November 3, 2022 In calculating self-dealing excise tax, disqualified person's loan balance includes unpaid interest from closed years
In an internal legal memorandum (ILM) (ILM 202243008), an IRS deputy chief counsel has concluded that interest accruing in closed years on a private foundation's loan to a disqualified person must be included in the loan balance used to compute the excise tax on self-dealing in open years. Facts A private foundation made a loan to a disqualified person, described under IRC Section 4946(a), that constituted an act of self-dealing (IRC Section 4941(d)(1)(B)). The disqualified person did not make any interest or principal payments; therefore, unpaid interest on the loan was added to each year's balance. When the IRS conducted its examination, the limitations period had expired for the initial loan offering and the first several acts of self-dealing. Law In part, IRC Section 4941 prohibits a private foundation from lending money or extending credit to a disqualified person. A 10% excise tax applies to (IRC Section 4941(a)(1)) each act of self-dealing for each year or part of a year in the taxable period. The "taxable period" begins when the act of self-dealing occurs and continues until one of the following events occur:
Generally, in determining the amount to which the 10% excise tax applies, the fair market value (FMV) of the property is determined as of the date on which the act of self-dealing first occurred. If the transaction involves a loan or other extension of credit, the transaction is treated as giving rise to several acts of self-dealing — first on the date the transaction initially occurs, and then on the first day of each tax year thereafter (Treas. Reg. Section 53.4941(e)-1(e)(1)(i)). Over the course of a four-year loan, for example, four acts of self-dealing would be deemed to occur. The IRC Section 4941(a) excise tax would be determined each year, based on the FMV of the outstanding loan balance (principal and any accrued, unpaid interest). IRS analysis Although IRC Section 6501 prohibits the IRS from assessing tax for acts that occurred in "closed" years beyond the three-year time limit, the ILM noted, "the loan balance, including accrued but unpaid interest, is not an amount of tax." Therefore, IRC Section 6501 "does not prevent accrued interest and payments of principal, regardless of whether they were incurred or made in open or closed years, from affecting the loan balance used in determining the amount involved," the IRS concluded. As a result, interest that accrued on the loan in closed years must be added to the principal balance to compute the self-dealing excise tax due for each open year. Implications The IRS's determination to include accrued interest from closed years highlights the need for organizations to carefully analyze which amounts are needed to determine a loan's balance. Though prior taxable periods may have simply been written off as "closed" for IRS determination and not heavily scrutinized for current computations, organizations need to carefully review all closed periods for applicable interest amounts. Please contact your EY Tax professional with any questions. ———————————————
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor | ||||||||||||
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