Form 990-PF: Latest Compliance Strategiesmedia.straffordpub.com/products/form-990-pf-latest...Nov 28, 2012 · Attendees can still view the presentation slides online. If you have

Form 990-PF: Latest Compliance Strategies Meeting IRS Demands for Fiscal, Grant and Other Data From Private Foundations

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WEDNESDAY, NOVEMBER 28, 2012

Presenting a live 120-minute teleconference with interactive Q&A

Brian Yacker, Partner, YH Advisors, Huntington Beach, Calif.

Candice Meth, Senior Manager, EisnerAmper, New York

Amanda Adams, Tax Partner, Blazek & Vetterling, Houston

Milton Cerny, Counsel, McGuire Woods, Washington, D.C.

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Form 990-PF: Latest Compliance Strategies Seminar

Milton Cerny, McGuire Woods

[email protected]

[email protected]

Nov. 28, 2012

Amanda Adams, Blazek & Vetterling

[email protected]

Brian Yacker, YH Advisors

[email protected]

Candice Meth, EisnerAmper

Today’s Program

Form 990-PF Review

[Amanda Adams]

Critical Compliance Issues With Form 990-PF

[Milton Cerny, Amanda Adams and Brian Yacker]

Best Practices With Future Form 990-PF Filings

[Candice Meth]

Slide 8 – Slide 28



Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

7

FORM 990-PF REVIEW


Part I: Analysis Of Revenue And Expenses

Column (a) reflects revenue and expenses per books – cash or accrual.

Column (b) reflects revenue and expenses that are subject to the

4940

excise tax on net investment income.

Column (c) reflects revenue and expenses that are included in the

calculation of adjusted net income. For private operating foundations,

this column is relevant to determining the spending requirement. For

non-operating foundations, this column is generally not completed unless

the foundation has income from a charitable activity.

Column (d) reflects expenses which are treated as qualifying

distributions. This column is relevant to determining satisfaction of both

operating and non-operating foundations’ minimum spending

requirements.

9

Part II: Balance Sheets

This section of the return presents the balance sheet of the

foundation at the beginning of the year and the end of the year.

The FMV of assets held at the end of the year is also reported. A

detailed listing of investments held at the end of the year (other

than mortgage loans) is required.

Lines 6 and 20 report receivables/payables occurring between the

foundation and disqualified persons. Having an entry on either of

these lines could be a sign that impermissible self-dealing has

occurred.

10

Part III: Analysis Of Changes In NA Or FB

This section of the return demonstrates the components of the

change in net assets from the beginning of the year to the end of

the year. For many cash-basis foundations, current income is the

only change. For foundations that follow the accrual method and

report their investments at fair market value, unrealized gains

and losses are reported here. Returned grants are also reported in

this section rather than as a reduction of expense or income in

Part I.

11

Part IV: Capital Gains And Losses

After the passage of the Pension Protection Act of 2006, capital gains

and losses from the sale of virtually all capital assets became subject

to the

4940 tax on net investment income. Two important

exceptions still exist:

1. Capital gains and losses subject to unrelated business income tax

are not also subject to

4940 tax.

2. Gains and losses from charitable-use assets held for at least one

year are not subject to

4940 tax, if the proceeds from sale are used

to purchase similar charitable-use assets, in much the same way as

the like-kind exchange rules of

1031.

Remember that all sales of publicly traded securities can be reported

on a single line. Details are only required for non-publicly traded

securities.

12

Part V: Qualification For Reduced Tax

The normal rate of

4940 tax on net investment income is 2%.

This section of the return provides a calculation that may enable

the foundation to reduce the tax percentage to 1%. A ratio of

qualifying distributions to non-charitable-use assets is calculated

based on a five-year history. If current year qualifying

distributions equal or exceed the amount determined by

multiplying the five-year ratio by the current year’s average of

non-charitable-use assets plus 1% of net investment income, then

the foundation qualifies for the 1% tax rate for the year.

13

Part VI: Excise Tax

This section reports the tax due on the return as well as any

payments made towards the tax. If the foundation was

erroneously subject to back-up withholding, such amounts can be

reported here as credits toward the foundation’s tax liability.

Foundations whose tax liability exceeds $500 for the year must

make quarterly tax payments (which must be deposited

electronically), and those whose net investment income has

exceeded $1 million in the past three years must base their 2Q-4Q

payments using annualization calculations, which use actual

income earned during the year. This can be problematic for those

foundations with partnership investments and that do not have

timely information.

14

Part VII-A: Statements Regarding Activities

Although questions 1(political activities), 6 (governing instrument) and 13

(public inspection) search for possible non-compliance with the

requirements of

501(c)(3), the bulk of the questions in this part ask for

information that does not necessarily have a negative impact on the

foundation. Changes in activities, organizing documents, new substantial

contributors and similar information are required to be reported.

A new question is asked for 2011: Did the foundation make a distribution

to a donor-advised fund over which the foundation or a disqualified

person had advisory privileges? If “Yes,” attach statement.

The statement must report whether the foundation treated the

distribution as a qualifying distribution and how the distribution will be

used for

170(c)(2) purposes.

One wonders whether the IRS plans to restrict grants to DAFs, as they

have grants to supporting organizations.

15

Part VII-B: Statements Regarding Activities For Which Form 4720 May Be Required

Care should be taken in answering the questions in this section, as

“Yes” answers may indicate that Form 4720 (a penalty return) is

required to be filed. Questions 1-5 seek information to determine

if the foundation is subject to one of the Chap. 42 excise taxes on

self-dealing, under-distribution, excess business holdings,

jeopardizing investments and taxable expenditures. Questions 6

and 7 relate to non-Chap. 42 excise taxes.

16

Part VIII: Information About Officers, Etc.

All officers, directors, trustees and foundation managers that

served during the year are reported along with their

compensation and average hours per week devoted to the

foundation.

The top five highest-paid employees compensated >$50,000 are

reported.

The top five highest-paid independent contractors compensated

>$50,000 are reported.

17

Part IX-A: Summary Of Direct Charitable Activities

Many foundations conduct direct programs in conjunction with, or

instead of, making grants to other organizations. Even if the

foundation is a non-operating foundation, it has the opportunity

to describe its four largest activities and provide the total

expenditures related to each. Some foundations are concerned

about the appearance of a large percentage of expenses coming

from non-grant sources, because it may seem that administrative

expenses are too high. Describing direct activities in this part can

help indicate when expenses are related to a charitable program

rather than being administrative.

18

Part IX-B: Summary Of Program-Related Investments

Program-related investments are made primarily to accomplish a

charitable purpose of the foundation, rather than to produce

investment income or capital gain from the sale of the

investment.

Examples include educational loans to individuals and low-

interest loans to other 501(c)(3) organizations.

Only the top two PRIs made during the year are reported, so that

ongoing investments are not reported on succeeding returns.

19

Part X: Minimum Investment Return

This section of the return reports the average fair market value of

non-charitable use assets including cash, securities and other

assets. This calculation is the first step in determining the amount

the foundation is required to spend for charitable purposes.

20

Part XI: Distributable Amount

The minimum investment return (5% of investment assets) is

reduced in this section by the excise tax on investment income

for the year, as well as the income tax (990-T) for the year.

Recoveries of amounts previously treated as qualifying

distributions (i.e., returned grants) are added to the MIR to

determine the distributable amount.

21

Part XII: Qualifying Distributions

This section calculates the total amount of qualifying distributions

for the year by combining the expenses paid from Part I, Col. (d)

with amounts spent to purchase program-related investments or

charitable use assets and any amounts set aside for charitable

purposes.

Set-asides:

Type I: Suitability test – straightforward and applicable to

foundations of any age; must request in advance and may not

receive approval until after deadline for return to be filed

Type II: Cash distribution test – generally applicable to

foundations in their first few years of existence; complex rules

which are difficult to understand; advance approval not required

22

Part XIII: Undistributed Income

This section illustrates satisfaction or failure of a non-operating

foundation’s payout requirements. It is important to remember

that the amount shown on Line 6f, Col. (d) is not required to be

distributed until the tax year after the tax year covered by the

return.

Normal ordering of application of distributions:

1. Current-year payout requirement (calculated on prior return)

2. Next year’s payout requirement (calculated on current return)

3. Excess distribution carryover

Elections can be made to divert distributions after Step 1 in order

to satisfy requirements from a prior year (penalty situation) or

to meet redistribution requirements.

23

Part XIV: Private Operating Foundations

This section illustrates satisfaction of a private operating

foundation’s payout requirements. The test can be met on an

aggregate basis (i.e., total for all four years), or on a three-out-of-

four-year basis.

Two-part test:

1. Income test (based on lesser of adjusted net income or MIR)

2. One of the following:

I. Asset test (65%-plus are charitable-use)

II. Endowment test (spend 2/3 of MIR)

III. Support test (certain required percentages of support

from public)

Failure of test means the foundation becomes a non-operating

foundation that completes Part XIII.

24

Part XV: Supplementary Information

This section provides information about grant programs.

Foundation can describe what kinds of organizations/individuals it

supports or attempt to forestall submission of unsolicited

applications by checking the box.

Details regarding grants paid during the year and those approved

for future payment are presented. Importantly, the public charity

status (on the return, this is referred to as foundation status)

must be reported for each grantee [e.g., 509(a)(1)].

25

Part XVI-A: Analysis Of Income-Producing Activities

This section analyzes the sources of revenue during the year to

show how much revenue was unrelated business income that is

taxable, unrelated business income that is not taxable, and

related/exempt function income.

26

Part XVI-B: Relationship Of Activities

For exempt function revenue reported in Col. (e) of Part XVI-A, a

description is reported in this section explaining how the income-

producing activity contributed to the foundation’s exempt

purposes.

27

Part XVII: Information Regarding Transfers To, And Transactions And Relationships With, Non-

Charitable Exempt Organizations

As the title implies, this section reports information about

transfers and other transactions with non-charitable exempt

organizations, as well as relationships with such organizations. It

is important to demonstrate that such transactions, etc. do not

result in the improper use of charitable funds for non-charitable

purposes.

28

CRITICAL COMPLIANCE ISSUES WITH FORM 990-PF

Milton Cerny, McGuire Woods


Brian Yacker, YH Advisors

Current Developments

I. 2012 IRS work plan

A. Based on information reported on Form 990-PF, the Exempt

Organization Division is examining a selection of the largest private

foundations.

1. Proposed regulations

a. Reliance standards for making good faith determinations of

foreign organization’s charitable status (Reg. 134974-12)

b. Sections 4942 and 4945 require a determination, based on

an affidavit of the foreign organization or an opinion of

counsel (equivalency letter), to the grantor foundation that

the grantee is a charitable organization. Now includes in

the list of “qualified tax practitioners” an enrolled agent

30

Current Developments (Cont.)

c. Other changes under consideration by the IRS:

• Time limitation, during which foundation could rely on

equivalency written advice

• Revision of Rev. Proc. 92-94 to take into account

changes in public support test for public charities

• Elimination of the good faith determination based on

grantee affidavit

3. New examples regarding program-related investments under

Sect. 53-4944 of the regulations were revised.

The new examples include the following investments:

a. The purchase of stock in a business that will develop a

vaccine to prevent a disease that predominantly affects

poor individuals in developing countries

31


b. The purchase of stock, or the provision of a loan with

below-market interest rates accompanied by the

acceptance of stock, in a business in a developing

country that collects recyclable solid waste and delivers

such waste to recycling centers that would otherwise be

inaccessible to a majority of the population

c. A loan with below-market interest rates to a business in

a rural area that employs a large number of poor

individuals, where the business has sustained damage

from a natural disaster

d. A loan with below-market interest rates to individuals in

a developing country that was damaged by natural

disaster, for the purpose of starting small businesses

32


e. A loan with below-market interest rates to a company that

purchases coffee from farmers in a developing country, for

the purpose of training poor farmers about water

management, crop cultivation, pest management and farm

management

f. A loan with below-market interest rates to an organization

described in IRC Sect. 501(c)(4) that develops and

encourages interest in painting, sculpture and art by

conducting weekly community art exhibits, for the

purchase of a large exhibition space

g. A deposit as security, or a guarantee and reimbursement

agreement, for a loan to a charitable organization

described in IRC Sect. 501(c)(3) that provides childcare

services in a low-income neighborhood, for the

construction of a new childcare facility

33


4. Guidance on charitable donations to disregarded single-member

LLCs

a. The IRS announced in Notice 2012-52 that a contribution to a

domestic single-member LLC that is wholly owned and

controlled by a U.S. charity and disregarded for federal tax

purposes is deductible, because the IRS will treat the gift as

being made to a branch or division of the charity. The charity

will be treated as the recipient of the gift, for purposes of

meeting the substantiation and disclosure requirements.

b. Before this notice, foundations had no definitive guidance as

to whether a charitable contribution to a disregarded LLC

owned by a public charity would be a charitable grant. Now,

foundations will be able to direct their grants directly to the

LLC without uncertainty over the charitable deductibility of

the grant.

34

Disclosing Operational Activities: Part VII-A, Question 2

Has the foundation engaged in any activities that have not been

previously reported to the IRS?

1. Generally, any substantially different activities that have not

previously been reported (Form 1023 or 990-PF) should be reported

here. The foundation will not receive a letter from the IRS approving

of such activities as a result. However, it may protect the foundation

from retroactive challenges to exempt status by putting the IRS on

notice of new activities.

2. Certain new activities require advance approval from the IRS:

I. Grants to individuals for study, travel, similar purposes

II. Termination of private foundation status through operation

as a public charity

35

Disclosing Operational Activities: Part IX-A, Direct Charitable Activities

The top four programs are reported. Statistical data such as the

number of persons served, classes taught, books distributed, etc.

enhance the descriptions. The expenses reported include capital

expenditures for related assets but not depreciation. A reasonable

and consistent allocation of overhead expenses is permitted.

Unless there is significant involvement in the foundation’s grant

programs, they are typically not reported as direct charitable

activities.

This section is critical for private operating foundations.

36

Prepared by YH Advisors, Inc. 37

Minimum Distribution Requirements (Sect. 4942)

Definitions

o Undistributed income

• Distributable amount exceeds qualifying distributions for any given year

o Distributable amount

• Overview

Two years to make qualifying distributions

• Calculation

Essentially, the private foundation’s minimum investment return, with certain adjustments

Private foundation’s grants that are returned to the private foundation (

4942(f)(2)(C)(i))

Amounts received or accrued from the sale of property, to the extent that the acquisition of the property was considered a qualifying distribution (

4942(f)(2)(C)(ii))

Any amount set aside for a specific project, to the extent the amount set aside was not necessary for the purposes for which it was set aside (

4942(f)(2)(C)(iii))


Minimum Distribution Requirements (Sect. 4942), Cont.

Definitions (Cont.)

o Minimum investment return

• 5% of fair market value of non-charitable assets (net total assets less exempt purpose assets)

Examples of exempt purpose assets

Art owned by private foundation that is displayed in museum

Desks in classroom of school operated by private foundation

• Fair market value calculations

Cash

Calculate average monthly cash balances

See regulations (53.4942(a)-2(c)(4)(ii))

Securities

Readily available market quotations

+ NYSE or NASDAQ

+ Any city or regional exchange on which quotations appear on a daily basis

+ Any other exchange (foreign, national, regional) on which quotations appear on a daily basis

+ Regularly traded in a market for which published quotations are available

+ Locally traded in a market for which quotations can be obtained from established brokerage firms

Consistently calculate average monthly fair market value

Marketability discounts permitted (Sec. 4942(e)(2)(B))

See five examples in regulations (53.4942(a)-2(c)(4)(i)(e))



Definitions (Cont.)

o Minimum investment return (Cont.)

• Real estate

Five-year optional reliance, if written appraisal prepared by unrelated (Reg.

53.4942(a)-2(c)(4)(iv))

Written, certified and independent appraisal of the fair market value of any real estate

Qualified person may not be disqualified person or an employee of the private foundation.

Commonly accepted valuation methods must be used in making the appraisal.

Valuation based upon acceptable methods of valuing property for federal estate tax purposes will be considered acceptable.

Appraisal must include a closing statement that, in the appraiser’s opinion, the appraised assets were valued according to valuation principles regularly employed in making appraisals of such property, using all reasonable valuation methods.

Private foundation must keep a copy of the independent appraisal for its records.

IRS will continue to accept the appraisal for a five-year period, even if actual FMV changes.

Planning opportunity: When the FMV of real estate is increasing, the private foundation should utilize the independent appraisal for determining the value of its real estate investments. When it is decreasing, consider obtaining another independent appraisal, even if the five-year period has not yet concluded for the original appraisal of the real estate.

Real estate valuation planning will help the private foundation minimize its minimum distribution requirements, by minimizing the value of total non-charitable assets.



Definitions (Cont.)


• Valuation of other assets

Fair market value consistently determined annually (see Reg.

53.4942(a)-2(c)(4)(iv)(a))

Valuation can be conducted by a private foundation insider.

May be valued as of any day in PF’s tax year, provided that the PF values the asset as of that date in all tax years

• Exempt purpose assets are not considered for the minimum investment return calculation.

Reg.

53.4942(a)-2(c)(3): Asset is used directly in carrying out the foundation's exempt purpose only if the asset is actually used by the foundation in the carrying out of the charitable, educational or other similar purpose that gives rise to the exempt status of the foundation.

Assets held for production of income or for investment are not being used directly in carrying out the foundation's exempt purposes, even though the income from such assets is used to carry out such exempt purposes.

Whether an asset is held for the production of income, rather than used directly to carry an exempt purpose, is a question of fact.

For example, an office building used for the purpose of providing offices for employees engaged in the management of endowment funds of the foundation is not being used directly by the foundation to carry out its exempt purposes.

Where property is used both for exempt purposes and for other purposes, if the exempt use represents 95% or more of total use, such property shall be considered to be used exclusively for an exempt purpose.



Definitions (Cont.)


• Exempt purpose assets not considered for minimum investment return calculation (Cont.)

Examples (in the IRS regulations) of assets that are used directly in carrying out exempt purposes

Administrative assets, such as office equipment and supplies, that are used to the extent such assets are devoted to and used directly in the administration of the foundation's exempt activities

Real estate used by the foundation directly in its exempt activities

Paintings or other works of art owned by the foundation and which are on public display, fixtures and equipment in classrooms, research facilities and related equipment

Any interest in a functionally related business or in a program-related investment

Property leased by a private foundation in carrying out its exempt purposes at no cost (or at a nominal rent) to the lessee or for a program-related purpose, such as the leasing of renovated apartments to low-income tenants at a low rental as part of the lessor foundation's program for rehabilitating a blighted portion of a community



Definitions (Cont.)


• Reasonable cash balances for administrative expenses (Reg.

53.4942(a)-2(c)(3)(iv))

1.5% of total assets (less exempt purpose assets)

Exclude 1.5% amount, even if greater than average cash balances (see Rev. Rul. 75-392)

May exceed 1.5% amount under certain limited circumstances

Attach statement to Form 990-PF

• Short tax years

Minimum investment return percentage is reduced based on number of days in period

• PLR 9530033

IRS ruled that a private foundation may re-compute its minimum investment return for several years, in order to take into account an adjustment to the value of real property donated to the foundation.



Definitions (Cont.)

o Qualifying distributions (Sect. 4942(g))

• Any amount, including reasonable/necessary admin expenses, paid to accomplish charitable purposes; and any amount paid to acquire asset used directly in carrying out charitable purposes

Expenses incurred directly in carrying out the private foundation’s charitable purposes

Grants and gifts made by the private foundation to qualifying recipients

Exercise expenditure responsibility for grants and gifts made to non-public charities

NOT including amounts paid to directly or indirectly controlled charitable organizations (see Sec. 4942(g)(1)(A)) or paid to non-functionally integrated Type III charitable support organizations (see also Reg.

53.4942(a)-3(a)(3))

• Acquisition of exempt purpose assets

• Reasonable and necessary administrative expenses (Cont.)

Examples

Expenses attributable to soliciting grants

Expenses related to inspecting determination letter of public charities

NOT expenses related to the management of an investment endowment fund



Definitions (Cont.)

o Qualifying distributions (Cont.)

• Reasonable and necessary administrative expenses (Cont.)

Internal Revenue Service rulings

Rev. Rul. 75-495: Legal fees paid in a lawsuit to determine the proper beneficiary of part of the private foundation’s income

PLR 9623058: Reasonable legal and accounting expenses incurred by a private foundation in obtaining an IRS ruling with respect to transfer of assets for purposes of furthering charitable purposes

PLR 9629019: Reasonable and necessary legal, accounting, and other expenses incurred to implement the transfer of assets from one private foundation to another were considered qualifying distributions

Rev. Rul. 74-560: Depreciation expense generally will NOT be considered a qualifying distribution.

1988 EO CPE Text

“Other qualifying distributions include expenses attributable to soliciting grants or contributions to the foundation; preparing Form 990-PF … making the return available for public inspection or providing copies ...”


Verifying Grant Recipients

Grants to small exempt organizations

o Grants made to small exempt organizations whose exempt status was revoked

• Not taxable expenditure until the IRS published revocation list on June 8, 2011

See www.irs.gov for the “Auto-Revocation List”

• Would be taxable expenditure if make grant to a revoked entity thereafter

Key for the private foundation to check the Auto-Revocation List and IRS Select Check before making grants to smaller exempt organizations

Can avoid classification as a taxable expenditure if exercise expenditure responsibility

o Grants made to single-member LLCs of public charities

• See IRS Information Letter 2010-0052: Grant to single-member LLC owned by public charity is considered to be a qualifying distribution and as such, the exercise of expenditure responsibility is not required.


Verifying Grant Recipients (Cont.)

Grants to supporting organizations

o Controlled supporting organizations

• Not a qualifying distribution if private foundation makes grant to any supporting organization, if a disqualified person directly or indirectly controls the supporting organization or a supported public charity of the supporting organization

• Grant to controlled supporting organization will be considered a taxable expenditure if expenditure responsibility is not exercised

o Non-functionally integrated Type III supporting organization

• Even if exercise expenditure responsibility, grant to non-functionally integrated Type III supporting organization will NOT be considered a qualifying distribution (see Sect. 4942(g)(4))

• Grant to non-functionally integrated Type III supporting organization will be considered a taxable expenditure, if expenditure responsibility is not exercised.

• Check status before making contribution

• Publication 78 does not indicate whether organization is a supporting organization, or if so, what type

o Required analysis when make grants to certain supporting organizations

• Who are the private foundation’s disqualified persons?

• Which supporting organizations does the disqualified person control?

• To which supporting organizations does the private foundation make grants?

• Was expenditure responsibility exercised for grants made to organizations listed, in response to the two questions immediately above?



Grants to supporting organizations (Cont.)

Is donee a supporting organization (SO)?

Is donee SO a Type I, Type II or Type III ?

Is the Type III SO functionally

integrated or not?

Does a DQP control the SO or a charity it

supports?

Has the PF exercised expenditure

responsibility?

Violation of Sect. 4945 + excise taxes

imposed

No violation of Sect. 4945 re taxable

expenditures

Grant will be considered a qualifying

distribution

YES

Type I or II

Type III

YES

YES

NO NO

+



Grants to foreign charities

o Expenditure responsibility

• Take responsibility for the funds granted to the foreign charity

• Granting private foundation conducts specific oversight and monitoring procedures

Takes lots of ongoing effort and energy

• Necessary steps

Pre-grant due diligence that foreign recipient is a bona fide charity

Ensure that grant is actually spent only for the purpose for which it is made

Obtain full and complete reports from the foreign grantee organization on how funds were spent

Make full and detailed reports on the expenditures to the IRS on Form 990-PF

• Private letter rulings

See PLR 200813043 for IRS guidance when making grants to foreign charities

See also PLR 201039047

See PLR 200852038 for IRS guidance regarding when expenditure responsibility should be exercised for grants made to domestic non-charitable entities



Grants to foreign charities (Cont.)

o Expenditure responsibility (Cont.)

• Pre-grant inquiry

Investigate, based on readily available information, that the grantee will use the granted funds from the private foundation for proper purposes

Inquiry should include identity, experience, history of grantee and its governing body, information on management activities, finances and practices of the grantee.

Private foundation must document the purposes of the grant, assessment of the grantee’s ability to achieve goal, and assessment of grantee’s ability to report on the use of the funds.

Please e-mail me for examples of pre-grant inquiry forms

• Written grant agreement

Specify the charitable purpose

Require the grantee to maintain grant funds in separate account

Require grantee to maintain records of receipts and expenditures and make such records available to the private foundation for inspection

Require the grantee to repay grant funds, if they were not utilized for purposes of the grant

Require the grantee to provide annual reports and a final report on its use of the grant funds

Prohibit the use of the grant funds for lobbying, political activities, re-granting and non-charitable uses

Must be executed by the private foundation and the grantee

Please e-mail me for a copy of the sample agreement letter





• Annual reports (must be received in all years that grant funds expended)

Detailed breakdown of how grant funds were expended during the relevant period, in comparison to the initial budgets of the grantee

Narrative description of the grantee’s progress in achieving the purposes of the grant during the year

Statement whether the grantee has fully complied with the terms of the grant agreement

Signature of the authorized officer of the grantee

Please e-mail for a sample grantee report form

• Final reports

Must be received within a reasonable period of time after the close of the grantee’s annual accounting period in which all the grant funds were expended or the grant was terminated (generally, 90 days)

• Reports to the IRS

Must annually report to the IRS on every expenditure responsibility grant made

Please see the example of the Form 990-PF attachment in the course materials

• Investigate problems with grant

Private foundation must take corrective measures, if a diversion of grant funds has taken place.

Take all reasonable and appropriate steps to recover the grant funds

Withhold further payments to the grantee until receive assurances that further diversions will not occur





• How to fail expenditure responsibility

Fail to conduct sufficient pre-grant inquiry

Fail to include required terms in grant agreement

Fail to receive annual or final reports

Fail to attach required support documents to the Form 990-PF

• Disadvantages of expenditure responsibility

Tougher to make general support grants under expenditure responsibility

Required periodic reporting could be tough to obtain from certain countries

Probably not the preferred method if the private foundation grantor expects to fund the foreign charity over a long-term period

Types Of Self-Dealing

I. Sale between PF (private foundation) and DP (disqualified person)

A. Foundation holds charitable auction and sells item to DP.

B. Foundation makes bad investment; DP wants to buy from

foundation at more than FMV.

C. Foundation manager retires, and PF sells him the car owned

by the PF that he used for site visits.

II. Lease transaction between PF and DP

A. DP leases office space larger than needed; sublets space to

foundation.

III. Loan between PF and DP

A. Foundation needs money to make distributions, DP loans.

B. Foundation loans money to DP’s business at an above-

average interest rate.

52

Types Of Self-Dealing (Cont.)

IV. Furnishing of goods, services, or facilities between PF and DP

A. PF provides office space to DP at no charge.

B. DP uses PF’s office supplies.

V. Payment of compensation by PF to DP

A. DP receives directors’ fees.

B. DP receives payment for serving as PF’s investment

manager.

VI. Use of PF’s income or assets by a DP

A. DP uses PF’s deposits in a bank as collateral for a loan.

B. DP uses PF’s accounts with an investment manager to

reduce the amount of fees paid on his personal account.

C. PF purchases table at charity gala; DPs and friends

attend. 53

Tips To Prevent Self-Dealing

I. Know who the PF’s DPs are. This includes family members,

businesses owned by DPs, etc.

II. Carefully scrutinize any financial transaction between the PF and

a DP, to assure yourself whether an exception to self-dealing

applies. Self-dealing is different from a conflict of interest.

III. DPs should clearly identify PF checkbooks/credit cards, so that

they are not inadvertently used when making a personal purchase.

Similarly, when making account transfers, care should be taken.

IV. Consider whether grants to charities that include membership

benefits, event tickets and similar quid pro quos result in self-

dealing when a DP uses the benefits. If a claim is made that the

benefits are incidental to accomplishing a charitable purposes,

then written documentation should be maintained.

54

Alternative Investments

I. Alternative investments

A. Alternative investments include notional contracts, hedge funds,

fund of funds, private equity funds and other investment

partnerships.

B. Generally, income from such investments is not subject to federal

income tax. Sect. 512(b)(5)

C. If the fund borrows to make investments and generates income from

leveraged funds, the foundation will have to pay its share of income

attributable to the debt financed property. Sect. 514

D. Option: Establish a “blocker corporation,” created offshore in a

jurisdiction that does not impose income tax at the corporate level

and avoids the corporate level tax for the foundation the blocker

distributes dividends to the foundation that are not taxed as UBIT to

the foundation. See PLR 20031538

55

56

Alternative Investments (Cont.)

E. U.S. anti-deferral regime for passive foreign investment

companies (PFICs) 20031538

F. Seventy-five percent of PFIC’s income comes from passive

income.

G. No taxes are due until there is a distribution of

accumulated dividends.

H. Reported income is taxed as ordinary income, and an

interest penalty must be paid. See IRC

297(c) and

1291

Revenue Included In Net Investment Income

I. Interest

II. Dividends

III. Rents

IV. Royalties

V. Payments with respect to securities loans

VI. Income from sources similar to those above (????)

VII. Capital gain (special exclusion is listed on next slide).

Remember that for donated assets, the donor’s tax basis

carries over to the foundation.

57

Revenue Excluded From Net Investment Income

I. Revenue subject to unrelated business income tax

II. Inventory sales

III. Income from sources not similar to those listed on the

previous slide 1-5 (????)

IV. Capital gain from the sale of charitable use assets held for at

least one year, when the proceeds are used to purchase similar

charitable assets

V. Net capital loss cannot be used to offset other investment

income, carried forward or carried back.

VI. Tax-exempt income (interest on municipal bonds)

58

Deductions Included In Net Investment Income

I. Ordinary and necessary expenses related to the production or collection

of gross investment income

II. Ordinary and necessary expenses related to the management,

conservation or maintenance of property held for the production of

investment income

III. Depreciation of investment assets must be straight-line.

IV. Cost depletion of investment assets is permitted, but percentage

depletion is not.

V. Overhead expenses can be allocated based on a reasonable and

consistent allocation.

VI. Deductions related to income earned from a charitable activity cannot

exceed the income.

VII. Documentation for allocations of joint activities is critical. Example:

Foundation manager’s compensation, which is allocated between

investment and charitable activities (timesheets!)

59

Tips For Qualifying For The 1% Tax Rate

I. Check calculation before year-end, to determine estimate of

spending needed to qualify; accelerate the payment of grants

that would have been paid in the following year anyway

II. Alternate years between 1% and 2% and coordinate distributions,

so that they are as low as possible in 2% years in order to drive

the historical ratio down

III. In initial year of existence, make no qualifying distributions. This

will ensure the 1% for the second year, as the historical ratio will

be 0.

IV. Consider not accelerating distributions, in order to qualify for

the 1% rate when the tax savings is immaterial (i.e., spending

$100,000 in grants to save $1,000 in tax.) This will improve the

ratio for future years when capital gains might increase tax

savings.

60

61

Excess Business Holdings Rules

(Sect. 4943)

I. General overview

A. Generally, holdings not permitted in excess of 20%

B. Combine the holdings of the private foundation and disqualified

persons

II. Definitions

A. Business enterprises

1. Not including functionally related business

2. Trade or business conduct that is substantially related to

exercise of charitable functions

3. Trade or business in which substantially all work is performed

without compensation

4. Business carried on primarily for the convenience of members,

students, patients, officers or employees (such as a cafeteria

operated by a museum)

62


(Sect. 4943), Cont.

5. Business that consists of selling of merchandise, substantially all

of which was received as gifts or contributions

6. Activity carried on within larger combination of similar

activities related to exempt purpose

B. Not including “passive” businesses (95% of income from “passive”

sources)

1. For example, a business that generated only royalty income

2. See PLR 200420029 (activity deemed not to be a business

enterprise)

3. IRS rules that a private foundation’s ownership of 100% of the

stock of a company would not be classified as excess business

holdings, because at least 95% of the company’s gross income

came from passive sources. See PLR 201127011

63


(Sect. 4943), Cont.

4. See Sect. 4943(d)(3) and Reg. 53.4943-10(c)(1) for the 95%

rule

C. Excess business holdings (Sect. 4943(c)(2))

1. General rule: Hold no more than 20% of voting stock

a. PLR 199124061: Cannot “convert” voting stock to non-

voting stock by agreeing not to vote the stock

b. No limit on the amount of non-voting stock that private

foundation can own

D. Exceptions

1. Increase to 35% when unrelated owner has effective control

(Reg. 53.4943-3(b)(3)(ii))

64


(Sect. 4943), Cont.

a. Effective control is the power to direct the management

and policies of a business enterprise

E. Private foundation can own 2% of voting stock of business enterprise,

regardless of what is owned by disqualified persons.

F. Ownership of the stock of a functionally related business (Reg. 53.

4943-10(b))

1. General rule: Hold no more than 20% of voting stock

a. Business related to the exempt purposes of the private

foundation

b. See Sect. 4942(j)(4) and Reg. 53.4942(a)-2(c)(3)(iii)

c. See PLR 201006032

2. Private foundation’s program-related investments

65

Excess Business Holdings Rules (Sect. 4943), Cont.

G. Disposition of excess business holdings

1. 90-day period (knows or reason to know of the excess business

holdings)

a. Private foundation acquires ownership other than by purchase

b. For example, disqualified person acquires additional holdings

H. Gifts and bequests

1. Five-year time period (ability to obtain another five years under

certain circumstances)

a. See Sect. 4943(c)(7)(A)

b. PLR 200650018: Private foundation received five-year extension

when making best efforts to dispose of interest in farm

66


(Sect. 4943), Cont.

c. PLR 200833018: Private foundation received five-year extension

when making best efforts to dispose of interest in farm.

d. PLR 200650018: Private foundation received five-year extension

for publicly traded stock (thin volume/sales restrictions).

e. PLR 201105053: IRS granted a private foundation an additional

five years under Sect. 4943(c)(7) to dispose of excess business

holding that resulted from an unusually large bequest.

III. PLR 2011220037

A. Voting stock gifted to non-functionally integrated Type III

supporting organization was treated as subject to 4943, due to

redemption from ESOP.

B. IRS permitted a five-year extension for disposition of the stock.

67

Jeopardizing Investments

I. Consider gifts of “excess” stock/securities, as opposed to just selling

A. Potentially reduces capital gain subject to the net investment

income excise tax

II. Rules for the application of the extension of five-year holding

period

A. Request for an extension to the IRS before the expiration of the

initial disposal period

B. Diligent efforts to dispose of the holdings within the five-year

period

C. Submission to the IRS of a plan for disposition

D. Submission of the plan to the attorney general of such plan, and

the attorney general’s response to the plan

68

Jeopardizing Investments (Cont.)

E. IRS determination that such plan can reasonably be expected to

be carried out before the close of the extension period.

F. IRS may grant an additional period up to five years to dispose of

stock

III. Options for disposition of excess business holdings

A. Sale of stock

B. Liquidation of the corporation when the foundation is the sole

owner of the stock

C. Reorganization of the corporation through conversion of voting

stock to non-voting stock

D. Transfer of shares of stock to one or more public charities

69

Jeopardizing Investments (Cont.) E. Conversion of foundation to a supporting organization affiliated with

a public charity

IV. Jeopardizing investments

A. What are jeopardizing investments?

1. Sect. 4944 provides that if a private foundation invests its assets in

such a manner that will jeopardize the accomplishments of its

exempt purposes, the foundation and possibly its managers are

subject to certain excise taxes.

2. Foundation managers failed to exercise ordinary business care and

prudence under the facts and circumstances at the time of mailing

the investment. Knowingly and willing engages in a transaction

when manager is aware that transaction may violate Sect. 4944. IRS

decision is made on an investment-by-investment basis. No category

of investments are treated as a “per se” violation of Sect. 4944.

Transaction may be protected by a reasoned opinion of counsel.

70


3. IRS will closely scrutinize trading in securities on

margin, commodity futures, puts calls and

“straddles.”

B. Program-related investments exempted from jeopardy

investment rules

1. The primary purpose is to accomplish one or more tax

exempt purposes, and no significant purpose is the

production of income or the appreciation of property.

2. PRIs are not subject to excess business holdings rules

under Sect. 4943 and may be treated as qualifying

distributions under Sect. 4942.

71


1. An investment can be made to either a charity, non-profit or

commercial business that is carrying out the charitable purposes of

the foundation.

2. Investment would not have been made but for the investment and

the accomplishment of the exempt purpose.

a. Examples:

― Low-interest or interest-free loans to needy students

― High-risk investments in non-profit/low-income housing

― Low-interest loans to small businesses in economically distressed

areas, owned by disadvantaged groups where commercial loans

are not available

72


― Investment in businesses in deteriorated urban

areas

― Investments combating community deterioration

― Purchase of stock or loans to businesses in a

developing country

― Loans to businesses in rural areas that employ large

numbers of poor people

― Guarantee for a loan to charitable organization

engaged in charitable activities

73


V. Each program related investment must be made subject to

a written commitment that includes:

A. An agreement by the recipient to use the funds only

for the purposes of the investment

B. Submit at least once a year a full and complete

financial report ordinarily required by commercial

investors

C. Keep adequate books and records

D. Funds must not be used for legislative or political

activities

74


VI. General observations on program-related investments

A. Take responsibility for the funds granted to the foreign charity

B. Granting private foundation conducts specific oversight and

monitoring procedures

C. Necessary steps to take

1. Pre-grant due diligence that foreign recipient is a bona fide

charity

2. Ensure that grant is actually spent only for the purpose for

which it is made

3. Obtain full and complete reports form the foreign grantee

organization on how funds were spent

75


4. Make full and detailed reports on the expenditures to the

IRS on Form 990-PF

D. Private letter rulings

1. See PLR 200813043 for IRS guidance when making grants to

foreign charities

― Also see PLR 201039047

2. See PLR 20085203 for IRS guidance regarding when

expenditure responsibility should be exercised for grants

made to domestic non-charitable entities

3. See PLR 20114527 for IRS guidance on the receipt of royalty

payments resulting from funding hospital research program

Reporting Self-Dealing On Form 4720

I. For self-dealing transactions that involve the use of money (loan), the

amount involved is the FMV of the use of the money, not the amount of

money borrowed. With today’s interest rates, that amount is usually

pretty small.

II. The self-dealer must file a separate Form 4720 if his tax year is different

from the foundation’s (typically an issue if the foundation is on a fiscal

year that is other than the calendar year).

III. No abatement of the penalty is permitted.

IV. Penalty is 10% of the amount involved and is owed by the self-dealer. If

the PF pays a penalty, this results in another self-dealing transaction.

V. Correction involves undoing the transaction to the extent possible, but

not putting the PF in a worse position than if it had engaged in the

transaction with a non-insider. If terms are favorable to the PF and must

be rescinded, the DP has to make the PF “whole”.

76

Reporting Taxable Expenditure On Form 4720

I. Remember that a taxable expenditure may still be a qualifying distribution. A

scholarship grant that is a taxable expenditure because an approved plan is

not in place, was still made for charitable purposes.

II. Abatement of the penalty can be requested as long as the taxable event was

due to reasonable causes and not willful neglect, and the event was corrected

within the prescribed correction period.

III. Correction is generally accomplished by recovering part or all of the

expenditure, to the extent recovery is possible. When full recovery is not

possible, additional corrective action includes one or more of the following:

Requiring that any unpaid funds due to the grantee be withheld

Requiring that no further grants be made to the particular grantee

Requiring reports regarding the use of the funds

Requiring improved methods of exercising expenditure responsibility

Requiring improved methods of selecting recipients of individual

grants

77

Form 4720: Foundation Manager Liability

Remember that foundation managers who approve of certain

transactions (listed below) reported on Form 4720 may

personally be subject to a penalty. The tax is imposed only

when the foundation manager knew that the expenditure was

improper and agreed to the making of the expenditure willfully

and not due to reasonable causes.

The following types of penalty transactions could result in FM

liability:

• Self-dealing

• Taxable expenditure

• Jeopardizing investment

• Political expenditure

78


Form 990-PF: Red Flag Items

Receivables/payables with insiders (Part II)

Capital gains not computed properly for donated securities (Part IV)

Undertaking political activities (Part VII-A)

Undertaking of transactions with disqualified persons (Part VII-B)

Exercising expenditure responsibility without required Form 990-PF attachment (Part VII-B)

Compensating disqualified persons (Part VIII)

Reporting grants to certain types of recipients (Part XV)

Generating unrelated business income (Part XVI-A)


IRS Audits Of Private Foundations

General overview

o Have experienced marked increase in IRS audits of our private foundation clients

• IRS referenced such in their 2012 EO work plan

o Audit selection

• Appear to be targeted audits, to the best of our knowledge

o Audit procedures

• Interestingly, the majority of audits of our private foundation clients are being conducted by out-of-state auditors.


IRS Audits Of Private Foundations (Cont.)

Common IRS audit issues

o Self-dealing

• Reimbursement of personal expenses

• Loans

• Unreasonable compensation

o Employment tax issues

• Failure to file 1099s

Failure to undertake required back-up withholding

o Under-reported unrelated business income

• K-1s

o Foreign reporting

• FBAR

o Expense allocations

• Form 990-PF, Part I

BEST PRACTICES WITH FUTURE FORM 990-PF FILINGS

Candice Meth, EisnerAmper

Lessons Learned From Self-Dealing

Leases: Don’t pay rent to disqualified person

Special events: A private foundation cannot purchase tickets to a charitable fundraising event and then provide the tickets to disqualified persons or to third parties, if doing so benefits a disqualified person. There is an exception that permits foundation managers to use the tickets, if attending the event furthers their duties for the foundation.

83

Lessons Learned From Self-Dealing (Cont.)

Investment management services might be okay.

Loan to disqualified person – bad idea (exception for “qualified disaster” super-storm Sandy)

Using credit cards: If a disqualified person uses a foundation credit card for personal expenses and later reimburses the foundation for the expenses, this is considered a loan and a form of self-dealing, even if the person reimburses the full amount within a month of the transaction.

84

Providing Investment Management Services For A Fee Is Okay

Per Private Letter Ruling 200217056, it was determined that payment for fees by a private foundation for investment services provided by a disqualified person, as described in Sect. 53.4941(d)-3(c)(2), will not be an act of self-dealing.

85

Pro-Bono, Please!

As stated in the IRS’ Publication 578 Tax Information for Private Foundations and Foundation Managers “providing goods, services, or facilities between a private foundation and a disqualified person … is not self-dealing if a disqualified person provides them to the foundation without charge and the goods, services, and facilities are used exclusively for purposes specified in section 501(c)(3) of the Code”.

86

Lessons Learned With Respect To

Qualifying Distributions

IRS revocation: Keep a record of tax status based on when you

made the grant

Foreign grants: Expenditure responsibility or equivalency

determination (pay attention to new rules)

Giving to donor-advised fund: A good option if you are trying to

target the 1% tax

Scholarships/honorariums: Might need to create a 1099; special

IRS rules!

87

Concerns About Compensation

Executive compensation is a hot topic in the press.

Are you doing compensation studies? Do you have a

compensation-setting committee? Can you show that

compensation is reasonable in comparison to that of other

foundations?

The box for payment to disqualified person should be checked

“Yes” (Part VII-B Question 1(a)4), since the executive director is

a disqualified person and is paid (if no compensation was paid,

it’s possible this box would get checked “No”).

88

Concerns About Compensation

(Cont.)

Does it “look bad” if the directors or trustees receive stipends?

A private foundation may pay reasonable compensation to a

disqualified person for providing necessary professional

services to the foundation. Example: A foundation can pay a

member of its board of directors, who also provides accounting

services to the foundation, as long as the fees are reasonable.

W-2 vs. 1099: An individual receives one or the other, but never

both!

Remember, in a family foundation, your relative or spouse

should not be the person setting your compensation – best

practices!

89

Problems With The Current Form

• The form has not been significantly revised since the 1970s, yet

private foundations have evolved significantly and are diverse in

size, mission and endowment structure.

• The information about private foundations is extremely delayed

due to the fact that many foundations are still paper-filing their

returns, and therefore benchmarking and better understanding of

the sector are hampered.

• There are no governance questions on the form.

• The current excise tax structure, which varies from 1% to 2%, is

confusing, unpredictable and needs to be reviewed.

90

The number of U.S. foundations has grown by 246%, and the total

assets of U.S. foundations by 395%, since 1975 – while the 990-PF

regulatory structure has remained static.

Number of U.S. Foundations

22,08825,639

32,401

40,140

56,582

71,095

75,595

21,877

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

1975 1980 1985 1990 1995 2000 2005 2008

Source: The Foundation Center

91

The Excise Tax: Keep It Simple And

Focused On Its Primary Purpose

Primary purpose: To raise tax revenue!

With this in mind, gear the tax to be as reliable, predictable and

steadily growing as possible. Avoid schemes that invite distortion of

what foundations are supposed to be about (charitable

distributions) in order to “game” tax payments.

• Highly volatile net income (including realized capital gains), as

the tax basis meets none of these requirements

• A flat tax will help, but we will still have fluctuation.

92

Excise taxes on net investment income paid by foundations average $552 million annually, with large fluctuations from year to year.

$523

$730

$625

$305

$234

$328

$469

$624

$796

$890

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

$1,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Mil

lio

ns

$552

Mil. Ave.

Source: www.irs.gov/taxstats/charitablestats,IRS Data Files

93

http://www.irs.gov/taxstats/charitablestats

Current Status Of The Tax

Administration’s FY13 budget proposal

On Feb. 13, 2012, the Administration released its fiscal year 2013

budget proposal. The budget included a provision calling for a

single, 1.35% excise tax rate on investment income of private

foundations, rather than the revenue-neutral 1.39% that Congress

has been advocating. The proposed change would be effective for

taxable years beginning after the date of enactment. The

Administration estimated that permanently setting the rate at 1.35%

would result in a tax revenue loss of $54 million over 10 years.

Future of the flat tax : It seems that the president, the House and

the Senate agree that a flat tax is needed, but don’t necessarily

agree on what that percentage should be.

94

Change Is In The Air

• Tax reform is inevitable, however, given the concerns over

modification to the charitable giving deduction. The future of the

excise tax for private foundations is greatly unknown.

• There may be changes in reporting for donor-advised funds

coming soon. How will that affect private foundations that give to

such entities?

95

IRS Workplan: What’s On The Horizon

FY 2012 projects:

• Colleges and universities – compensation, endowment,

UBIT

• Disaster relief communications

• Group rulings

• Mortgage foreclosure assistance

• State-sponsored workers’ compensation organizations

(501(c)(27))

• Private foundations – PRI, UBIT, foreign grant-making,

?? Stay tuned!

• EO services and assistance

96

Documents

Form 990-PF: Latest Compliance Strategiesmedia.straffordpub.com/products/form-990-pf-latest...Nov 28, 2012 · Attendees can still view the presentation slides online. If you have