Foundation Finance Services

Foundation Finance Services

Criteria for Private Foundations to Make Grants to Individuals for Educational Purposes

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Private foundations may make grants to individuals for educational purposes; however, the grant must be awarded on an objective and nondiscriminatory basis, be made pursuant to a procedure approved in advance by the IRS, and meet one of three tests. The tests are: (1) qualify as a scholarship under section 117 of the Internal Revenue Code, (2) qualify as a prize excludable from income under section 74(b) of the Code, or (3) have the purpose of achieving a specific objective, providing a report, or improving a literary, artistic, musical, scientific, teaching, or other skill or trade of the grantee. If the foundation does not comply with these rules, a taxable expenditure occurs.

Private foundations must not engage in taxable expenditures. If they do, significant penalties are imposed and continue to be imposed each year until the taxable expenditure is “corrected.”

A taxable expenditure is an amount paid or incurred to:

  1. Carry on propaganda or otherwise attempt to influence legislation;
  2. Influence the outcome of any specific public election or carry on any voter registration drive unless certain requirements are satisfied;
  3. Make a grant to an individual for travel, study, or other similar purposes unless certain requirements are satisfied;
  4. Make a grant to an organization (other than certain public charities or an exempt operating foundation) unless the foundation exercises expenditure responsibility with respect to the grant; or
  5. Carry out a noncharitable purpose (subject to certain exceptions). 

Grants to individuals for travel, study, or other similar purposes are taxable expenditures unless the grant is awarded on an objective and nondiscriminatory basis under a procedure approved in advance by the IRS, and certain requirements are met. For more information, please contact us.

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Private Foundations Contributing to Public Charities

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A private foundation can give to most public charities without any concerns. However, if the public charity is a “supporting organization” under section 509(a)(3) of the Internal Revenue Code, the private foundation might need to exercise “expenditure responsibility” to avoid a taxable expenditure, depending on the type of 509(a)(3) organization involved.

Private foundations must not engage in taxable expenditures. If they do, significant penalties are imposed and continue to be imposed each year until the taxable expenditure is “corrected.”

A taxable expenditure is an amount paid or incurred to:

  1. Carry on propaganda or otherwise attempt to influence legislation;
  2. Influence the outcome of any specific public election or carry on any voter registration drive unless certain requirements are satisfied;
  3. Make a grant to an individual for travel, study, or other similar purposes unless certain requirements are satisfied;
  4. Make a grant to an organization (other than certain public charities or an exempt operating foundation) unless the foundation exercises expenditure responsibility with respect to the grant; or
  5. Carry out a noncharitable purpose (subject to certain exceptions). 

Grants to organizations are subject to special rules. These will be taxable expenditures unless either (1) the recipients are public charities (with one exception) or (2) the granting foundation exercises expenditure responsibility with respect to the grant. The effect is to ensure that funds granted to organizations other than public charities are used in accordance with the terms of the grant. 

If the foundation is required to exercise expenditure responsibility, this means that the foundation must exert all reasonable efforts and establish adequate procedures:

  1. To see that the grant is spent only for the purpose for which it is made;
  2. To obtain full and complete reports from the grantee organization on how the funds are spent; and
  3. To make full and detailed reports on the expenditures to the IRS.

For more information, please contact us.

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May Owners of an Interest in a Business Contribute Shares or Units to Private Foundations?

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Perhaps. There are complex rules that govern how much of a business enterprise a private foundation may own. These are known as the excess business holdings rules. The foundation might also be subject to tax on the earnings (unrelated business income tax) in some circumstances.

Excess business holdings are the holdings of a private foundation in any business enterprise that exceed permitted holdings. A foundation and its disqualified persons (defined below) together may not hold more than 20% of the voting stock of a corporation conducting a business that is not substantially related to the exempt purpose of the foundation. If non-disqualified persons have effective control of the business, the 20% limit is raised to 35%.The term “business” does not include an enterprise that obtains at least 95% of its gross income from passive sources. If disqualified persons hold more than 20% of the voting stock (or 35% where non-disqualified persons have effective control), a foundation may not hold nonvoting stock of the business.

The excess business holdings rules apply to unincorporated businesses as well. However, in the case of a partnership or joint venture, “profits interest” shall be substituted for “voting stock,” and “capital interest” shall be substituted for “nonvoting stock.” In other cases, “beneficial interest” is substituted for “voting stock.”  Further, a private foundation may have no permitted holding in a sole proprietorship. 

A de minimis rule allows a foundation to own no more than 2% of voting stock and no more than 2% in value of all outstanding stock, without regard to holdings of disqualified persons (except for certain related private foundations).

“Disqualified persons” include:

  • a substantial contributor to the foundation (one who contributed more than $5,000 to the private foundation if such amount is more than 2% of the contributions received by the foundation during the year);
  • a foundation manager (includes an officer, director, or trustee of a foundation as well as an individual having powers or responsibilities similar to the aforementioned);
  • owners of more than a 20% interest in a substantial contributor to the foundation;
  • certain family members of an individual described above;
  • a corporation in which a disqualified person owns more than 35% of the voting power;
  • a partnership in which a disqualified person owns more than 35% of the profits interest;
  • a trust or estate in which a disqualified person holds more than 35% of the beneficial interest; and
  • certain related private foundations.

If the foundation has excess business holdings, a 10% tax is imposed on the value of the excess business holding (with value being determined as of the day during the taxable year when the holdings were greatest), and the tax is imposed on the foundation on the last day of each year until corrected, unless the foundation can show reasonable cause. If the 10% tax is imposed, and at the end of the taxable period there are still excess business holdings, an additional 200% tax on the holdings will be imposed at the end of the taxable period.

If a gift or bequest causes a private foundation to have excess business holdings, the foundation has a five-year period to reduce its holdings to a permitted level. This five-year period specifically does not apply if the change in holdings is due to a purchase by the private foundation or disqualified person. Under certain circumstances, the IRS may extend the initial five-year disposition period for another five years.

The above is only a brief discussion of some of the basic excess business holdings rules. For a more detailed discussion regarding the rules and how they apply to specific circumstances, please contact us.

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