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March 1, 2023

IRS allows private foundation to set aside funds for a construction project to meet qualifying distribution requirement

  • In a recent private letter ruling, the IRS granted a private foundation permission to set aside funds for use on a construction project.
  • The set-aside will not cause the foundation to incur IRC Section 4942 excise tax on undistributed income.
  • Private foundations should continue to consider potential set-aside treatment related to undistributed income, if appropriate. 

In a private letter ruling (PLR 202308013), the IRS has approved a private foundation's request to set aside funds under IRC Section 4942(g)(2) to allow the foundation to pay for construction work on an "as work is done" basis rather than by immediate payment.


The mission of the private foundation, recognized by the IRS as tax-exempt under IRC Section 509(a), is to establish, operate, sponsor and manage "programs that provide educational services and resources to the general public." The foundation has begun construction on a facility that will be used directly to carry out the foundation's exempt purposes by displaying cultural and educational exhibits and providing space for music, theater and art performances and exhibits. Once construction of the facility is complete, it will be open to the general public.

The foundation wants to set aside a certain amount of money so it can pay for the construction work as each stage of the project is completed. The IRS noted that paying for construction on an "as work is done" basis is customary and appropriate for such construction projects. The foundation provided a statement to the IRS that it will pay out all of the set-aside funds within 60 months to satisfy the qualifying distribution requirements of IRC Section 4942(g)(2).

Applicable law

IRC Section 4942 generally requires a private foundation to make annual payments for charitable purposes (qualifying distributions) equal to at least 5% of the average fair market value of its investment assets in the preceding tax year, reduced by the debt incurred to acquire the property (distributable amount). IRC Section 4942 also imposes a 30% excise tax on the "undistributed income" of most domestic private foundations (i.e., the amount by which the foundation's minimum distributable amount each year exceeds its qualifying distributions for that year). However, a private foundation can avoid the excise tax on undistributed income if:

  • An amount set aside for a specific project is treated as a qualifying distribution under IRC Section 4942(g)(2)(A)
  • Its total qualifying distributions for the year that include the set-aside amount meet or exceed the minimum distributable amount for that year

A private foundation may treat such a set-aside amount as a qualifying distribution by establishing, to the satisfaction of the IRS, that it meets the "suitability test"; that is, the set-aside amount will be paid within 60 months of the time of the initial set-aside and the project can be better accomplished by setting the funds aside than by paying the funds out immediately.


Concluding that the set-aside would be used to further the foundation's exempt purposes and that the foundation's construction project would be better accomplished by the set-aside approach than by the immediate payment of funds, the IRS ruled that the set-aside was permissible and would not result in adverse tax consequences.

The ruling directs the foundation to:

  • Document the approved set-asides in the foundation's records as pledges or obligations
  • Pay the set-aside amounts within 60 months after the date of the first set-aside, as IRC Section 4942(g)(2) requires
  • Take into account both:
    • The set-aside amounts when determining the foundation's minimum investment return under IRC Section 4942(e)(1)(A)
    • Income attributable to the set-asides when computing the foundation's adjusted net income under IRC Section 4942(f)


Using set-aside funds to meet qualifying distribution requirements can be a beneficial tool for many private foundations. Because only the taxpayer to whom an IRS private letter ruling is issued may rely on it, and because each PLR involves unique circumstances, a foundation generally must request and obtain its own IRS ruling to treat a set-aside amount as a qualifying distribution. Before doing so, an organization should gather applicable facts and analyze whether treating a set-aside as a qualifying distribution would be permissible and beneficial. Once a foundation obtains IRS approval of a set-aside as a qualifying distribution under the suitability test, it should keep such approval on file along with supporting documentation.

Please contact your Ernst & Young tax professional with any questions.



— For more information about EY's Exempt Organization Tax Services group, visit us here.


Contact Information
For additional information concerning this Alert, please contact:
Exempt Organization Tax Services
   • Stephen Clarke (
   • Melanie McPeak (
   • Morgan Moran (
   • Cal Hoke (

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor