, (2) to obtain full and complete reports from the grantee on how funds are spent, and (3) to make full and detailed reports with respect to such expenditures to the Secretary.

Treas. Reg. § 53.4945-5(b)(2)(i) provides that before making a grant to an organization with respect to which expenditure responsibility must be exercised, a private foundation should conduct a limited inquiry concerning the potential grantee. Such inquiry should be complete enough to give a reasonable individual assurance that the grantee will use the grant for the proper purposes. The inquiry should concern itself with matters such as: (a) the identity, prior history, and experience (if any) of the grantee organization and its managers; and (b) any knowledge which the private foundation has (based on prior experience or otherwise) of, or other information which is readily available concerning, the management, activities, and practices of the grantee organization.

Treas. Reg. § 53.4945-5(b)(3) states that “in order to meet the expenditure responsibility requirements of section 4945(h), a private foundation must require that each grant to an organization, with respect to which expenditure responsibility must be exercised under this section, be made subject to a written commitment signed by an appropriate officer, director, or trustee of the grantee organization. Such commitment must include an agreement by the grantee:

(i) to repay any portion of the amount granted which is not used for the purposes of the grant, (ii) to submit full and complete annual reports on the manner in which funds are spent and the progress made in accomplishing the purposes of the grant, except as provided in paragraph (c)(2) of [Treas. Reg. § 53.4945-5], (iii) to maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times, and (iv) not to use any of the funds … to make any grant which does not comply with the requirements of section 4945(d)(3) or (4).”

Ruling 4: self-dealing

Section 4941 imposes an excise tax on each act of self-dealing between a disqualified person and a private foundation.

Section 4941(d)(1)(E) provides that the term “self-dealing” includes any direct or indirect “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation.”

Section 4946(a)(1)(B) defines the term “disqualified person” to include, with respect to a private foundation, a foundation manager. Section 4946(b) provides that a “foundation manager” includes an officer, director, or trustee of a foundation.

Section 4946(a)(1)(D) defines the term “disqualified person” to include a member of the family of a foundation manager. Section 4946(d) provides that for purposes of section 4946(a)(1), family members include only spouses, ancestors, children, grandchildren, great grandchildren, and the spouses of children, grandchildren, and great grandchildren.

Treas. Reg. § 53.4941(d)-2(f)(2) states, in part, that the fact that a disqualified person receives an incidental or tenuous benefit from the use by a foundation of its income or assets will not, by itself, make such use an act of self-dealing, and specifically notes that the public recognition a person may receive arising from the charitable activities of a private foundation with which they are associated are incidental and tenuous benefits not giving rise to self-dealing.

In Rev. Rul. 77-371, 1977-2 C.B. 388, a private foundation gave a grant to a public charity to establish a student loan guarantee program. Under the terms of the program, the public charity agreed to guarantee loans only for children of the private foundation’s employees, some of whom were disqualified persons. The IRS held that “[e]ach time a loan made to a disqualified person is guaranteed with funds granted by the private foundation, the income or assets of the foundation are being used indirectly to satisfy the legal obligation of a disqualified person.”

Ruling 5: Whether Rulings 2 and 3 will be adversely affected by the failure of the Foreign Organizations and Secondary Grantees to comply with notice requirements of section 508.

Section 508(a) of the Code generally prohibits an organization from being treated as described in section 501(c)(3) unless it has filed notice with the Secretary of the Treasury that it is applying for recognition of such status. The Secretary prescribes the method for filing the notice.

A foreign grantee should be treated as an organization described in section 501(c)(3) or as a private foundation under section 509(a) only if (1) the foreign grantee has received a ruling or determination letter recognizing such status, or (2) the grantor private foundation has made a good faith determination of such status. Neither the Internal Revenue Code nor the Treasury Regulations require a private foundation to make such a determination.

If a private foundation makes a grant to a foreign charity for one or more purposes described in section 170(c)(2)(B) and exercises expenditure responsibility with respect to the grant in accordance with the requirements of section 4945(h) and the regulations thereunder, then the grant will be a qualifying distribution under section 4942 and not a taxable expenditure under section 4945.

Rulings

1. The Grants in each case will be amounts paid for a charitable purpose.
2. The Grants will be qualifying distributions within the meaning of section 4942.
3. The Grants will not be taxable expenditures within the meaning of section 4945.
4. The Grants will not create any self-dealing under section 4941.
5. Rulings 2 and 3 will not be adversely affected by the failure of the Foreign Organizations and Secondary Grantees to comply with notice requirements of section 508.

Thoughts Regarding Application and Analysis of Authorities

The IRS relied upon representations by the private foundation that:

• The Secondary Grantees engaged in charitable activities consistent with the private foundation’s exempt purposes.
• The private foundation did not earmark the grants to its grantees (Foreign Organizations) to be regranted to the Secondary Grantees; the regrants were made by each Foreign Organization at its sole discretion; further, the private foundation had no control over any Foreign Organization (though there was some board overlap).
• The private foundation would exercise expenditure responsibility (ER) with regard to grants made to the Foreign Organizations (but no mention was made of exercising ER with respect to the regrants to the Secondary Grantees even though the Secondary Grantees had been identified).
• Neither the Foreign Organizations nor any of the Secondary Grantees were disqualified persons as to the private foundation, and no such disquaified persons would receive any benefits from the grants other than possible public recognition arising from their association with the charitable work performed.

It appears then that a private foundation should carry out its self-dealing analysis beyond its grantees to sub-grantees, if identified, even if the selection of such sub-grantees will not be under the private foundation’s control. Such prohibition should be reflected in the grant agreement, but reasonable due diligene would also be expected to avoid a subgrant from conferring more than an incidental benefit to a disqualified person. However, the private foundation need not exercise ER with respect to the grants made to the sub-grantees.