10 March 2016 IRS rules on private foundation's plan to divide into three separate foundations In PLR 201609001, the IRS has ruled on various issues relating to a private foundation's plan to distribute amounts equal to 20% of its fair market value to each of two newly created private foundations. Foundation is a Section 501(c)(3) organization and private foundation under Section 509(a). Foundation was organized under the terms of a trust created by Founder for the purpose of making contributions to tax-exempt US charities. Foundation's nine-person board of directors is composed of Founder's five children and four grandchildren. Due to differing opinions about the charitable direction of Foundation, the board of directors has decided to divide Foundation into three separate private foundations. This reorganization would involve the creation of two new private foundations, each to be governed by one of Founder's five children (and other family members). Each of the two new private foundations will receive from Foundation, for no consideration, a distribution in an amount equal to 20% of the fair market value of Foundation's assets. Foundation will retain an amount equal to the other 60% of its fair market value and will be governed by the remaining three children of Founder and two of the grandchildren. Prior to the distributions to the new private foundations, each of the newly formed organizations will receive IRS recognition as 501(c)(3) organizations and 509(a) private foundations. Foundation has not and does not plan to give the IRS notice of intent to terminate. Rulings 1 and 2: The newly created private foundations will not be treated as newly created organizations for purposes of imposing Section 507 termination tax Under Section 507(b)(2), in the case of a transfer from one private foundation to another according to any liquidation, merger, redemption, recapitalization or other adjustment, organization, or reorganization, the transferee foundation is not treated as a newly created organization. Under the accompanying regulations, a significant disposition of assets (specifically, more than 25%) qualifies as a Section 507(b)(2) transfer. Reg. Section 1.507-4(b) specifies that a private foundation making a transfer described in Section 507(b)(2) is not subject to the private foundation termination tax imposed under Section 507(c) on the transfer unless the provisions of Section 507(a) become applicable. Because Foundation is transferring more than 25% of its assets to the newly formed private foundations for no consideration, the transfer qualifies under Section 507(b)(2). Accordingly, the newly created private foundations will not be considered new foundations for these purposes. Because Foundation has not and will not notify the Secretary of its intent to terminate its status as a private foundation (before the final transfer of assets) and it has neither committed willful repeated acts (or failures to act) nor committed a willful and flagrant act (or failure to act) giving rise to tax under Chapter 42, Section 507(a) does not become applicable, and the Section 507(c) tax does not apply. Because the amounts transferred will be distributed to recognized 501(c)(3) organizations and Foundation will continue to operate in accordance with its exempt purposes after the transfer, the transfers will be in accordance with Foundation's 501(c)(3) purposes. Under Revenue Ruling 2002-28, Section 507(b)(2) transfers do not constitute investments for purposes of Section 4940 and, accordingly, do not give rise to new investment income subject to tax under Section 4940(a). Because the IRS had already determined the proposed transfers were described in Section 507(b)(2), it ruled tax will not be imposed under Section 4940. Ruling 5: Foundation's transfers to the newly created organizations will not constitute acts of self-dealing So long as the newly created organizations are recognized by the IRS as 501(c)(3) organizations, the IRS ruled, neither the transfers to them from Foundation, nor the payment of associated expenses will constitute acts of self-dealing under Section 4941. The IRS specified, however, that its ruling is directed at Foundation, and not at the newly created organizations, Founder's children or grandchildren, or any other disqualified persons with respect to Foundation. Ruling 6: The proposed transfers will not jeopardize Foundation's exempt purposes, nor subject it to Section 4944 tax As with Section 4940, under Revenue Procedure 2002-28, Section 507(b)(2) transfers do not constitute investments for purposes of Section 4944. Accordingly, because Foundation's transfers are recognized as 507(b)(2) transfers, the transfers will not jeopardize Foundation's exempt purposes nor subject it to tax under Section 4944. Ruling 7: Related legal, accounting and other expenses will not be considered "taxable expenditures" Section 4945 imposes a tax on each "taxable expenditure" of a private foundation, with "taxable expenditure" defined to include any amount paid or incurred for any purpose other than one specified in Section 170(c)(2)(B). Under Reg. Section 53.4945-6(b)(2), legal, administrative and other expenses incurred by a private foundation are not taxable expenditures if they were paid or incurred in the good faith belief that they were reasonable and were consistent with ordinary business care and prudence. Accordingly, the IRS ruled that, assuming Foundation's legal, accounting and other expenses incurred in connection with the proposed transactions will be reasonable and consistent with ordinary business care and prudence and paid to accomplish one or more purposes described in Section 170(c)(2)(B), such expenses will not be considered taxable expenditures under Section 4945, and will be considered qualifying distributions under Section 4942. Ruling 8: Foundation may count distributed amounts towards minimum distribution requirements to extent new foundations make qualifying distributions The IRS ruled that Foundation may count as qualifying distributions portions of the amounts distributed to the two newly created private foundations that satisfy the requirements of Section 4942(g)(3)(A) and (B). Specifically, under Section 4942(g)(3)(A), the transferee organizations must satisfy certain "pass-through" requirements, and, under Section 4942(g)(3)(B), the transferor must obtain adequate records or other sufficient evidence from the transferee organizations showing that the required pass-through distributions were made. Ruling 9: Grants to the newly created foundations will not constitute "taxable expenditures" under Section 4945, provided Foundation exercises expenditure responsibility with respect to the transfers Reg. Section 53.4945-6(c)(3) allows a private foundation to transfer its assets to 501(c)(3) organizations, including private foundations, under Section 507(b)(2), without the transfers being Section 4945 "taxable expenditures." However, the Section 4945(d)(4) requirement subjecting grants to private, non-operating foundations to the expenditure responsibility requirements of Section 4945(h) still applies. An override available under Reg. Section 1.507-3(a)(9) in the case of a foundation transferring all of its assets does not apply in Foundation's case. Accordingly, the IRS ruled that Foundation will have to exercise expenditure responsibility with respect to its grants to the two newly created private foundations to avoid liability for tax under Section 4945. Circumstances often present reasons to divide and separate the assets of a private foundation into two or more private foundations. PLR 201609001 demonstrates how private foundations wishing to separate assets and form new private foundations can properly utilize Section 507(B)(2) to avoid being treated as terminated and therefore not invoke the Section 507(c) termination tax or other private foundation excise taxes. As noted in the ruling, a transferee foundation will not be considered a newly created organization following its receipt of a significant disposition of a transferor foundation's assets (25% or more). The transferor foundation is not considered then to have terminated for purposes of the Section 507(c) termination tax, unless it affirmatively notifies the IRS of its intent to terminate its foundation status or the IRS takes steps to terminate that status following the foundation's repeated willful or flagrant acts giving rise to excise tax liabilities. In addition to the proposed partial termination transfer of assets in accordance with the private foundation termination rules, the IRS ruled that acts of self-dealing will not occur, the transfers will be qualifying distributions, there will not be any jeopardizing investments, and the transfers will not be a sale or other distribution of property for purposes of the tax on net investment income. Also, the IRS ruled that the transfers to the two new foundations will not be taxable expenditures as long as expenditure responsibility is exercised. Private foundations should note that, through careful planning, a Section 507(b)(2) transfer can be structured to avoid taxable expenditure treatment and the need for perpetual expenditure responsibility through certain corporate reorganization structures. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
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