23 May 2017 Foundation's grant to related organization results in indirect self-dealing, IRS rules In PLR 201719004, the IRS has ruled that a private foundation's grant to a related public charity, while being treated as a qualifying distribution, will result in an indirect act of self-dealing when the charitable use of the funds will ultimately provide an economic benefit to a for-profit entity that is a disqualified person with respect to the foundation. Foundation is a Section 501(c)(3) nonprofit organization that is a private foundation under Section 509(a). DP, the granddaughter of Foundation's founder, is a disqualified person under Section 4946 with respect to Foundation. DP founded Intermediary, another Section 501(c)(3) organization that is not a private foundation. DP has the power to cause Intermediary to make, or prevent it from making, expenditures. DP also owns LLC, a for-profit limited liability company that is also a disqualified person with respect to Foundation. Foundation proposes to make a grant to Intermediary. Intermediary will use the full amount of the funds to purchase recycling containers and place them throughout its state by the end of its tax year following receipt of the funds. Intermediary will also collect the waste from the containers and transfer it to LLC. LLC will recycle the waste and seek to sell it for profit in its ordinary course of business. The IRS assumed, because Foundation did not respond to a request for such information, that LLC would not pay Intermediary for the waste transferred to it. Private foundations that fail to distribute their income can be subject to an excise tax under Section 4942. The tax applies against undistributed income, which is the excess of the organization's distributable amount over "qualifying distributions." A qualifying distribution can include a contribution from a private foundation to another charitable organization controlled directly or indirectly by the transferor foundation (or one of its disqualified persons) if it meets the pass-through requirements of Section 4942(g)(3)(A) (sometimes referred to as the "conduit rules") and obtains adequate records or other sufficient evidence from the transferee organization that the pass-through requirements were met. Under the conduit rules of Section 4942(g)(3)(A)(i), the recipient charity must, no later than the close of the first tax year after the tax year in which it receives the contribution, make a distribution equal to the amount of the contribution it received from the private foundation. That distribution must otherwise be considered a qualifying distribution, which is treated as a distribution out of corpus. The IRS ruled that Foundation's proposed grant to Intermediary will constitute a qualifying distribution under Section 4942(g)(1) and (3). The IRS explained that amounts paid to accomplish charitable purposes generally are treated as qualifying distributions. As noted above, however, when distributions are made to an organization controlled by a disqualified person, additional requirements apply. Specifically, the transferee organization must satisfy "pass-through" requirements and the transferor must retain records of the satisfaction of this requirement. Even though the distributions will be made to an organization controlled by a disqualified person (DP), the IRS also concluded that the additional pass-through requirements will be met if Intermediary pays out the funds towards the charitable purposes in a timely manner (as planned) and Foundation keeps adequate records. The IRS noted that recycling for environmental preservation may be in furtherance of a charitable purpose. Here, the unrestricted grant to a controlled public charity would meet the pass-through requirements because the charity planned to use the full amount of the funds in a timely manner, and recycling and preserving the environment is a charitable purpose. Further, Foundation represented it would meet the records requirement. Therefore, this would be a qualifying distribution. Section 4941(a) imposes a tax on each act of self-dealing between a disqualified person and a private foundation, whether direct or indirect. Section 4941(d)(1)(E) defines self-dealing to include the direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation. The IRS ruled that Intermediary's proposed transfers of the collected waste to LLC, made possible by the grant proceeds, will result in indirect acts of self-dealing under Section 4941. The IRS concluded this transaction is an indirect act of self-dealing based on the premise that, "if a private foundation cannot directly engage in a transaction without committing an act of self-dealing, then it cannot also indirectly engage in the transaction without committing an act of self-dealing." Even though there was a legitimate charitable purpose to the grant, if the charity is removed from the transaction, the result is no different than the foundation purchasing the bins, collecting the waste, and then distributing the waste to the LLC for sale in its business, which would then be a direct act of self-dealing. (If Foundation directly collected the waste and transferred it to LLC, a disqualified person, that would be an act of self-dealing.) With a public charity (Intermediary) interposed between Foundation and LLC, the transfers will still constitute an indirect act of self-dealing. The IRS dismissed Foundation's arguments that a regulatory exception to self-dealing for incidental and tenuous benefits should apply. The IRS distinguished other rulings that applied this exception, noting that that the waste transfers in Foundation's case represent an economic benefit to LLC and Intermediary is not independent (but rather is controlled by DP). This is distinguishable from the examples in the regulations, which refer to non-economic benefits such as public recognition. This PLR illustrates for private foundations the workings of the "pass-through" or "conduit" rule under Section 4942, which allows distributions by a private foundation to charities controlled directly or indirectly by a disqualified person to be treated as qualifying distributions. The PLR also confirms that interposing a controlled public charity between a private foundation and a disqualified person will not prevent a transfer of assets from constituting self-dealing under Section 4941, as an indirect act of self-dealing. A private letter ruling is a written statement issued to a particular taxpayer that interprets and applies tax laws to the taxpayer's specific, represented set of facts, and may not be used or cited as precedent by other taxpayers or by IRS personnel. Thus, although the ruling is instructive on how the IRS might rule regarding a particular matter, organizations are cautioned not to rely on the ruling as authority, and to consult with their tax advisors to determine the tax consequences of their own facts and circumstances. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
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