Private Foundations and Public Charities — Termination and Special Rules (Sections 507 and 508) (Portfolio 458)

Tax Management Portfolio, Private Foundations and Public Charities — Termination and Special Rules (Sections 507 and 508), No. 458, is one of several Portfolios dealing with the problems encountered by private foundations and other charitable organizations. To view this Portfolio, visit Bloomberg Tax for a free trial.

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Tax Management Portfolio, Private Foundations and Public Charities — Termination and Special Rules (Sections 507 and 508), No. 458, is one of several Portfolios dealing with the problems encountered by private foundations and other charitable organizations. This Portfolio considers in depth the various restrictions imposed under §508 upon charitable organizations. Included among these are the rule that requires organizations purporting to be tax-exempt under §501(c)(3) to notify the IRS of their claimed status, and the rule that presumes a §501(c)(3) organization to be a private foundation unless it notifies the IRS to the contrary. This Portfolio discusses the manner of giving such notifications by filing applications for recognition of exemption and the exceptions to such notification requirements. The governing instrument requirements imposed by §508(e) are also fully addressed. In addition, the terms “substantial contributor” and “disqualified person,” which have significance to foundations whether they are terminating or continuing in operation, are fully explained and illustrated from a practical standpoint.

This Portfolio also considers in depth the rules under §507 whereby the status of a charitable organization as a private foundation may be terminated voluntarily or involuntarily. Special emphasis is placed upon the planning aspects of such terminations, including consideration of whether private foundation status should be terminated and selection of the most advantageous method of accomplishing termination. Finally, the Portfolio describes the conditions for disallowance of the income, estate, and gift tax charitable deductions for contributions made to organizations subject to the §507(c) termination tax and to organizations that run afoul of the §508 notification and/or governing instrument requirements.

The statutory rules governing termination of private foundation status were added by the Tax Reform Act of 1969. Accordingly, both the legislative history of that Act and the regulations issued thereunder (including temporary and proposed) are explained and analyzed.

For detailed discussions of related topics, see 456 T.M., Private Foundations and Public Charities — Definition and Classification450 T.M., Tax-Exempt Organizations: Organizational Requirements451 T.M., Tax-Exempt Organizations: Operational Requirements452 T.M., Tax-Exempt Organizations: Reporting, Disclosure and Other Procedural Aspects; and 459 T.M., Supporting Organizations.

This Portfolio may be cited as Cesare, 458 T.M., Private Foundations and Public Charities — Termination and Special Rules (Sections 507 and 508).


Lauren Watson Cesare, Esq.

Lauren Watson Cesare, A.B., University of California at Davis; J.D., Hastings College of the Law, University of California; LL.M. in Taxation, New York University School of Law; admitted to practice, California, U.S. Tax Court; author of 456 T.M., Private Foundations and Public Charities — Definition and Classification.

Table of Contents

Detailed Analysis
I. Introduction
A. Historical Background
B. Outline of Discussion
II. Overview of Special Rules for §501(c)(3) Organizations
A. Private Foundation vs. Public Charity
B. Presumption of Private Foundation Status
C. State Enforcement
III. Notification of §501(c)(3) Status
A. New Organizations
1. Section 508(a) General Rule
2. Filing of Notice
a. Filing Form 1023-EZ, Streamlined Application for Recognition of Exemption
b. Form 1023, Application for Recognition of Exemption
c. Requests for Extension of Filing Deadline
d. Expedited Processing of Applications
e. Contents of Form 1023
f. Incomplete Application
3. Date of Organization
4. Appeals from Adverse Determinations
a. Appeal of Proposed Adverse Determination Letter Issued by EO Rulings and Agreement
b. Declaratory Judgment
5. Nonexempt Trusts
6. Community Trusts
7. Donor Advised Funds
B. Foreign Organizations
C. Reinstatement After Revocation of Exempt Status
1. Streamlined Retroactive Reinstatement Process
2. Retroactive Reinstatement of Tax-Exempt Status Within 15 Months of Revocation
3. Retroactive Reinstatement More than 15 Months After Revocation
4. Reinstatement of Tax-Exempt Status from Post-Mark Date
5. Impact of Failure to Satisfy Form 990 Series Return Requirements Prior to Recognition of Exempt Status
IV. Section 508(b) Notification Concerning Private Foundation Status
A. Section 508(b) Contrasted with §508(a)
B. Filing of Notice
1. In General
2. “Old” Organizations
3. “New” Organizations
a. Form 1023 Required
b. Approval Process for Publicly Supported Charities
(1) Taxable Years After 2007
(2) Taxable Years Before 2008
(i) No Advance Ruling
(ii) Advance Ruling
(3) Transition Rules
C. Effect of Filing Notice Under §508(b)
1. Effect on Filing Organization
2. Effect on Grantors, Contributors, and Transferors
a. General
b. Cumulative List of Organizations
c. Taxable Years Prior to 2008
d. Pre-1976 Reliance
D. Notice of Operating Foundation Status
E. Penalties
V. Exceptions to Notification Requirements
A. Excepted Organizations
1. In General
2. Churches
a. “Church” Undefined
b. Religious Purpose and “Associational Aspect” Requirements
c. Conventions or Associations of Churches
d. Integrated Auxiliary of a Church
3. Organizations with Gross Receipts of $5,000 or Less
4. Subordinate Organizations Covered by Group Exemption Letters
a. General
b. Request for Group Exemption Letter
c. User Fee
d. Annual Update
B. Voluntary Notifications
1. Voluntary §508(a) Notice
2. Voluntary §508(b) Notice
VI. Governing Instruments
A. General Rule
B. Nature of Governing Instrument
1. General Restrictions
2. Prohibited Distribution of Corpus
3. Savings Provisions
4. Excess Business Holdings
5. Revocation of Public Charity Status
6. Definition of Governing Instrument
7. Treatment of Foreign Organizations
8. Transfers of Private Foundation Assets to Other Private Foundations
C. State Law
1. In General
2. Presumption that State Laws Are Valid
3. Conflict Between a Governing Instrument and State Law
a. In General
b. Required Notice to IRS
(1) Conflicting State Law Expressly Inapplicable
(2) Conflicting State Law Allows Election from Coverage
c. Retroactive Effect of State Law
4. Transitional Rules for Existing Private Foundations
5. Extension of Time — In General
VII. Disqualified Persons
A. In General
B. Statutory Definition of Disqualified Person
C. The Substantial Contributor
1. In General
2. Special Rules for Public Charities
3. Subsidiaries of Public Charities
4. Contributions
5. Determination of Substantial Contributors
D. Foundation Manager
E. Members of the Family
F. Attribution Rules
1. Corporations
a. Section 4946(a)(1)(C)(i) Attribution
b. Section 4946(a)(1)(E) Attribution
2. Partnerships and Trusts
VIII. Statutory Scheme of Termination Provisions
IX. Voluntary Termination
A. Termination Under §507(a)(1)
1. General Rule
2. Situations in Which Voluntary Termination May Be Desirable
3. Status After Voluntary Termination
B. Non-Terminating Transfers
X. Involuntary Termination
A. General Rule
B. Willful, Repeated Acts
C. Willful and Flagrant Act
XI. Termination by Transfer of Assets to Certain Public Charities
A. General Rules
B. Permissible Distributees
C. Effect of Restrictions on Transfers
1. General Rule
2. Independent Governing Body
3. Permissible Restrictions and Conditions
4. Restrictions and Conditions that May Jeopardize Termination
D. Sanctions Against Restricted Transfers
E. Special Rules Relating to §4940 Tax
F. Filing Requirements
XII. Termination by Operation as a Public Charity
A. General Rules
B. Types of Organizations into Which the Terminating Private Foundation May Convert
C. Notice of Intent to Terminate
D. Section 170(b)(1)(A)(i) Through (v) Organizations
E. Section 170(b)(1)(A)(vi): Determining Normal Sources of Support
F. Section 509(a)(2): Determining Normal Sources of Support
1. The One-Third Support Test
2. The Not-More-Than-One-Third Support Test
G. Section 509(a)(3) Supporting Organizations
1. General Requirements
2. Importance of §509(a)(3) Organization
H. Advance Ruling
I. Status After Termination
J. Effect of Failure to Successfully Complete Termination
K. Annual Return Filing Requirements for Terminating Organizations
L. Transitional Rules
XIII. Transfers of Assets to Private Foundations
Introductory Material
A. Situations in Which a §507(b)(2) Transfer Might Be Appropriate
B. What Constitutes a §507(b)(2) Transfer?
C. Inapplicability of §507(a)
D. Transferee Organization
E. Changes in Form
F. Attributes Transferred to Transferee Organization
1. Carryover of Aggregate Tax Benefit
2. Treatment of Substantial Contributors
3. Chapter 42 Taxes
a. Section 4941 Self-Dealing
b. Section 4942 Income Distribution Requirements
c. Section 4943 Excess Business Holdings — Transfer of Holding Period
d. Section 4944 Jeopardizing Investments
e. Section 4945 Expenditure Responsibility
f. Carryover of Saving Provisions
G. Transfers to or from Certain Public Charities
H. Reporting Requirements
XIV. Termination Tax
A. Imposition of Tax
B. Time of Imposition of Termination Tax
C. Determination of Tax
1. Aggregate Tax Benefit
2. Value of Assets
D. Appellate Procedure
E. Comments
XV. Abatement
Introductory Material
A. Abatement by Distribution to Public Charities
B. Abatement by State Proceedings
1. In General
2. Corrective Action
XVI. Disallowance of Charitable Deductions
A. Disallowance of Deductions for Contributions to Certain Terminating Private Foundations
B. Disallowance of Deductions for Contributions to Certain Noncomplying Organizations
1. General Rule
2. Section 508(e) Requirements for Governing Instruments
3. Special Conditions for Split-Interest Trusts
a. Exceptions from Chapter 42 Restrictions
b. Split-Interest Trusts Not Subject to Some §508(e) Requirements
4. Charitable Trusts
5. Transitional Rules

Working Papers

Table of Worksheets
Worksheet 1 Legislative History: The Tax Reform Act of 1969 (Pub. L. No. 91-172)
Worksheet 2 Internal Revenue Manual Excerpts: Private Foundations Handbook — Termination of Private Foundation Status
Worksheet 3 Exempt Organizations Continuing Professional Educational Technical Instruction Program for 1989 (Excerpt) — Section 507 Terminations
Worksheet 4 Preamble to T.D. 9423, 73 Fed. Reg. 52527-52555, Sept. 9, 2008, Returns by Exempt Organizations — Revised Form 990
Worksheet 5 IRS Letter 3367C — “Triage Letter” for Application for Exemption
Worksheet 6 IRS Letter 1312 — Information Request for Application for Exemption