By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
Section 4942 Qualifying Distributions. Section 4942 generally requires a private foundation (other than a private operating foundation) to make "qualifying distributions" equal to or exceeding a minimum "distributable amount" for each taxable year. A private foundation's distributable amount for any taxable year generally equals five percent of the aggregate fair market value of its non-exempt-use assets, increased by any repayments of amounts treated as qualifying distributions in prior years, and reduced by any taxes imposed under subtitle A and §4940. The failure to make these distributions can result in the imposition of an escalating series of excise taxes, and even loss of tax exempt status.
Section 4942 defines a "qualifying distribution" as including, in most cases, amounts paid to accomplish one or more charitable, educational, etc. purposes described in §170(c)(2)(B). However, a grant to another private nonoperating foundation, even though made for charitable purposes, will not be a qualifying distribution unless the foundation exercises "expenditure responsibility" over the grant, or unless the grant is passed through by the donee private foundation to a qualifying public charity or private operating foundation within a specified period of time after its receipt.1
Section 4945 Taxable Expenditures. Section 4945 imposes an excise tax on a private foundation's "taxable expenditures" as defined in §4945(d), including expenditures for other than charitable purposes. Under §4945(d)(4), a taxable expenditure includes any grant to an organization unless: (1) the grantee is a public charity (other than a disqualified supporting organization) or an exempt operating foundation; or (2) the private foundation exercises expenditure responsibility with respect to the grant in accordance with §4945(h).
For purposes of both §§4942 and 4945, a grant for charitable purposes to a foreign organization that does not have a determination letter from the IRS may be treated as a qualifying distribution (and not a taxable expenditure) if the grantor private foundation makes a "good faith determination" that the foreign organization is a public charity (or private operating foundation), provided that the foreign organization is not controlled by the foundation or its disqualified persons.
Good Faith Determination. A private foundation will ordinarily be considered to have made a "good faith determination" if the determination is based on either (i) an affidavit of the grantee or (ii) an opinion of counsel of either the grantor or the grantee. The affidavit or opinion must set forth sufficient facts concerning the operations and support of the grantee for the IRS to determine that the grantee would be likely to qualify as a public charity or a private operating foundation.2 The affidavit option generally has been deemed to be cumbersome and unworkable for many grantor foundations.
Exercise of Expenditure Responsibility. In 2001, another option (in lieu of an affidavit or an opinion of counsel) was approved by letter from the IRS to the Council on Foundations, in which the IRS acknowledged that, if a private foundation makes a grant for exclusively charitable purposes to a foreign grantee, provides that the grant must be maintained as a separate fund, and exercises expenditure responsibility without first attempting to make a good faith determination that the foreign grantee is described in §501(c)(3), or after abandoning an inconclusive effort to make such a determination, the grant will be a qualifying distribution for purposes of §4942 and will not be a taxable expenditure for purposes of §4945.3
To exercise expenditure responsibility, a private foundation must see that its grant is spent solely for the charitable or other exempt purposes for which it was made; obtain full and complete reports from the grantee confirming how the grant was spent; and provide full and detailed reports on such expenditures to the IRS.4
Proposed Regulations. On September 24, 2012, the IRS published a Notice of Proposed Rulemaking in the Federal Register which would modify the "opinion of counsel" rule to identify a broader class of tax practitioners upon whose written advice a private foundation may base a "good faith determination." The proposed regulations also make certain conforming changes consistent with statutory amendments that have been made to §§4942 and 4945.
Under the proposed regulations, a private foundation's good faith determination ordinarily may be based on written advice given by a "qualified tax practitioner" who is subject to the requirements in Circular 230. A qualified tax practitioner means an attorney, a certified public accountant (CPA), or an enrolled agent, as those practitioners are defined in Circular 230, but would not include foreign counsel (unlike the current rule), unless the foreign counsel is included in the definition of "qualified tax practitioner."
The proposed regulations limit the definition of a qualified tax practitioner to attorneys, CPAs, and enrolled agents "because these practitioners generally provide advice to clients with respect to taking positions on tax returns, and these practitioners are generally authorized to represent their clients before the IRS without limitations applicable to other types of practitioners (such as enrolled actuaries)." The government also believes that "expressly allowing reliance on a broader spectrum of professional tax advisors may encourage more private foundations to obtain written tax advice, thus promoting the quality of the determinations being made."
The proposed regulations further provide that a private foundation's determination that is based on the written advice of a qualified tax practitioner will be considered as made in "good faith" if the private foundation's reliance on the written advice meets the requirements of Regs. §1.6664-4(c)(1), which are the standards that must be taken into account in determining whether a taxpayer has reasonably relied in good faith on advice for purposes of §6664 (relating to accuracy-related and fraud penalties). Additionally, as is the case under the present regulations under §§4942 and 4945, the written advice must provide sufficient facts about the operations and financial support of the foreign organization for the IRS to determine that the grantee would be likely to qualify as a public charity (other than a disqualified supporting organization) or as a private operating foundation or an exempt operating foundation, as applicable.
Treasury and the IRS are requesting comments on a number of issues relating to the proposed rule, including:
With regard to the third point, the preamble to the proposed regulations state that:The Treasury Department and the IRS are concerned, however, that eliminating the ability to base a good faith determination on an affidavit of a foreign grantee may inappropriately discourage foreign grantmaking by smaller private foundations, or inhibit smaller foreign grants generally. While Rev. Proc. 92-94 continues to provide a simplified procedure that private foundations may follow in making good faith determinations based on affidavits, the Treasury Department and the IRS request comments on whether a foundation's ability to base a good faith determination on affidavits should be retained, and if so, whether the use of affidavits should be restricted. For example, future guidance could prohibit the use of affidavits for grants above a certain dollar threshold, or could require supporting factual information that might serve to corroborate the content of affidavits.
Proposed Effective/Applicability Date. The proposed regulations would apply for grants made after the date of publication of the Treasury decision adopting these paragraphs as final regulations in the Federal Register. However, a private foundation may rely on these proposed regulations for grants made on or after September 24, 2012.
The proposed regulations should ease somewhat the burden imposed on private foundations in making grants to foreign organizations. However, the process of vetting foreign charities and other organization remains cumbersome, particularly for small grantmakers.
This commentary also will appear in the January 2013 issue of the Tax Management Estates, Gifts and Trusts Journal. For more information, in the Tax Management Portfolios, see Schenkelberg and Gross, 880 T.M., Private Foundations - Distributions (Section 4942), and Sanders, Roady and Berry, 474 T.M., Private Foundations - Taxable Expenditures (Section 4945), and in Tax Practice Series, see ¶6880, Taxes on Failure to Distribute Income, and ¶6910, Taxes on Taxable Expenditures.
1 §4942(g)(3); Regs. §53.4942(a)-3(d).
2 Regs. §§53.4942(a)-3(a)(6), 53.4945-5(a)(5). The requirements and format of this affidavit were initially described in Rev. Proc. 92-94, 1992-1 C.B. 507.
3 See, e.g., PLRs 200704037 and 200706015.
5 1992-2 CB 507.