Private Foundations: Tax Law and Compliance, 2016 Cumulative Supplement

By Bruce R. Hopkins and Jody Blazek

The must-have tax law reference for private foundations, updated for 2016

Private Foundations provides an authoritative reference and extensive analysis of tax law and compliance in the private foundations arena, with a wealth of practical tools to streamline applications, filing, and reporting. This 2016 Cumulative Supplement captures the latest regulatory developments for easy reference, with coverage of tax-exempt status, mandatory distribution, annual reporting to the IRS, winding up a foundation's affairs, and much more. Comprehensive line-by-line instructions are included for a variety of exemption applications and tax forms, and easy-to-use checklists highlight areas of critical concern to help you avoid oversights. Sample documents are provided to guide the composition of organizational bylaws and letters of application, and completed IRS forms provide practical reference for side-by-side comparison. With comprehensive, up-to-date coverage of the private foundations space alongside helpful tools and visual reference, this book is a resource every foundation needs.  

Written by two of the nation's leading authorities on private foundations, this supplement provides essential guidance you can trust. Clear, concise instructions focused on real-world use makes this reference a critical companion for those tasked with the responsibility of maintaining a foundation's tax-exempt status.

• Learn the latest guidelines for compliance, reporting, and eligibility
• Access the latest regulatory changes quickly and easily
• Organize reporting and applications with checklists and sample forms
• Find valuable tools and reference for all aspects of private foundation compliance

Increasing IRS scrutiny makes compliance a more critical issue than ever before. An organization's tax-exempt status is generally vital to its continued operation, and a single oversight can put the future in jeopardy. Private Foundations provides detailed instructions, examples, and much-needed answers on all aspects of private foundation tax law and compliance.

• Language: English
• Publisher: Wiley
• Release date: Aug 24, 2016
• ISBN: 9781119308522

Book preview

Contents

Cover

Series Page

Title Page

Copyright

Preface

Book Citations

Chapter One: *Introduction to Private Foundations

*§ 1.6 Foundations in Overall Exempt Organizations Context

Chapter Two: Starting and Funding a Private Foundation

§ 2.5 Acquiring Recognition of Tax-Exempt Status

§ 2.7 When to Report Back to the IRS

Chapter Three: Types of Private Foundations

§ 3.1 Private Operating Foundations

Chapter Four: Disqualified Persons

§ 4.4 Family Members

Chapter Five: Self-Dealing

§ 5.3 Definition of Self-Dealing

§ 5.4 Sale, Exchange, Lease, or Furnishing of Property

§ 5.6 Payment of Compensation

§ 5.8 Uses of Income or Assets by Disqualified Persons

§ 5.11 Indirect Self-Dealing

§ 5.12 Property Held by Fiduciary

Chapter Six: Mandatory Distributions

§ 6.2 Assets Used to Calculate Minimum Investment Return

§ 6.5 Qualifying Distributions

§ 6.7 Satisfying the Distribution Test

Chapter Seven: Excess Business Holdings

§ 7.1 General Rules

§ 7.2 Permitted and Excess Holdings

*§ 7.3 Functionally Related Businesses

§ 7.6 Excise Taxes on Excess Holdings

Chapter Eight: Jeopardizing Investments

§ 8.1 General Rules

§ 8.2 Prudent Investments

§ 8.3 Program-Related Investments

Chapter Nine: Taxable Expenditures

*§ 9.1 Legislative Activities

§ 9.2 Political Campaign Activities

§ 9.3 Grants to Individuals

§ 9.4 Grants to Public Charities

*§ 9.5 Grants to Foreign Organizations

§ 9.10 Excise Tax for Taxable Expenditures

Chapter Ten: Tax on Investment Income

§ 10.3 Formula for Taxable Income

Chapter Eleven: Unrelated Business Income

§ 11.1 General Rules

*§ 11.3 Rules Specifically Applicable to Private Foundations

§ 11.5 Calculating and Reporting the Tax

Chapter Twelve: Tax Compliance and Administrative Issues

§ 12.1 Successful Preparation of Form 990-PF

§ 12.2 Reports Unique to Private Foundations

§ 12.3 Compliance Issues

Chapter Thirteen: Termination of Foundation Status

§ 13.4 Operation as a Public Charity

§ 13.5 Mergers, Split-Ups, and Transfers Between Foundations

Chapter Fifteen: Private Foundations and Public Charities

§ 15.5 Service Provider Organizations

§ 15.7 Supporting Organizations

Chapter Seventeen: Corporate Foundations

§ 17.3 Private Inurement Doctrine

§ 17.5 Self-Dealing Rules

Chapter Eighteen: Nonprofit Governance and Private Foundations (New)

§ 18.1 State Law Overview

§ 18.2 Board of Directors Basics

§ 18.3 Principles of Fiduciary Responsibility

§ 18.4 Duties of Directors

§ 18.5 Board Composition and Federal Tax Law

§ 18.6 Sources of Nonprofit Governance Principles

§ 18.7 Relevant Nonprofit Governance Issues

§ 18.8 Nonprofit Governance Policies

§ 18.9 Role of IRS in Nonprofit Governance

§ 18.10 Governance Principles and Private Foundations

Cumulative Table of Cases

Cumulative Table of IRS Revenue Rulings and Revenue Procedures

Cumulative Table of IRS Private Determinations Cited in Text

Cumulative Table of IRS Private Determinations Discussed inBruce R. Hopkins' Nonprofit Counsel

Cumulative Table of IRS Private Letter Rulings, Technical Advice Memoranda, and General Counsel Memoranda

*Table of Private Foundation Law Tax Reform Proposals

About the Authors

About the Online Resources

Cumulative Index

End User License Agreement

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Private Foundations

Tax Law and Compliance

Fourth Edition

2016 Cumulative Supplement

Bruce R. Hopkins

Jody Blazek

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Cover image: ©iStock.com/phleum

Cover design: Wiley

Copyright © 2016 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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ISBN 978-1-118-53247-8 (main edition)

ISBN 978-1-119-30850-8 (supplement)

ISBN 978-1-119-30851-5 (ebk)

ISBN 978-1-119-30852-2 (ebk)

Preface

This is the second supplement to accompany the fourth edition of Private Foundations: Tax Law and Compliance. The book attempts to capture developments through the close of 2013. This cumulative supplement essentially covers federal tax law developments in the private foundation context for the multi-month period ending as of the close of 2015.

As noted in the preface to the book, matters in recent months have been relatively quiet on the private foundation tax law and compliance front. This is due in large part to the good behavior of foundations in recent times and the reluctance at the IRS to initiate much in the realm of tax-exempt organizations as the IRS tries to recover from the management and regulatory chaos caused by the brouhaha over the processing of certain applications for recognition of exemption.

Somewhat of an exception to the foregoing is the guidance that was published on application of the jeopardizing investments rules to investments that are made by private foundations for charitable purposes (other than program-related investments), often referred to as mission-related investments. This guidance is summarized herein. Moreover, as we discuss, the Department of the Treasury and the IRS finalized the regulations addressing good-faith determination standards in connection with grants to foreign charitable organizations.

We have reported on a variety of private letter rulings issued in the foundation context. These range from various interpretations of the self-dealing and excess business holdings rules, to technical advice memoranda on abatements or refusals to abate private foundation excise taxes, to a flurry of favorable private rulings concerning unusual grants. Also, we have updated the chapter (17) on the application of the foundation rules specifically in the corporate foundation context.

In addition, we have brought back our chapter on governance (18), updated, with emphasis (of course) on this body of law as it specifically relates to private foundations. The IRS has yet to apply its unique views, as to how charitable organizations should be governed and what the IRS's role ought to be in regulating that governance, to private foundations but the agency is likely to eventually do so. The chapter is there to provide guidance to foundations that may be intrigued by this matter of governance or those that want to get a head start on the IRS.

We appreciate the assistance we have received from John Wiley & Sons in the preparation of this supplement. Thanks are particularly extended to our editors in connection with this project, namely, Matthew Davis, Dawn Kilgore, and Judy Howarth.

Bruce R. Hopkins

Jody Blazek

September 2016

Book Citations

Throughout this book, 12 books by the authors (in some instances, as co-author), all published by John Wiley & Sons, are referenced in this way:

Hopkins, IRS Audits of Tax-Exempt Organizations: Policies, Practices, and Procedures (2008): IRS Audits.

Blazek, IRS Form 1023 Tax Preparation Guide (2005): IRS Form 1023 Tax Preparation Guide.

Hopkins, The Law of Fundraising, Fifth Edition (2013): Fundraising.

Hopkins, The Law of Intermediate Sanctions: A Guide for Nonprofits (2003): Intermediate Sanctions.

Hopkins, The Law of Tax-Exempt Organizations, Eleventh Edition (2016): Tax-Exempt Organizations.

Hopkins, Nonprofit Governance: Law, Practices & Trends (2009): Nonprofit Governance.

Blazek, Nonprofit Financial Planning Made Easy (2008): Nonprofit Financial Planning Made Easy.

Hopkins, Nonprofit Law for Colleges and Universities: Essential Questions and Answers for Officers, Directors, and Advisors (2011): Colleges and Universities.

Hopkins, Planning Guide for the Law of Tax-Exempt Organizations: Strategies and Commentaries (2004): Planning Guide.

Hopkins, The Tax Law of Charitable Giving, Fifth Edition (2014): Charitable Giving.

Hopkins, The Tax Law of Unrelated Business for Nonprofit Organizations (2005): Unrelated Business.

Blazek, Tax Planning and Compliance for Tax-Exempt Organizations, Fourth Edition (2004): Tax Planning and Compliance.

The third, fifth, tenth, and twelfth editions of these books are annually supplemented. Also, updates on all of the foregoing law subjects (plus private foundations law) are available in Bruce R. Hopkins' Nonprofit Counsel, a monthly newsletter also published by Wiley.

Chapter One

*Introduction to Private Foundations

*§ 1.6 Foundations in Overall Exempt Organizations Context

*§ 1.6 Foundations in Overall Exempt Organizations Context

*p. 18, note 82. Insert as second paragraph:

The Tax Exempt and Government Entities Division, on October 1, 2015, issued its work plan for the federal government's fiscal year 2016. This work plan identifies TE/GE's five key areas of focus in the coming months. One of these areas is knowledge management. The Division is developing a knowledge management framework, which entails gathering information from employees and staffing the knowledge networks (what the IRS likes to refer to as K-Nets). The IRS has begun building knowledge libraries within each K-Net, containing technical resources searchable by key issue areas and resource type. One K-Net that is currently under way concerns private foundation tax law.

Chapter Two

Starting and Funding a Private Foundation

§ 2.5 Acquiring Recognition of Tax-Exempt Status

(a) Preparing Form 1023

(e) Application Processing Timeline

*(h) Applications Processing Controversy

§ 2.7 When to Report Back to the IRS

(a) When Should a Ruling Be Requested

§ 2.5 Acquiring Recognition of Tax-Exempt Status

(a) Preparing Form 1023

p. 45. Add after third paragraph:

Extraordinary turmoil racked the IRS determination process in the recent past, though several changes have improved the work flow. Because the tax code provision that provides an organization's tax exemption is automatically revoked if the entity fails to file a required Form 990 for three consecutive years effective as of the filing due date of the third year,67.1 more than 500,000 organizations were revoked, including many private foundations. The Cincinnati office that processes applications for recognition of tax exemption was inundated with applications for reinstatement beginning in 2010 as the number of applications significantly increased. Concurrently, that office enhanced their scrutiny of applicants for exemption as social welfare organizations to look for potential participation in promoting the election of persons to public office. They developed a BOLO (be on the lookout list) to identify applicants that could not satisfy the exclusively operated for social welfare purposes standard needed to qualify for exemption.67.2 The standard applied was that the activity aimed at influencing an election could not be the entity's primary activity, though there was no numerical definition of the word primary. Applicants with names that implied political involvement, including Tea Party or Democrat, were given enhanced scrutiny. As a result of pressure from Congress, the media, and the organizations themselves, the system was abandoned and officials in the exempt organization division were relieved of their duties. Regulations were proposed to clarify the rules, but they have been withdrawn.

As a consequence of the turmoil, applications took a significant time to be reviewed and a streamlined procedure to reduce the time required was implemented.67.3 Modest organizations eligible to file either Form 990-EZ or 990-N which filed an application for reinstatement within 15 months of revocation were retroactively reinstated and penalties for failure to file not imposed if they demonstrated reasonable cause by attesting that the organization's failure to file was not intentional and that it has put in place procedures to file in the future. Resubmission after 15 months requires demonstration of reasonable cause. Those entities that were required to and did not file Form 990 or 990-PF must submit the application with a reasonable cause description and complete and submit the returns they failed to file. For these entities, penalties will not be imposed.

The next step to address the turmoil came in June 2014, when the IRS released a new Form 1023-EZ. Prospective exempts with revenue of $50,000 or less and assets of $250,000 or less are eligible to use this abbreviated 4-page application subject to completion of a 7-page eligibility checklist that excludes foreign, successors, LLC, churches, schools, hospitals, and many other types of applicants.67.4

Applicants are asked to attest that the organizational documents:

Limit purposes to one or more exempt purposes within § 501(c)(3) = religious, charitable, scientific, testing for public safety, literary, educational, fostering national or international amateur sports competition, or preventing cruelty to children or animals;

Not expressly empower the entity to engage, otherwise than as an insubstantial part of your activities, in activities that in themselves are not in furtherance of one or more exempt purposes; and

Provide that, upon dissolution, remaining assets will be used exclusively for § 501(c)(3) purposes.

Form 1023-EZ must be filed electronically, as shown in the form below.

Form 1023-EZ for Streamlined Application for Recognition of Exemption Under Section 501 (c)(3) of the Internal Revenue Code where Part I collects the contact information of the applicant. Part II requires the information about the structure of organization whereas Part III enquires about the different activities undertaken by the organization . Part IV requires the applicant to classify the organization as Public charities or Private foundations. Part V is to be filled by the applicant applying for reinstatement of exemption after being automatically revoked for not filing returns for three consecutive years. Part VI establishes that the information filled in the application is true and complete to the best of applicant's knowledge.

The version of Form 1023 with a box at the top directing one to the Internet at StayExempt.irs.gov, allows submission of the form electronically. This on-line version contains prompts to technical information contained on the IRS/EO Division and can be very useful.

Figure depicting a page from form 1023, Application for Recognition of Exemption Under Section 501 (c) (3) of the Internal Revenue Code. On the top of the form is a box that contains the information about the interactive version of the form along with the website that allows submission of the form electronically.

(e) Application Processing Timeline

p. 102. Revise second sentence in first paragraph:

As of June 1, 2015, the IRS no longer reports the number of applications pending, but instead says our inventory is current. The applicant can expect to be contacted within 90 days of submission and if not, is instructed to contact them on 877-829-5500.

p. 102. Insert following paragraphs, before heading:

*Applications that are properly and completely prepared may result in issuance of a favorable determination letter in a few months. Others will likely entail the gathering of additional information by the IRS, by means of one or more information requests. For many years, EO Determinations gave applicant organizations 21 days to respond to an information request. An organization could obtain a 14-day extension to respond. If a response did not timely arrive, EO Determinations placed the case in suspense and notified the applicant that it had 90 days to supply the requested information. Absent a response within that time period, the case would be closed. Because the IRS has increased the timeliness of its processing of these applications, the IRS has revised the procedures, principally by eliminating the suspense period.

The essence of this new approach, which took effect in September 2015,*132.1 is that, if an applicant organization does not respond to an information request by the designated due date, EO Determinations will close the case without making a determination and will not refund any user fee paid. The concept is that an applicant that does not timely provide the requested information fails to establish that it meets the requirements for tax-exempt status. An organization whose case is closed under this procedure will have to submit a new application package and pay another user fee.

IRS personnel are instructed to issue a letter to an applicant when it is necessary to seek information in addition to that provided in the application. The letter will incorporate appropriate streamline, pre-written, or individually composed questions. The applicant will be given 28 calendar days to respond. The applicant organization is to be called and notified about the letter on the day it is mailed. The agent is to emphasize the importance of responding by the due date, to avoid a case closing. Issues in the case may be discussed on this call.

If the organization requests an extension, the case manager must approve it, based on the facts and circumstances. The normal extension period is 14 days, at the most. Managers can approve longer extensions as needed (such as for filing of an amendment to a corporate document). If the response is incomplete, the agent may issue an additional request for information. An agent must consult with his or her manager before a third request for information is issued.

If a response to an information request has not been received, the agent is to call the applicant organization three business days prior to the response due date. The organization is to be reminded of the due date and the imminent case closing.

If the organization does not respond by the due date, the agent is to close the case as a failure to establish eligibility for recognition of tax exemption.*132.2

*p. 104. Insert following fourth paragraph, before heading:

*(h) Applications Processing Controversy

The Senate Committee on Finance, on August 5, 2015, released its report on the Committee's bipartisan investigation of the IRS's handling of applications for recognition of tax exemption submitted by political advocacy organizations.*138.1 This investigation found that, from 2010 to 2013, IRS management was delinquent in its responsibility to provide effective control, guidance, and direction over the processing of applications for [recognition of] tax-exempt status filed by Tea Party and other political advocacy organizations. IRS managers were said to fail in their responsibility to keep informed about the very existence of the applications or recognize the sensitivity of these applications. As to the former, IRS management forfeited the opportunity to shape the IRS's response to the influx of political advocacy applications by simply failing to read reports informing them of the existence of those applications. As to the latter, IRS managers did not take appropriate steps to ensure that the applications were processed expeditiously and accurately.

References to IRS management largely means those heading the Exempt Organizations Division, the Director of which during 2006 through May 2013 was Lois Lerner. This report states that she first became aware of applications from Tea Party groups in April or May of 2010. The report states that, [f]or the next two years, Lerner failed to adequately manage the EO employees who processed these applications and failed to inform upper-level IRS management of the serious delays in processing applications [for recognition of] tax-exempt status from Tea Party and other politically sensitive groups. It is stated that, under the leadership of Ms. Lerner, the Division undertook a number of initiatives to process these applications, with [e]ach of these initiatives . . . flawed in design and/or mismanaged.

The report discusses the dysfunctional culture in the EO Division during this period, stating that it operated without sufficient regard for the consequences of its actions for the applicant organizations. The brouhaha over the loss of and recovery of some emails is related; this was said to delay issuance of this report for more than a year. The report concludes that [o]verall, the IRS's less than complete response to these circumstances cast[s] doubt about the thoroughness of their efforts to recover all relevant records related to the investigation, as well as their candor to this and other Congressional committees.

This Senate Finance Committee report offered a number of recommendations, including the following: (1) the IRS should publish in the applications' instructions objective criteria that may trigger additional review and the procedures IRS specialists use to process applications involving political campaign activity; (2) the IRS should be prohibited from requesting individual donor identities at the application stage, although generalized donor questions should continue to be allowed; (3) a position within the Taxpayer Advocate Service should be created, dedicated solely to assisting nonprofit organizations in applying for recognition of exemption; (4) the EO Division should track the age and cycle time of its cases, so that it can detect backlogs early in the process and conduct periodic reviews of over-aged cases to identify the cause of the delays; (5) the standards in the Internal Revenue Manual for timely processing of cases should be enforced and employees who fail to follow them should be disciplined; (6) IRS employees should be directed to conclude application cases within 270 days of filing; (7) the Sensitive Case Report process should be revised or a more effective way to elevate important issues within the IRS should be developed; (8) there should be minimum training standards for all EO Division managers to ensure that they have adequate technical ability to perform their jobs; and (9) the IRS should fully implement the recommendations of the Government Accountability Office in its July 2015 report.*138.2

The majority and minority staff were unable to reach agreement as to these topics: (1) the extent to which, if any, political bias of IRS employees affecting IRS's processing of applications for recognition of tax-exempt status; (2) whether the IRS used improper methods to screen and process applications for recognition of exempt status submitted by progressive and left-leaning organizations; and (3) the involvement, if any, of