March 18, 2022
IRS TE/GE publishes three new Technical Guides on self-dealing taxes, taxable expenditure excise taxes and religious entities
The IRS Tax Exempt and Government Entities division (TE/GE) has published three new Technical Guides (TGs) to combine with other IRS technical content and update Audit Technique Guides (ATGs) available on irs.gov: (1) TG 58 Excise Taxes on Self-Dealing under IRC 4941, Publication 5616; (2) TG 62 Excise Taxes on Taxable Expenditures under IRC 4945, Publication 5590; and (3) TG 23 Religious and Apostolic Associations IRC 501(d), Publication 5627. In addition, TG 3-8 Termination of Private Foundation Status IRC 507 has been renamed TG 3-22 Termination of Private Foundation Status IRC 507.
IRC Section 4941 prohibits a private foundation and any disqualified person (DP) from entering into any direct or indirect: (1) sale, exchange or lease of property, (2) lending of money or other extension of credit, (3) furnishing of goods, services or facilities, (4) payment of compensation, (5) transfer of assets, or (6) transfer of payment to a government official.
IRC Section 4945 imposes an excise tax on a private foundation's "taxable expenditures," defined to include any grants the foundation makes, 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 IRC Section 4945(h).
IRC Section 501(d) establishes four requirements for exemption for religious and apostolic associations:
- The organization must be a religious or apostolic association or corporation.
- It must maintain a common treasury or community treasury.
- It must engage in a business for the common benefit of its members.
- Its members must include in their gross income, as dividends received, their entire pro-rata share of the organization's taxable income for the year, regardless of whether such income is actually distributed to them.
Technical Guides under IRC Sections 4941 and 4945
Discussing pre-examination considerations in the IRC Section 4941 and 4945 TGs, the IRS instructs its TE/GE Examination agents to review the private foundation's exemption determination file, focusing on these questions:
- Who are the founders, initial substantial contributors, and foundation managers?
- What is the foundation's purpose (e.g., actively operating, grantmaking)?
- Did the organization request advance approval of individual grantmaking under IRC Section 4945(g)?
- If the foundation is involved in grantmaking, what criteria were provided, and what constitutes the applicant pool?
- What donated assets form the foundation's corpus?
- Who contributed the assets?
The IRS will then:
- Note whether the articles of incorporation, articles of association or trust document contains the required IRC Section 508(e) language (e.g., prohibiting the foundation from engaging in self-dealing described in IRC Section 4941 and making taxable expenditures described in IRC Section 4945) and who signed the document
- Visit the foundation's website to determine whether the information presented matches information on the application
- Obtain copies of all filed Forms 990-PF and 990-T information returns, review them for consistency and perform a standard risk analysis to identify questionable items for inclusion in an information document request (IDR)
- Obtain any Integrated Data Retrieval System (IDRS) transcripts for the foundation and its DPs; research the DPs and review the research results "for possible compliance issues (such as missing returns, prior Chapter 42 liabilities, same DP and foundation addresses, foundation vehicles registered under DPs, payments to DP businesses listed on the Form 990-PF)"
- Review the Form 990-PF for the period(s) under examination
- Modify/update the initial interview/questionnaire to incorporate any items identified in reviewing the application and tax returns
- Request in the IDR any additional items needed for the tax years at issue
Correspondence examination information
In the "Field/Office Correspondence Exam Information" chapter of the IRC Section 4941 and 4945 TGs, the IRS instructs agents to:
- Determine whether the foundation has modified the exempt purposes stated in its organizing documents, and whether any changes made jeopardize exemption
- Perform a foundation status test and verify whether the entity continues to fail to qualify under IRC Section 509(a) as a public charity; if the foundation meets the public charity test, inform the entity of the possibility of an IRC Section 507(b)(1)(B) termination (the foundation may apply for an advance ruling of public charity status by filing Form 8940, Request for Miscellaneous Determination)
- Examine the foundation's financial statements and financial records
- Determine how the foundation used its assets, and verify the relationship of assets to exempt purposes
- Tour all foundation facilities, including any real estate investment property, keeping in mind indicia of potential self-dealing (e.g., DPs use of foundation's offices, land, artwork)
- Use a blank Form 990-PF to revise the amounts reported according to the exam findings; if financial records from prior years have been reviewed, revise the prior-year Forms 990-PF as needed
- Determine whether the foundation has engaged in self-dealing transactions, failed to make qualifying distributions, held or acquired excess business holdings, made jeopardizing investments or made taxable expenditures
- Prepare a report of examination for each liable party and ensure there are no disclosure violations
- Verify that any required corrections are made before closing an agreed case
- Protect the statute of limitations by requesting extensions from the foundation and each DP if any of their acts or failures to act give rise to Chapter 42 taxes
- Consider terminating/revoking exempt status in egregious cases
Issue indicators and audit tips
IRC Section 4941 TG. The "Issue Indicators and Audit Tips" chapter regarding acts of self-dealing under IRC Sections 4941 lists these indicators of possible noncompliance to examine:
- A self-dealing transaction occurred but no Form 4720 was filed
- There is evidence of loans from the foundation to DPs
- DPs have been using the foundation's property
- A review of the Form 990-PF indicates the DP made lease payments to the foundation
- A review of the Form 990-PF indicates the foundation sold property to a DP
The chapter also instructs agents to consider whether other Chapter 42 sections might apply to the same transaction, noting that IRC Section 4941 and IRC Section 4945 issues "can commonly occur for the same transaction."
"Audit tips" provided regarding self-dealing transactions in the IRC Section 4941 TG include:
- Investigate and identify the private foundation's DPs and determine whether any transactions occurred between the foundation and the DPs
- Review balance sheet listings of assets, including depreciation schedules
- Determine where all assets are located and who is using them
- Determine how fully appreciated assets were disposed of, including whether they were given to a DP
- Tour any property the foundation leases or owns and determine whether a DP is using it
- Review all the foundation's contracts and agreements
- Review compensation of officers and directors reported on Form 990-PF, Part VIII
- Review the type of services provided if the foundation has claimed a personal service exception
- Review the foundation's organizing documents to determine if (1) compensation was approved and authorized; (2) the nature of services to be rendered relate to the foundation's exempt purposes; and (3) compensation is reasonable
- Review books and records to determine whether services were rendered
- Review expenditure journals for any payments to DPs
- Examine the foundation's income stream to ensure the income is not being derived from any activity involving a DP, while also considering the exceptions to self-dealing
- Determine whether any non-cash gifts are encumbered by mortgages or liens and whether the sale was from a DP
- Review balance sheet items on Form 990-PF, Part II
- Determine whether any self-dealing transactions were reported on Form 4720, the applicable excise taxes were paid, and corrections were made
IRC Section 4945 TG. Issue indicators with regard to IRC Section 4945 differ somewhat from those for IRC Section 4941. The IRC Section 4945 TG lists the following issues as indicating a foundation might have made prohibited taxable expenditures and/or engaged in related noncompliance:
- A taxable expenditure was made but no Form 4720 was filed
- Amounts have been spent to carry on propaganda or attempt to influence legislation
- Expenditures have been made to influence a specific public election outcome or to conduct, directly or indirectly, a partisan voter registration drive
- Grants have been paid to an individual for travel, study or similar purposes that don't satisfy IRC Section 4945(g)
- Amounts have been disbursed as grants (1) to an organization that is not a public charity or (2) for which the private foundation has not exercised IRC Section 4945(h) expenditure responsibility
- Expenditures have been made for any purpose other than one addressed in IRC Section 170(c)(2)(B)
"Audit tips" provided regarding taxable expenditures in the IRC Section 4945 guide also differ somewhat from those for IRC Section 4941, and include the following:
- Review all expenditures and determine which ones constitute grants to organizations, as grants to organizations not listed in IRC Section 4945(d)(4)(A) (public charities described in IRC Section 509(a)(1) or 509(a)(2)) are subject to expenditure responsibility under IRC Section 4945(h)
- Determine whether a foundation making grants to individuals for travel, study or other similar purposes submitted Form 8940 to request advance approval of its grantmaking procedures
- Determine whether the person or group selecting grant recipients can derive a direct or indirect private benefit
- Determine whether the requirements for grants to individuals were followed:
- Awarded on an objective and nondiscriminatory basis
- Made under a procedure approved in advance by the IRS
- Constitutes a scholarship or fellowship grant that would be subject to the provisions of IRC Section 117(a) and will be used for study at educational organization described in IRC Section170(b)(1)(A)(ii)
- Intended to serve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill or talent of the grantee
- Determine whether grant recipients are DPs, the grant process was followed, and grants were made on a nondiscriminatory basis
- Determine whether the foundation ensures the grant proceeds are used to further the purposes for which the grant was made
- Review any grantees with foreign addresses
- Ask the private foundation if it has an equivalency determination for any foreign organization that does not have a determination letter; verify that a qualified tax practitioner prepared the equivalency determination, that it contains current information and that it appears reasonable
- Review Form 990-PF for compliance with reporting requirements around exercising expenditure responsibility
Worksheets and exhibits
IRC Section 4941 TG. The IRC Section 4941 TG provides examples of worksheets and exhibits for use by TE/GE Examination agents "focusing on practical applications when asserting excise taxes under Section 4941." Under the 1969 excise tax scheme, IRC Section 4941(a) imposed an initial (first-tier) tax of 5% of the amount involved for each act of self-dealing for each tax year that ends during the tax period.1 If the act of self-dealing remains uncorrected during the statutory correction period, IRC Section 4941(b) imposed an additional (second-tier) tax on the self-dealer's failure to correct. The second-tier taxes applied at the end of the tax period.
- Examples of when the first-tier tax under IRC Section 4941 might apply include the following:
- A private foundation pays a DP, but no services were rendered
- A DP sells property to a private foundation
- A DP uses foundation property
- A private foundation loans money to a DP
- IRC Section 4941 second-tier taxes are:
- Triggered by the failure to make a correction
- Imposed at the same time as first-tier taxes for assessment or when a notice deficiency is issued
- Abated if correction occurs within the correction period
IRC Section 4945 TG. The IRC Section 4945 TG provides worksheets and exhibits for use by TE/GE Examination agents "focusing on practical applications when asserting Section 4945 excise taxes for taxable expenditures made by a private foundation." Examples pertaining to both the first-tier tax and second-tier penalty follow.
- Examples of when the first-tier tax under IRC Section 4945 might apply include the following:
- The expenditure doesn't meet any exception listed in IRC Section 4945
- The transaction is a taxable expenditure
- IRC Section 4945 second-tier taxes typically apply if the transaction is not corrected within the correction period
Technical Guide for religious organizations
The TG addressing religious and apostolic associations described in IRC Section 501(d) explains the history behind this exemption category, the various requirements for exemption, how to apply for exempt status and how an IRS examiner should conduct an audit.
At a general level, an examination of an IRC Section 501(d) organization should consist of three main components: (1) confirming the organization qualifies for exemption for the year under examination, (2) ensuring the accuracy of the organization's net income, and (3) substantiating that the organization reported each member's pro-rata share of net income.
Technical guides provide specific items of interest and examples to help IRS agents in their examinations. Publishing TG 58 Excise Taxes on Self-Dealing under IRC 4941 and TG 62 Excise Taxes on Taxable Expenditures under IRC 4945 highlights the complexity of private foundation rules and the IRS's continued effort to curb perceived abuses. The TGs contain examples to help IRS TE/GE Examination agents determine if acts between a DP and a private foundation are considered acts of self-dealing and provide detailed explanations of the expenditure responsibility provisions. Private foundations should review these guidelines to help ensure compliance and safeguard against IRC Section 4941 and IRC Section 4945 violations and ensuing excise taxes.
Please contact your EY Tax professional with any questions.
For additional information concerning this Alert, please contact:
1 The term "taxable period" as redefined in IRC Section 4941(e)(1) and Treas. Reg 53.4941(e)-1(a), for any act of self-dealing, means the period beginning with the date on which the act of self-dealing occurs and ending on the earliest of (a) the date the IRS mails a notice of deficiency for tax imposed by subsection (a)(1) under IRC Section 6212, (b) The date on which the tax imposed by IRC Section 4941(a)(1) is assessed, or (c) the date on which correction of the act of self-dealing is completed.