outline is meant to be a reference resource, but it
is not intended to be exhaustive and technically complete.
If the formation of a private foundation is contemplated,
specific professional help should be sought. These
comments were the basis of a talk given to the Vermont
Tax Seminar in South Burlington on December 12, 2000.
is a private foundation?
"private foundation" is specifically
defined in the Internal Revenue Code as a domestic
or foreign organization described in section 501(c)(3),
church, school, hospital, organization supporting
a public college or university, the United States,
any state or political subdivision thereof,
or a publicly supported organization;
organization meeting certain public support
organization which supports an organization
described in sections 509(a)(1), 509(a)(2),
organization which is organized and operated
exclusively for testing for public safety.
charitable trust described in section 4947(a)(1)
is treated as an organization described in section
A split interest trust described in section 4947(a)(2)
is also treated as a private foundation for certain
organization described in section 501(c)(3) is presumed
to be a private foundation unless it is proved otherwise.
are some exceptions. In particular, churches and
any organization which is not a private foundation,
and the gross receipts of which in each taxable
year are normally not more than $5000, are not
required to apply for non-private foundation status
and are not presumed to be a private foundation.
are the consequences of being classified as a private
is a two percent (sometimes one percent) excise
tax on net investment income.
are excise taxes on the following prohibited
to distribute income;
business holdings, usually closely held;
investments which jeopardize charitable
termination tax will be incurred.
are significant reporting requirements.
the entire area of taxation of private foundations,
"disqualified persons" are treated specially.
The following are disqualified persons:
substantial contributor to the foundation. This
means any person who contributed or bequeathed
an aggregate amount of more than $5000 to the
private foundation, if such amount is more than
two percent of the total contributions and bequests
received by the foundation before the close
of the taxable year of the foundation in which
the contribution or bequest is received from
foundation manager. This means any officer,
director, or trustee of the foundation, or any
individual having powers or responsibilities
similar to those of officers, directors, or
trustees of the foundation, and employees of
the foundation having authority or responsibility
with respect to a particular act.
owner of more than twenty percent of the following
entities, if such entity is a substantial contributor
to the foundation: (a) the total combined voting
power of a corporation, including attribution
rules; (b) the profits interest of a partnership,
including attribution rules; (c) the beneficial
interest of a trust, including attribution rules;
or (d) the beneficial interest of an unincorporated
member of the family of any individual described
in section 4946(a)(1). This includes a spouse,
ancestors, children, grandchildren, great grandchildren,
and the spouses of children, grandchildren and
great grandchildren. It does NOT include siblings,
cousins, nieces, nephews, etc.
corporation of which persons described in D
above own more than 35% of the total combined
voting power. The attribution rules do apply.
partnership of which persons described in D
above own more than 35% of the total profits
interests. The attribution rules do apply.
trust or estate of which persons described in
D above own more than 35% of the beneficial
interest. The attribution rules do apply.
for purposes of section 4943, a controlled or
related private foundation.
for purposes of section 4941, a government official
described in section 4946(c).
supported organizations escape private foundation
is a two-pronged test under section 509(a)(2).
Both tests are on the cash basis, even if the
foundation is on the accrual basis.
organization "normally" receives
more than one-third of its support in each
taxable year from any combination of gifts,
grants, contributions, or membership fees,
and gross receipts from admissions, sales
of merchandise, performance of services,
or the furnishing of facilities, in an activity
which is not an unrelated trade or business.
Receipts from persons and governmental entities
are included, except that such receipts
are not considered to the extent that they
exceed the greater of $5000 or one percent
of the organization's support for such taxable
year. Receipts from organizations described
in section 509(a)(1) are included. Receipts
from disqualified persons are excluded.
The one-third refers to the amount of support
included in these categories, divided by
the total support received.
organization "normally" receives
not more than one-third of its support in
each taxable year from the sum of (a) gross
investment income, and (b) the excess, if
any, of the unrelated business taxable income
over the tax on that unrelated business
taxable income. Again, the one-third refers
to the amount of support from these sources,
divided by the total support received.
satisfaction of this broadly-supported test
is reported on Schedule A of Form 990.
concept "normally" means during the
four taxable years immediately preceding the
current taxable year. For an organization that
has been in existence for more than eight months,
but less than five years, the number of years
for which it was in existence immediately before
the current year is substituted for the four
taxable years period.
a newly-created organization, the Internal Revenue
Service will generally issue an advance ruling
that the organization meets these two tests
for a period of up to three years if the requirements
of regulation 1.509(a)-3(d) are met. Under certain
circumstances, this period may be extended up
to six years.
there are material changes in sources of support
in the current year, other than an "unusual
grant", the four taxable years period is
"unusual grant" is excluded from both
of the broadly-supported tests. An "unusual
grant" must be one attracted by reason
of the publicly supported nature of the organization,
as well as one that is large. The factors to
be considered in determining whether a grant
is an "unusual grant" are set forth
in regulation 1.509(a)-3(c)(4).
includes the following:
grants, contributions, or membership fees;
receipts from admissions, sales of merchandise,
performance of services, or furnishing of
facilities in any activity which is not
an unrelated business;
income from unrelated business income activities,
whether or not such activities are carried
revenues levied for the benefit of the organization;
value of services or facilities furnished
by a government unit without charge (unless
such services or facilities are generally
furnished to the public without charge).
does not include the gain from the sale of a
supported organizations are excluded from private
publicly supported organization is one that
normally receives from the general public and
governmental units at least one-third of its
total support. "Support" is defined
in regulation 1.170A-9(e)(6), (7) and (8). Note
that this is a different one-third test than
that described in section 509(a)(2) above.
publicly supported organization that fails this
one-third test may still meet a facts and circumstances
test under the regulations.
supporting organization also escapes private foundation
status. A supporting organization is one that:
organized, and at all times thereafter, is operated
exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of,
one or more specified organizations described
in section 509(a)(1) or (2);
operated, supervised, or controlled by, or in
connection with, one or more organizations described
in section 509(a)(1) or (2);
not controlled, directly or indirectly, by one
or more disqualified persons, other than foundation
managers, and other than one or more organizations
described in section 509(a)(1) or (2).
order to be exempt from tax, a private foundation
must include in its governing instruments various
states (including Vermont) have enacted legislation
that incorporates these requirements in one fashion
or another into the governing instruments by operation
of law. Accordingly, it may not be necessary to
specifically include these provisions in the instrument.
distribution of income in accordance with section
engagement in any act of self-dealing;
any excess business holdings;
speculative investments which jeopardize its
taxable expenditures under section 4945.
are several ways in which the status as a private
foundation can be terminated. Specific obligations
and requirements should be reviewed for each instance.
organization can notify the Internal Revenue
Service of its intention to terminate.
organization's private foundation status can
be involuntarily terminated if it commits willful
repeated acts, or a willful and flagrant act,
or failures to act, that cause liability for
any of the excise taxes, and the Internal Revenue
Service notifies the organization that it is
liable for the termination tax, and its pays
organization may distribute all of its net assets
to one or more bonafide public charities that
has been in existence for at least sixty months;
organization has become a public charity.
termination tax is the lower of:
termination tax may be abated by the Internal Revenue
Service if the appropriate state officer notifies
the IRS that corrective action has been started
under state law to ensure the foundation's assets
are preserved for charitable or other similar purposes,
and later certifies that the action has resulted
in the preservation of the assets.
amount, which the private foundation can substantiate
by adequate records or other corroborating evidence,
is the aggregate tax benefit resulting from
the exempt status of the foundation;
value of the net assets of the foundation.
private foundation may be subject to a 2% tax on
net investment income.
tax is reduced to one percent if the qualifying
distributions for the year represent an increase
over prior years.
"exempt operating foundation" is not
liable for the tax on net investment income.
investment income is gross investment income
and capital gain income, less allowable deductions.
initial tax of 5% is imposed on a self-dealer for
each act of self-dealing. The tax is paid by any
disqualified person who participates in the act,
but is not imposed on a foundation manager who is
acting only in that capacity.
is an additional tax imposed of 200% where the
act of self-dealing is not corrected during
the taxable period. The taxable period is the
period beginning on the date of the act of self-dealing,
and ending 90 days after the earlier of (a)
the date of mailing of the deficiency notice
with respect to the additional tax, (b) the
date on which the excise tax is assessed, and
(c) the date on which correction of the act
tax is the appropriate percentage of the amount
involved in the act of self-dealing.
means undoing the transaction to the extent
possible, but in any case, placing the private
foundation in a financial position not worse
than that in which it would be if the disqualified
person were dealing under the highest fiduciary
is any direct or indirect transaction of the
following types: sale, exchange, or leasing
of property, regardless of the amount paid;
lending of money or other extension of credit;
certain furnishing of goods, services, or facilities;
unreasonable compensation or reimbursement of
expenses; transfer to, or the use by, a disqualified
person of the income or assets; and bribes or
related payments to government officials.
is immaterial whether the transaction results
in a benefit or a detriment to the private foundation.
initial tax of 15% is imposed on the undistributed
income of a private foundation.
tax is imposed on the foundation on that income
not distributed before the first day of the
tax year following the tax year for which there
is a requirement to distribute. If the undistributed
income is still undistributed at the beginning
of the next succeeding year, there is another
tax. This additional tax can reach 100% of the
income is the amount by which the distributable
amount exceeds the qualifying distributions.
The calculation of this is rather complicated
and lengthy, but typically would only apply
to those organizations which are not using most
of their income for charitable purposes.
qualifying distribution is (a) any amount, including
reasonable and necessary administrative expenses,
paid to accomplish one or more exempt purposes,
(b) any amount paid to acquire an asset used
directly in carrying out one or more exempt
purposes, and (c) certain "set-asides".
foundations are not subject to the excise tax on
operating foundation is an organization that
makes qualifying distributions directly for
the active conduct of the activities constituting
the purpose or function for which it is organized
and operated, equal to substantially all (85%
or more) of the lesser of (a) its adjusted net
income, or (b) its minimum investment return,
and meets one of three tests.
test: substantially more (65% or more) than
half of the assets are devoted directly to the
exempt purpose or to functionally related businesses.
test: normally qualify distributions made directly
for the active conduct of the activities constituting
the purpose of the organization are not less
than two-thirds of its minimum investment return.
test: substantially all (85% or more) of the
support, other than gross investment income,
is normally received from the general public,
or through other exempt organizations within
foundations can be subject to several other excise
business holdings can be subject to an initial
tax of 5%. This tax is often triggered when
a foundation invests in closely held businesses.
that jeopardize the charitable purpose of the
foundation can be subject to an initial excise
tax of 5%. This tax can be imposed on both the
foundation and on the foundation manager who
participates in the questionable investment.
This tax can be increased to 25% if the inappropriate
investment is not removed in a timely manner.
expenditures can attract an initial tax of 10%
on the foundation. An additional tax of 2.5%
can be imposed on the foundation manager who
agrees to the making of a taxable expenditure,
and a further tax of 100% can be levied on the
foundation (with 50% being levied against the
manger) if the taxable expenditure is not appropriately
of taxable expenditures are:
on propaganda, or attempting or otherwise
to influence the outcome of any specific
on, directly or indirectly, any voter registration
grants to individuals for travel, study,
or other similar purposes by such individual,
unless such grant is awarded on an objective
and non-discriminatory basis. Specific detailed
rules must be followed;
grants to other organizations, unless (a)
the organization is described in section
509(a)(1), (2), or (3), (b) the organization
is an exempt operating foundation described
in section 4940(d)(2), or (c) the private
foundation exercises expenditure responsibility
with respect to such grant;
any purpose other than a charitable one
described in section 170(c)(2)(B).
to a private foundation:
options may not provide the full control and flexibility
of a private foundation, but they have the advantage
of being relatively simple to establish, they avoid
most of the risks and pitfalls associated with private
foundations, and they are administratively straight-forward
and inexpensive to operate on an on-going basis.
a supporting organization to a community foundation;
donor-advised fund within a community foundation.
Herrick, Ltd. 2000
resource outline is current. However, future
changes in the Internal Revenue Code and related regulations,
rulings, and court cases, may render some of this
information obsolete. Current law should be reviewed
with the appropriate professionals.