Nonprofit OrganizationsNonprofit OrganizationsPrivate Foundations Private Foundations

Michael V. BourlandMichael V. Bourland

Michelle Coleman-JohnsonMichelle Coleman-Johnson

Bourland, Wall & Wenzel, P.C.Bourland, Wall & Wenzel, P.C.

Tax Exempt Tax Exempt Organizations – ReviewOrganizations – Review I.R.C. Section 501(c) lists I.R.C. Section 501(c) lists

organizations that are exempt from organizations that are exempt from federal income taxfederal income tax

I.R.C. Section 501(c)(3) lists I.R.C. Section 501(c)(3) lists charitable organizations that are charitable organizations that are exempt from federal income tax, exempt from federal income tax, contributions to which are income contributions to which are income tax deductible to the donor under tax deductible to the donor under I.R.C. Section 170I.R.C. Section 170

Section 501(c)(3) Section 501(c)(3) Organizations - Organizations - PurposesPurposes Organized and operated exclusively for Organized and operated exclusively for

– Religious, charitable, scientificReligious, charitable, scientific– Testing for public safetyTesting for public safety– LiteraryLiterary– Educational purposes; orEducational purposes; or– To foster national or international amateur To foster national or international amateur

sports competition (but only if no part of sports competition (but only if no part of its activities involve the provision of its activities involve the provision of athletic facilities or equipment); orathletic facilities or equipment); or

– Prevention of cruelty to children or animalsPrevention of cruelty to children or animals

501(c)(3) Orgs – 501(c)(3) Orgs – Prohibited ActivitiesProhibited Activities No part of net earnings may inure No part of net earnings may inure

to the benefit of any private to the benefit of any private shareholder or individualshareholder or individual– Private benefit/inurement doctrinePrivate benefit/inurement doctrine

No substantial part of activities No substantial part of activities may be carrying on propaganda, may be carrying on propaganda, or otherwise attempting, to or otherwise attempting, to influence legislationinfluence legislation– Except as provided in (c)(h)Except as provided in (c)(h)

501(c)(3) 501(c)(3) Organizations – Organizations – Prohibited ActivitiesProhibited Activities May not participate in, or May not participate in, or

intervene in (including the intervene in (including the publishing or distributing of publishing or distributing of statements) any political statements) any political campaign on behalf of (or in campaign on behalf of (or in opposition to) any candidate for opposition to) any candidate for public office.public office.

Charitable Charitable ContributionsContributions Donors are allowed an income tax Donors are allowed an income tax

charitable deduction for charitable deduction for contributions to 501(c)(3) contributions to 501(c)(3) organizationsorganizations– See sections 170(a)(1) and 170(b)(1)See sections 170(a)(1) and 170(b)(1)

(A)(A)– Some organizations are “charitable” Some organizations are “charitable”

by definition or by the activities by definition or by the activities carried oncarried on

Private Foundation – under section Private Foundation – under section 509(a), an organization is presumed 509(a), an organization is presumed to be a private foundation unless it to be a private foundation unless it is demonstrated that it fits an is demonstrated that it fits an exception, and thus is a public exception, and thus is a public charitycharity

Further Classification - Further Classification - Private FoundationPrivate Foundation

There Are Two Types There Are Two Types of Private Foundationsof Private Foundations Private Operating FoundationPrivate Operating Foundation

– Has a stated charitable purpose and carries out its Has a stated charitable purpose and carries out its own programsown programs

– Generally seeks grants rather than awarding grants Generally seeks grants rather than awarding grants to other charitable organizationsto other charitable organizations

– Must expend substantially all of its net investment Must expend substantially all of its net investment income directly for the purposes of its own income directly for the purposes of its own charitable activitiescharitable activities

– Although donors receive the more liberal public Although donors receive the more liberal public charity income tax deduction limitations, this type charity income tax deduction limitations, this type of foundation remains subject to the private of foundation remains subject to the private foundation restrictions because its source of foundation restrictions because its source of funding is generally from one individual, family or funding is generally from one individual, family or corporation corporation

Private Nonoperating Private Nonoperating FoundationFoundation Private Nonoperating FoundationPrivate Nonoperating Foundation

– Most commonMost common– Generally receives its funding from one Generally receives its funding from one

primary source, such as an individual, a primary source, such as an individual, a family or a corporationfamily or a corporation

– Does not generally actively raise funds or Does not generally actively raise funds or seek grantsseek grants

– Required to distribute approximately 5% of Required to distribute approximately 5% of its assets annually to public charitiesits assets annually to public charities

– Donors’ charitable income tax deductions Donors’ charitable income tax deductions are more limited than when made to a are more limited than when made to a public charity. public charity.

Tax Treatment for Tax Treatment for DonorsDonors Gifts of Cash and Nonappreciated Gifts of Cash and Nonappreciated

PropertyProperty– Limited to 30% of AGILimited to 30% of AGI

50% if to public charity or private operating 50% if to public charity or private operating foundationfoundation

Gifts of Appreciated PropertyGifts of Appreciated Property– Limited to 20% of AGI Limited to 20% of AGI

If gift of qualified stock, donor can write off fair If gift of qualified stock, donor can write off fair market valuemarket value

If not qualified stock, donor must write off basisIf not qualified stock, donor must write off basis– 30% if to public charity or private operating 30% if to public charity or private operating

foundationfoundation Subject to Itemized Deduction LimitationSubject to Itemized Deduction Limitation

Excise Excise Taxes/Prohibited Taxes/Prohibited TransactionsTransactions Foundations are subject to prohibited Foundations are subject to prohibited

transaction rulestransaction rules Violation of these rules result in excise Violation of these rules result in excise

taxes, and can arise fromtaxes, and can arise from– Self DealingSelf Dealing– Failure to meet Minimum Distribution Failure to meet Minimum Distribution

RequirementsRequirements– Excess Business HoldingsExcess Business Holdings– Taxable ExpendituresTaxable Expenditures

Foundation Excise Foundation Excise TaxesTaxes On Investment Income (4940(a)) – On Investment Income (4940(a)) –

cannot be avoided, but can be reducedcannot be avoided, but can be reduced On Self-Dealing (4941)On Self-Dealing (4941) On Failure to Distribute Income (4942)On Failure to Distribute Income (4942) On Excess Business Holdings (4943)On Excess Business Holdings (4943) On Jeopardizing Investments (4944)On Jeopardizing Investments (4944) On Taxable Expenditures (4945)On Taxable Expenditures (4945) On Termination (507)On Termination (507)

Self DealingSelf Dealing

Self dealing – certain actions between a Self dealing – certain actions between a private foundation and a disqualified private foundation and a disqualified person – can be direct or indirect, and person – can be direct or indirect, and includes:includes:– Sale or exchange or leasing of propertySale or exchange or leasing of property– Lending of money or extension of creditLending of money or extension of credit– Furnishing of goods & services (limited Furnishing of goods & services (limited

exception)exception)– Payment of compensation (limited exception)Payment of compensation (limited exception)– See 4941 for comprehensive listSee 4941 for comprehensive list

More Acts of Self More Acts of Self DealingDealing Furnishing of Furnishing of

goods/services/facilitiesgoods/services/facilities– Unless available to the general public Unless available to the general public

on at least as favorable a basison at least as favorable a basis CompensationCompensation

– Payment for personal services, Payment for personal services, reasonable, necessary and not reasonable, necessary and not excessiveexcessive

Who is a Disqualified Who is a Disqualified Person for Self Person for Self Dealing?Dealing? Disqualified Person (IRC Section 4946)Disqualified Person (IRC Section 4946)

Substantial Contributor (507(d)(2))Substantial Contributor (507(d)(2)) Family Member of Substantial ContributorFamily Member of Substantial Contributor Persons owning more than 20% of an entity Persons owning more than 20% of an entity

which is a substantial contributorwhich is a substantial contributor If a corporation is a substantial contributor, any If a corporation is a substantial contributor, any

officer or director of the corporationofficer or director of the corporation Foundation managerFoundation manager Member of family of substantial contributor or Member of family of substantial contributor or

foundation managerfoundation manager Corporation which a disqualified person own Corporation which a disqualified person own

more than 35% of voting power (or 35% of more than 35% of voting power (or 35% of profit/beneficial interest)profit/beneficial interest)

Substantial Substantial ContributorContributor Any person who contributes or bequeaths Any person who contributes or bequeaths

an aggregate amount of more than an aggregate amount of more than $5,000 to the private foundation, if such $5,000 to the private foundation, if such amount is more than 2% of the total amount is more than 2% of the total contributions and bequests received by contributions and bequests received by the foundation before the close of the the foundation before the close of the taxable year of the foundation in which taxable year of the foundation in which the contribution or bequest is received by the contribution or bequest is received by the foundation from such personthe foundation from such person

Also means the creator of the foundationAlso means the creator of the foundation

Minimum Distribution Minimum Distribution RequirementsRequirements PF must generally distribute at PF must generally distribute at

least 5% of its assets on an annual least 5% of its assets on an annual basis in qualifying distributionsbasis in qualifying distributions– Asset base includes those assets not Asset base includes those assets not

used in furtherance of the used in furtherance of the foundation’s exempt purposes, such foundation’s exempt purposes, such as the foundation’s office buildingas the foundation’s office building

– Generally includes cash, stocks, Generally includes cash, stocks, bonds and other investment assetsbonds and other investment assets

MDR – Time Period for MDR – Time Period for DistributionDistribution 12 months after close of taxable 12 months after close of taxable

year to satisfy the minimum year to satisfy the minimum payout requirement for that payout requirement for that taxable yeartaxable year

Can retroactively satisfy last Can retroactively satisfy last year’s payout requirements with year’s payout requirements with the current year’s qualifying the current year’s qualifying paymentpayment

MDR – Qualifying MDR – Qualifying DistributionsDistributions Grants to qualified charitable Grants to qualified charitable

organizations (other 501(c)(3) organizations (other 501(c)(3) organizations)organizations)

Grants to charities and non-Grants to charities and non-charities for charitable purposescharities for charitable purposes– Special rules for grants to individualsSpecial rules for grants to individuals

Costs of direct charitable Costs of direct charitable activitiesactivities

Grants to IndividualsGrants to Individuals

Grants - Subject to IRC Section Grants - Subject to IRC Section 4945 restrictions pertaining to 4945 restrictions pertaining to grants for travel, study or any grants for travel, study or any similar purposesimilar purpose– Requires prior IRS approvalRequires prior IRS approval

Distributions that are not “grants”Distributions that are not “grants”– Distributions to non-charitable Distributions to non-charitable

organizations are permissible only if organizations are permissible only if the foundation follows expenditure the foundation follows expenditure responsibility guidelinesresponsibility guidelines

Excess Business Excess Business HoldingsHoldings Foundations are limited in business Foundations are limited in business

ownership, and may only ownownership, and may only own– 20% of voting stock in a corporation, 20% of voting stock in a corporation,

reduced by the percentage owned by reduced by the percentage owned by all Disqualified Personsall Disqualified Persons

– 35% of voting interest (reduced by 35% of voting interest (reduced by what DP owns) if control is not in DPwhat DP owns) if control is not in DP

– De minimis 2% voting stock or valueDe minimis 2% voting stock or value

Excess Business Excess Business HoldingsHoldings 5 years to dispose of excess 5 years to dispose of excess

holdingsholdings Additional 5 years if an unusually Additional 5 years if an unusually

large gift or bequestlarge gift or bequest May not dispose of interest to a May not dispose of interest to a

disqualified persondisqualified person

Jeopardizing Jeopardizing InvestmentsInvestments PF cannot make investments which PF cannot make investments which

would jeopardize the exempt purposewould jeopardize the exempt purpose– No per se violations in codeNo per se violations in code– ““prudent investor” standard of careprudent investor” standard of care– Examples:Examples:

Margins, selling shortMargins, selling short Speculative investmentsSpeculative investments

– Does not apply to gifts received by the PFDoes not apply to gifts received by the PF

Taxable Expenditures Taxable Expenditures

Expenditures not in furtherance of Expenditures not in furtherance of exempt purposeexempt purpose– Carrying on propaganda or political Carrying on propaganda or political

activitiesactivities– Distributions to non-charities, Distributions to non-charities,

including grants to individualsincluding grants to individuals Unless distribution is in fact charitable Unless distribution is in fact charitable

and expenditure responsibility is and expenditure responsibility is exercisedexercised

Awarding of GrantsAwarding of Grants

Need prior IRS approvalNeed prior IRS approval Must be awarded on objective and Must be awarded on objective and

nondiscriminatory basisnondiscriminatory basis May not benefit private individual or May not benefit private individual or

attempt to influence legislationattempt to influence legislation In furtherance of foundation’s In furtherance of foundation’s

charitable purposecharitable purpose Must follow specific guidelines set by Must follow specific guidelines set by

IRSIRS

Expenditure Expenditure ResponsibilityResponsibility If a distribution to an individual or If a distribution to an individual or

non-charity is charitable in nature non-charity is charitable in nature but not a “grant” under the Codebut not a “grant” under the Code– PF must exercise expenditure PF must exercise expenditure

responsibilityresponsibility Strict guidelines must be followed and Strict guidelines must be followed and

thorough records keptthorough records kept PF must monitor the charitable use of PF must monitor the charitable use of

the fundsthe funds

Investment Income Investment Income Excise TaxExcise Tax Excise tax on investment income Excise tax on investment income

(4940(a))(4940(a))– Tax of 2% (1% under certain Tax of 2% (1% under certain

circumstances) on net investment circumstances) on net investment income for a taxable yearincome for a taxable year Does not apply to operating foundationsDoes not apply to operating foundations

– Cannot be avoided - not a penalty Cannot be avoided - not a penalty for prohibited transactionsfor prohibited transactions

Self Dealing Excise Tax Self Dealing Excise Tax - 4941- 4941 11stst Tier: Tier:

– Disqualified person: 5% of amount Disqualified person: 5% of amount involved for each year uncorrectedinvolved for each year uncorrected

– Foundation manager: 2.5% if willingly Foundation manager: 2.5% if willingly participated, knowing prohibitedparticipated, knowing prohibited

22ndnd Tier: Tier:– Disqualified person: 200% Disqualified person: 200% – Foundation manager: 50%Foundation manager: 50%

Failure to Distribute Failure to Distribute Income - 4942Income - 4942 11stst tier: tier:

– Foundation: 15% on difference of Foundation: 15% on difference of what should have been distributed what should have been distributed and what was distributedand what was distributed

22ndnd tier: tier:– Foundation: 100% of undistributed Foundation: 100% of undistributed

amount if penalty assessed and amount if penalty assessed and correction not madecorrection not made

Excess Business Excess Business Holdings - 4943Holdings - 4943 11stst tier: tier:

– Foundation: 5% of the excess Foundation: 5% of the excess business holdingbusiness holding

22ndnd tier: tier:– Foundation: 200% of the excess Foundation: 200% of the excess

business holding if not timely business holding if not timely correctedcorrected

Jeopardizing Jeopardizing Investments -4944Investments -4944 11stst tier: tier:

– Foundation: 5% of improperly Foundation: 5% of improperly invested assetsinvested assets

– Foundation manager: 5% of Foundation manager: 5% of improperly invested assetsimproperly invested assets

22ndnd tier: tier:– Foundation: additional 25%Foundation: additional 25%– Foundation manager: additional 5%Foundation manager: additional 5%

Taxable ExpendituresTaxable Expenditures

11stst tier: tier:– Foundation: 10% on each taxable Foundation: 10% on each taxable

expenditureexpenditure– Foundation manager: 2.5% on each Foundation manager: 2.5% on each

taxable expendituretaxable expenditure 22ndnd tier: tier:

– Foundation: 100%Foundation: 100%– Foundation manager: 50%Foundation manager: 50%

Termination Tax - 507Termination Tax - 507

A private foundation must take A private foundation must take great care in dissolution or great care in dissolution or merger with another organization merger with another organization so as to avoid a taxable so as to avoid a taxable termination under Section 507termination under Section 507

Private Operating Private Operating FoundationsFoundations Directly carry on charitable Directly carry on charitable

activities, instead of making activities, instead of making grants to other organizationsgrants to other organizations

Must meet the “income test” and Must meet the “income test” and one of three other testsone of three other tests– ““assets test”assets test”– ““endowment test”endowment test”– ““support test”support test”

““Income Test”Income Test”

Must distribute substantially all of Must distribute substantially all of the lesser of its adjusted net the lesser of its adjusted net income or its minimum income or its minimum investment return directly for the investment return directly for the active conduct of its exempt active conduct of its exempt purposespurposes– Does not include grants to other Does not include grants to other

organizationsorganizations

Income testIncome test

Substantially all – means 85% or moreSubstantially all – means 85% or more Adjusted net income – gross income less Adjusted net income – gross income less

deductions allowable to a corporationdeductions allowable to a corporation– Does not include gifts, grants or contributionsDoes not include gifts, grants or contributions

Minimum investment return – 5% of the Minimum investment return – 5% of the assets not used directly in carrying out assets not used directly in carrying out exempt purposes (same test as minimum exempt purposes (same test as minimum distribution for a private foundation)distribution for a private foundation)

Assets/Endowment/Assets/Endowment/Support TestsSupport Tests Assets TestAssets Test

– Substantially more than ½ of assets Substantially more than ½ of assets be held for use for exempt function be held for use for exempt function activitiesactivities Defined to be 65% or moreDefined to be 65% or more

Endowment TestEndowment Test– Direct distributions of at least 2/3 of Direct distributions of at least 2/3 of

the foundation’s minimum investment the foundation’s minimum investment return, orreturn, or

– 33 1/3 % of its endowment33 1/3 % of its endowment

Support TestSupport Test

At least 85% of the organization’s support At least 85% of the organization’s support (excluding gross investment income) be (excluding gross investment income) be from a combination of the general public from a combination of the general public and 5 or more exempt organizations andand 5 or more exempt organizations and

Not more than 25% of support (other than Not more than 25% of support (other than gross investment income) be from any gross investment income) be from any one exempt organization andone exempt organization and

Not more than 50% of support be from Not more than 50% of support be from gross investment incomegross investment income

SupportSupport

Gifts, grants, contributions,Gifts, grants, contributions, Membership fees, gross receipts from Membership fees, gross receipts from

admissions, sales of merchandise,admissions, sales of merchandise, Performance of servicesPerformance of services Furnishing of facilitiesFurnishing of facilities Net income from UBI activitiesNet income from UBI activities Gross investment incomeGross investment income Tax revenuesTax revenues Value of services or facilities furnished Value of services or facilities furnished

by a governmental unit without chargeby a governmental unit without charge

Computation PeriodComputation Period

Based upon year in question and Based upon year in question and the three immediately preceeding the three immediately preceeding yearsyears– May be met on an aggregate basisMay be met on an aggregate basis

Tax on Undistributed Tax on Undistributed IncomeIncome Private Operating Foundations are Private Operating Foundations are

not subject to the tax on not subject to the tax on undistributed incomeundistributed income

Reporting Reporting RequirementsRequirements Private Operating Foundation Private Operating Foundation

generally subject to the same generally subject to the same reporting requirements as an reporting requirements as an private nonoperating foundationprivate nonoperating foundation– Annual return 990-PFAnnual return 990-PF