Insightful analysis and clarification of private foundation tax law combined with hands-on practice tools that make compliance simpler
Now in its sixth edition, The Tax Law of Private Foundations by Bruce Hopkins and Shane Hamilton serves as the ultimate reference for navigating the intricate regulatory landscape faced by private foundations. This comprehensive book is regularly updated to incorporate the latest changes in tax law, providing executives and professionals with valuable clarification, expert insights, and practical instruction.
With each edition supplemented annually, readers can rely on the book to remain current and relevant. It offers a clear and concise summary of the tax laws and regulations governing private foundations, unveiling the logic underpinning the rules. Readers will also find:
- Critical analyses and considerations of existing laws and regulations
- Expert guidance on obtaining or maintaining your foundation’s tax-exempt status
- In-depth explanations of the procedural and administrative requirements for dealing with a violation of the private foundation rules
An indispensable resource, this latest edition caters to individuals with personal or professional interests in private foundations, offering authoritative guidance and illuminating explanations in an intricate and perplexing area of the law. Whether navigating the complexities of compliance or seeking deep insights, this book remains the gold standard for understanding and managing the complexities of private foundation taxation.
Table of Contents
A Letter to the Reader xix
Preface xxi
Book Citations xxvii
1 Introduction to Private Foundations 1
§ 1.1 Private Foundations: Unique Organizations 2
§ 1.2 Definition of Private Foundation 4
§ 1.3 Background 7
§ 1.4 Private Foundation Tax Law Primer 10
(a) Introduction 11
(b) General Operational Requirements 11
(c) Disqualified Persons 12
(d) Self- Dealing Rules 12
(e) Mandatory Payout Rules 13
(f) Excess Business Holdings Rules 14
(g) Jeopardizing Investments Rules 14
(h) Taxable Expenditures Rules 15
(i) Tax on Investment Income 16
(j) Termination of Private Foundation Status 16
(k) Charitable Giving Rules 16
(l) Unrelated Business Rules 17
§ 1.5 Definition of Charity 17
§ 1.6 Operating for Charitable Purposes 19
§ 1.7 Organizational Rules 22
§ 1.8 Private Foundation Law Sanctions 24
(a) Sanctions (a Reprise) 25
(b) Self- Dealing Sanctions as Pigouvian Taxes 25
(c) Self- Dealing Sanctions: Taxes or Penalties? 26
(d) Abatement 31
(e) Potential of Overlapping Taxes 31
(f) Influence on Subsequent Law 32
§ 1.9 Statistical Profile 33
§ 1.10 Private Foundations and Law 50 Years Later 33
2 Starting, Funding, and Governing a Private Foundation 39
§ 2.1 Alternatives to Private Foundations 40
§ 2.2 Advantages of Private Foundations 42
§ 2.3 Choice of Organizational Form 46
§ 2.4 Funding a Foundation 47
§ 2.5 Estate Planning Principles 49
(a) Decedents’ Estates 50
(b) Estate and Gift Tax Considerations 50
§ 2.6 Foundations and Planned Giving 51
(a) Introduction to Planned Giving 51
(b) Charitable Remainder Trusts 52
(c) Other Planned Giving Vehicles 53
(d) Interrelationships with Private Foundation Rules 54
§ 2.7 Acquiring Recognition of Tax- Exempt Status 55
(a) Form 1023 56
(b) 27- Month Rule 59
(c) IRS Determination Letters Recognizing Exempt Status 61
(d) Administrative Procedures Where Recognition Denied 64
(e) Declaratory Judgment Procedures Where Recognition Denied 67
(f) Recognition of Foreign Organizations 70
(g) Exemption for State Purposes 71
§ 2.8 Governance 72
(a) IRS Entry into Nonprofit Governance 73
(b) Concept of Nonprofit Governance 74
(c) Nonprofit Governance Standards 76
(d) Early IRS Attempts at Nonprofit Governance Regulation 80
(e) Federal Tax Law as to Board Composition 81
(f) IRS’s Use of Private Benefit Doctrine 82
(g) IRS’s Ruling Policy 84
3 Types of Private Foundations 87
§ 3.1 Private Operating Foundations 87
(a) Direct Charitable Distributions 88
(b) Grants 92
(c) Individual Grant Programs 93
(d) Income Test 96
(e) Asset, Endowment, or Support Test 99
(i) Asset Test 99
(ii) Endowment Test 102
(iii) Support Test 103
(f) Compliance Period 104
(g) Advantages and Disadvantages of Private Operating Foundations 106
(h) Conversion to or from Private Operating Foundation Status 107
§ 3.2 Exempt Operating Foundations 109
§ 3.3 Conduit Foundations 109
§ 3.4 Common Fund Foundations 111
§ 3.5 Research and Experimentation Funds 112
§ 3.6 Nonexempt Charitable Trusts 114
§ 3.7 Split-Interest Trusts 116
§ 3.8 Foreign Private Foundations 119
4 Disqualified Persons 123
§ 4.1 Substantial Contributors 124
(a) General Rules 124
(b) 2 Percent Test 125
(c) Terminating Substantial Contributor Status 126
§ 4.2 Foundation Managers 127
§ 4.3 Certain 20 Percent Owners 128
§ 4.4 Family Members 130
§ 4.5 Corporations or Partnerships 131
§ 4.6 Trusts or Estates 132
§ 4.7 Private Foundations 132
§ 4.8 Governmental Officials 133
§ 4.9 Termination of Disqualified Person Status 135
5 Self-Dealing 137
§ 5.1 Private Inurement Doctrine 140
§ 5.2 Private Benefit Doctrine 143
§ 5.3 General Definition of Self- Dealing 151
§ 5.4 Sale, Exchange, Lease, or Furnishing of Property 154
(a) Sales 154
(b) Transactions by Agents 156
(c) Exchanges 157
(d) Leasing of Property 158
(e) Furnishing of Goods, Services, or Facilities 159
(f) Co-Owned Property 162
(g) Coinvestments 166
§ 5.5 Loans and Other Extensions of Credit 168
(a) Gifts of Indebted Property 170
(b) Interest-Free Loans 171
§ 5.6 Payment of Compensation 173
(a) Definition of Personal Services 174
(b) Definition of Compensation 177
(c) Definition of Reasonable 180
(d) Finding Salary Statistics 184
(e) Excess Executive Compensation Tax 185
(i) General Rules and Definitions 186
(ii) Compensation from Related Organizations 187
(iii) Exceptions to Covered Employee Status 188
(f) Commissions or Management Fees 190
(g) Expense Advances and Reimbursements 191
(h) Bank Fees 192
§ 5.7 Indemnification and Insurance 194
(a) Noncompensatory Indemnification and Insurance 195
(b) Compensatory Indemnification and Insurance 196
(c) Fringe Benefit Rules and Volunteers 197
§ 5.8 Uses of Income or Assets by Disqualified Persons 199
(a) Securities Transactions 200
(i) Summary of Law 200
(ii) Representative Case 201
(b) Other Transactions Involving Manipulation 203
(c) Payment of Charitable Pledges 203
(d) For the Benefit of Transactions 204
(e) Incidental or Tenuous Benefits 206
(f) Memberships 212
(g) Benefit Tickets 213
(h) Other Acts 213
§ 5.9 Sharing Space, People, and Expenses 214
(a) Determining What the Private Foundation Can Pay 215
(b) Office Space and Personnel 215
(c) Group Insurance 218
(d) Public Facilities 218
§ 5.10 Payments to Government Officials 218
§ 5.11 Indirect Self- Dealing 220
(a) Transactions with Controlled Entities 221
(b) Concept of Control 222
(c) Transactions and the Control Element 224
(d) Exceptions 225
(e) Fraudulent Investment Schemes 227
§ 5.12 Estate Administration Exception 228
(a) Concept of the Expectancy 228
(b) Estate Administration Exception - General Rules 230
(c) Determining Fair Market Value 233
§ 5.13 Early Terminations of Charitable Remainder Trusts 235
§ 5.14 Additional Exceptions 237
(a) Certain Corporate Organizations or Reorganizations 237
(b) Transitional Rules (Savings Provisions) 238
§ 5.15 Issues Once Self-Dealing Occurs 239
(a) Self-Dealing Excise Taxes 240
(i) Initial Taxes 240
(ii) Additional Taxes 243
(iii) Termination Tax 243
(iv) Limitation on Abatement 243
(v) Advice of Counsel 244
(b) Amount Involved 244
(i) Use of Money or Other Property 244
(ii) Compensation 245
(iii) Exceptions Predicated on Fair Market Value 246
(c) Date of Valuation 246
(d) Correcting the Transaction 247
(i) Sales by the Foundation 248
(ii) Sales to the Foundation 249
(iii) Loans 250
(iv) Use of Property by Disqualified Person 250
(v) Use of Property by Private Foundation 251
(vi) Unreasonable Compensation 251
(e) Court Jurisdiction as to Tax 251
6 Mandatory Distributions 255
§ 6.1 Mandatory Distribution Requirement 256
(a) Purpose and Policy 256
(b) Distributable Amount 257
§ 6.2 Minimum Investment Return 258
(a) General Calculation 258
(b) Investment Assets 259
(c) Future Interests or Expectancies 260
(d) Exempt Function Assets 261
(e) Acquisition Indebtedness 265
§ 6.3 Determining Fair Market Value 267
(a) Cash 267
(b) Readily Marketable Securities 267
(c) Other Assets 270
(d) Assets Held for Partial Year 272
(e) Investment Frauds 272
§ 6.4 Qualifying Distributions 273
(a) General Definition and Rules 273
(b) Charitable Grants in General 275
(c) Grants to Controlled Organizations and Other Foundations 276
(i) Definition of Control 277
(ii) Redistribution Rule 278
(d) Grantor Reliance Standards 279
(i) General Rules 279
(ii) Grants to Certain Supporting Organizations 282
(iii) No IRS Determination Letter 284
(iv) Charities Under a Group Ruling 285
(e) Grants to Foreign Organizations 286
(f) Direct Charitable Expenditures 289
(i) Exempt Function Assets 289
(ii) Administrative Expenses 290
(g) Set-Asides 292
(i) Suitability Test Set-Asides 294
(ii) Cash Distribution Test Set-Asides 296
(iii) Court Order Set-Asides 299
§ 6.5 Excise Taxes on Failure to Distribute Income 300
(a) Undistributed Income 300
(b) Ordering Rule for Qualifying Distributions 300
(c) Excess Qualifying Distributions 301
(d) Excise Taxes on Undistributed Income 303
(e) Valuation Mistakes 304
(f) Exception for Certain Accumulations 305
§ 6.6 History of the Mandatory Distribution Requirement 305
7 Excess Business Holdings 311
§ 7.1 General Rules 311
(a) Definition of Business Enterprise 312
(b) Passive Income Businesses 313
(c) Certain Investment Partnerships 315
(d) Percentage Limitations 317
§ 7.2 Permitted and Excess Holdings 319
(a) General Rules 319
(b) Partnerships, Trusts, and Proprietorships 321
(c) Constructive Ownership 322
(d) Disposition Periods 322
§ 7.3 Functionally Related Businesses 327
§ 7.4 Philanthropic Businesses 332
§ 7.5 Rules Applicable to Certain Supporting Organizations 332
§ 7.6 Rules Applicable to Donor- Advised Funds 333
§ 7.7 Excise Taxes on Excess Holdings 333
8 Jeopardizing Investments 337
§ 8.1 General Rules 338
(a) Defining Jeopardy 339
(b) Contributed Assets 343
§ 8.2 Prudent Investments 344
(a) Evaluating Investment Alternatives 346
(b) Facing the Unknown 348
(c) Risk versus Return 349
(d) Total Return Investing 350
(e) Reporting of Income 351
(f) Measuring Investment Return 351
(g) Mission-Related Investments 352
§ 8.3 Program-Related Investments 353
§ 8.4 Investment Frauds 359
(a) Background 359
(b) NYSBA Report 360
§ 8.5 Excise Taxes on Jeopardizing Investments 362
(a) Initial Taxes 362
(b) When a Manager Knows 363
(c) Reliance on Outside Advisors 364
(d) Additional Taxes and Removal from Jeopardy 365
9 Taxable Expenditures 369
§ 9.1 Legislative Activities 372
(a) Law Applicable to Charities Generally 373
(b) Law Applicable to Private Foundations 374
(c) Grants to Charities That Lobby 376
(d) Nonpartisan Study of Social Issues 378
(e) Self- Defense Exception 380
§ 9.2 Political Campaign Activities 381
(a) Law Applicable to Charities Generally 381
(b) Law Applicable to Private Foundations 382
(c) Voter Registration Drives 383
§ 9.3 Grants to Individuals 384
(a) Definition of Grant 384
(b) Individual Grants for Charitable or Other Permitted Purposes 384
(c) Disaster Relief and Other Assistance Grants 386
(d) Individual Grants for Travel, Study, or Other Similar Purposes 392
(i) Scholarships and Fellowships 393
(ii) Employer- Related Scholarship Programs 394
(iii) Prizes and Awards 399
(iv) Grants for Specific Objectives or to Enhance Skills 400
(e) Individual Grant Procedures 402
(i) Objective and Nondiscriminatory Basis for Selection 403
(ii) Grantee Reporting Requirements 405
(iii) Monitoring, Supervision, and Investigation Requirements 406
(iv) Recordkeeping Requirements 408
(f) IRS Approval of Grant Procedures 408
(i) Requests for Advance IRS Approval 409
(ii) Deemed IRS Approval 410
(iii) Impact of IRS Approval on Future Grants 411
(g) Individual Grant Intermediaries and Earmarking 412
§ 9.4 Grants to Public Charities 415
(a) Types of Public Charity Grantees 415
(b) Grantor Reliance Standards 416
(c) Intermediary and Secondary Grantees 417
§ 9.5 Grants to Exempt Operating Foundations 419
§ 9.6 Grants to Foreign Organizations 419
(a) General Rules 419
(b) Good Faith (Equivalency) Determinations 420
(c) Canadian and Mexican Organizations 422
(d) Anti- Terrorist Financing Guidelines 423
§ 9.7 Expenditure Responsibility 424
(a) General Rules 424
(b) Pre-Grant Inquiry 426
(c) Grant Terms 428
(d) Reports from Grantees 429
(e) Grantee’s Books and Records 430
(f) Reports to IRS 431
(g) Foundation’s Recordkeeping Requirements 432
(h) Grantee Diversions 432
§ 9.8 Spending for Noncharitable Purposes 435
§ 9.9 Excise Tax on Taxable Expenditures 440
(a) Initial and Additional Taxes 440
(b) Tax on Managers 441
(c) Paying the Tax 442
(d) Correcting the Expenditure 443
10 Tax on Net Investment Income 445
§ 10.1 Rate of Tax 446
§ 10.2 Payment of Tax 448
§ 10.3 Planning Opportunities to Reduce the Tax 448
§ 10.4 Calculating Taxable Net Investment Income 450
(a) Gross Investment Income 450
(b) Capital Gains and Losses 451
(i) Exceptions, Adjustments, and Exclusions 451
(ii) Basis 453
(iii) Wash Sales 454
(iv) Ponzi Scheme Losses 454
(c) Interest and Annuities 455
(d) Dividends 455
(e) Rent 456
(f) Royalties 456
(g) Estate or Trust Distributions 456
(h) Partnership and S Corporation Income 459
§ 10.5 Reductions to Gross Investment Income 460
(a) Deductions Allowed 460
(b) Deductions Not Allowed 462
§ 10.6 Foreign Foundations 464
§ 10.7 Exemption from Tax on Investment Income 465
11 Unrelated Business Activity 467
§ 11.1 General Rules 468
(a) Overview 468
(b) Trade or Business Income 469
(c) Substantially Related Activity 471
(d) Regularly Carried On 474
(e) Real Estate Activities 475
§ 11.2 Exceptions 477
(a) Royalties 479
(b) Rents 480
(c) Research 483
(d) Nonbusiness Activities 484
§ 11.3 Rules Specifically Applicable to Private Foundations 485
(a) Business Enterprises 486
(b) Permitted Businesses 488
(c) Partnerships and S Corporations 489
(d) Community Foundations’ Grant- Making Services 491
(e) Provision of Technical Assistance 494
§ 11.4 Unrelated Debt-Financed Income Rules 495
(a) Acquisition Indebtedness 495
(b) Related- Use Exceptions 499
(c) Includible Income 500
§ 11.5 Calculating and Reporting the Tax 501
(a) General Rules 501
(b) Bucketing Rule 502
(c) Tax Rates 505
(d) Tax Computation and Reporting Rules 506
(e) Penalties and Additions to Tax 507
(f) Statute of Limitations 508
12 Tax Reporting and Administration Issues 509
§ 12.1 Form 990- PF 510
(a) Annual Form 990- PF Filing Requirement 510
(b) Key Form 990- PF Disclosures 510
(c) Reporting Changes on Form 990- PF 512
(i) Changes in Activities 512
(ii) Changes in Governing Documents 512
(iii) Name and Address Changes 513
(d) Other Changes 513
(i) Change in Annual Accounting Period (Tax Year) 513
(ii) Change in Accounting Method 514
§ 12.2 Form 990- PF Penalties 515
(a) Daily Delinquency Penalty 515
(b) Form 990- PF Statute of Limitations 516
(c) Reasonable Cause 518
(d) Amended Returns 521
§ 12.3 Public Disclosure and Inspection of Returns 521
(a) Disclosure of Returns to the Public 521
(b) Disclosure of Returns to State Officials 524
§ 12.4 Reporting and Payment of Excise Taxes 525
(a) Reporting and Payment on Form 4720 525
(b) Additions to Tax and Penalties 527
(c) Abatement 529
(d) Form 4720 Statute of Limitations 533
(e) Closing Agreements 536
§ 12.5 Determination Letters and Letter Rulings 537
(a) Form 8940 Miscellaneous Determination Requests 538
(b) Letter Rulings 539
(c) Reliance on Determinations and Rulings 540
§ 12.6 IRS Examinations of Private Foundations 541
(a) Types of Examinations 542
(b) General IRS EO Examination Practices and Procedures 543
(c) Achieving Positive Results 545
§ 12.7 Revocation of Tax- Exempt Status 546
(a) Automatic Revocation for Non- Filing 546
(b) Retroactive Revocation 547
(c) IRS Administrative Appeal Procedures 548
(d) Contesting Revocation in Court 549
(e) Consequences of Revocation 550
13 Termination of Foundation Status 553
§ 13.1 Voluntary Termination 556
§ 13.2 Involuntary Termination 557
§ 13.3 Transfer of Assets to a Public Charity 558
(a) General Rules 558
(b) Restrictions and Conditions on Transfer 561
(i) Acceptable Restrictions and Conditions 562
(ii) Unacceptable Restrictions and Conditions 564
(c) Reservation of Right to Direct Distributions 565
(i) Factors Indicating a Permissible Reservation 566
(ii) Factors Indicating an Impermissible Reservation 566
§ 13.4 Operation as a Public Charity 567
(a) General Rules 567
(b) Initial Notice 569
(c) Advance Ruling Requests 570
(d) Final Notice 572
§ 13.5 Mergers, Split- Ups, and Transfers Between Foundations 573
(a) General Rules 573
(b) Complete Asset Transfers to Controlled Foundations 576
(c) Complete Asset Transfer to Non- Controlled Foundations 581
(d) Transfers of Significant but Not All Assets 583
§ 13.6 Termination of Trusts Treated as Private Foundations 585
§ 13.7 Termination Tax 586
§ 13.8 Abatement 588
14 Charitable Giving Rules 589
§ 14.1 Concept of Gift 589
§ 14.2 Basic Rules 592
(a) Percentage Limitations 593
(b) Estate and Gift Tax Deductions 595
§ 14.3 Gifts of Appreciated Property 595
§ 14.4 Deduction Reduction Rules 597
(a) Capital Gain Property Deduction Rule 597
(b) Other Deduction Reduction Rules 597
§ 14.5 Qualified Appreciated Stock Rule 599
§ 14.6 Special Gift Situations 601
(a) Donors’ Creations 601
(b) Bargain Sales 601
(c) Intellectual Property 602
(d) Vehicles 602
(e) Use of Property 603
(f) Services 603
(g) Conservation Property 603
§ 14.7 Administrative Considerations 604
(a) Recordkeeping Rules 604
(b) Substantiation Rules 604
(c) Disclosure Rules 608
(d) Appraisal Rules 609
(e) Doctrine of Substantial Compliance 611
(f) Reporting Requirements 612
(g) State Fundraising Regulation 612
15 Public Charities 613
§ 15.1 Advantages of Public Charity Status 614
§ 15.2 Statutory Categories of Public Charities 616
§ 15.3 Public Institution Charities 617
(a) Churches and Similar Entities 618
(b) Educational Institutions 619
(c) Hospitals 621
(d) Medical Research Organizations 621
(e) Agricultural Research Organizations 622
(f) Public College Support Foundations 623
(g) Governmental Units 623
§ 15.4 Donative Publicly Supported Charities 624
(a) General Rules 625
(b) Two Percent Limitation 626
(c) Support Test 628
(d) Facts and Circumstances Test 631
(e) Community Foundations 633
§ 15.5 Service Provider Publicly Supported Charities 635
(a) Support Test 636
(b) Investment Income Test 639
(c) Unusual Grants 641
(i) Unusual Grant Factors 641
(ii) Safe Harbor Criteria 646
(iii) Requests for Advance IRS Rulings 646
§ 15.6 Supporting Organizations 647
(a) Organizational Test 649
(b) Operational Test 650
(c) Specified Public Charities 652
(d) Required Relationships 656
(e) Type I: Operated, Supervised, or Controlled By 656
(f) Type II: Supervised or Controlled in Connection With 657
(g) Type III: Operated in Connection With 658
(i) Overview 658
(ii) Notification Requirement 659
(iii) Responsiveness Test 659
(iv) Types of Type III Supporting Organizations 660
(v) Integral Part Test - Functionally Integrated Type III Organizations 660
(vi) Integral Part Test - Nonfunctionally Integrated Type III Organizations 662
(vii) Pending Regulation Projects 666
(h) Contributions from Controlling Donors 668
(i) Excess Benefit Transactions Rules 669
(j) Limitation on Control 669
(k) Excess Business Holdings Rules 672
(l) Noncharitable Supported Organizations 673
(m) Use of For- Profit Subsidiaries 674
§ 15.7 Change of Public Charity Category 675
(a) From § 509(a)(1) to § 509(a)(2) or Vice Versa 675
(b) From § 509(a)(3) to § 509(a)(1) or § 509(a)(2) 675
(c) From § 509(a)(3) Type III to § 509(a)(3) Type I Or II 675
(d) IRS Recognition of Change in Public Charity Status 676
§ 15.8 Termination of Public Charity Status 677
§ 15.9 Relationships Created for Avoidance Purposes 678
16 Donor- Advised Funds 679
§ 16.1 Basic Definitions 681
§ 16.2 General Concept of a Gift 682
§ 16.3 Types of Donor Funds 684
§ 16.4 Donor- Advised Fund Litigation 687
(a) Exemption Challenges 687
(b) Donor Challenges 689
(c) Charitable Deduction Challenges 690
§ 16.5 Public Charity Status of Funds 692
§ 16.6 Interrelationship of Private Foundation Rules 693
§ 16.7 Statutory Criteria 694
§ 16.8 Studies 699
(a) Treasury Study 699
(b) Congressional Research Service Study 701
§ 16.9 Tax Regulations 704
(a) The Ever- Pending Regulations Project 704
(b) 2017 IRS Notice 705
(c) Comments on IRS Notice 707
§ 16.10 Proposed Legislation 713
17 Company Foundations 717
§ 17.1 Company Foundation Overview 717
§ 17.2 Reasons for Establishment of a Company Foundation 719
§ 17.3 Private Inurement Doctrine 719
§ 17.4 Private Benefit Doctrine 720
§ 17.5 Disqualified Persons Rules 721
§ 17.6 Self- Dealing Rules 722
(a) Payment of Compensation and Reimbursements 722
(b) Sharing of Facilities 723
(c) Provision of Tangible Benefits 725
(d) Grantmaking 726
(e) Incidental and Tenuous Benefits 727
(f) Corporate Reorganizations and Stock Transfers 731
§ 17.7 Other Private Foundations Rules 732
(a) Mandatory Payout Rules 732
(b) Excess Business Holdings Rules 732
(c) Jeopardizing Investments Rules 733
(d) Taxable Expenditures Rules 733
(e) Economic Returns 734
§ 17.8 Excess Executive Compensation Tax Exceptions 734
(a) Limited Hours Exception 734
(b) Nonexempt Funds Exception 736
About the Authors 739
About the Online Resources 741
Index 743
