PLR 200030026: University research grant avoids taxable expenditure treatment

Plain-English summary

A private foundation proposed a grant to a publicly supported university fundraising organization for a computing research project. The requested ruling focused on funding the university's economic development office and a related technology transfer organization, whose plans included business assistance and a seed capital fund. The IRS ruled that these portions of the grant would be qualifying distributions under section 4942(g) and would not be taxable expenditures under section 4945(d)(4) or (5). The recipient was exempt and was not a private foundation; it would choose any secondary grantees and make investment decisions independently, without earmarking by the grantor. The funded activities also furthered educational, scientific, and charitable purposes.

Ruling snapshot

• Question: Would grant funds for the university's economic development and technology transfer work count as qualifying distributions without becoming taxable expenditures?
• Outcome: Approved on the represented facts.
• Key authorities: IRC §§ 170(c)(2)(B), 4942(g), and 4945(d)(4)-(5); Treas. Reg. §§ 53.4945-5(a)(6)(i) and 53.4945-6(b)(1)(v).

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
Number: 200030026

Date: APR 26 2000
Contact Person:
ID Number:
Telephone Number:
UIL: 170.00-00
509.00-00
501.00-00
OP:E:EO:T4

LEGEND
R =
S =
T =
U =
V =
W =
X =
Y =
Z =
F =

Dear Applicant:

This is in response to a ruling request dated September 17, 1999, on the application of sections
4942 and 4945 of the Internal Revenue Code with respect to a proposed grant to S to support a "pervasive
computing" research project (the “Project”) at T.

FACTS

R is a nonprofit corporation organized under the laws of the State of U and is a private non-
operating foundation described in sections 501(c)(3) and 509 of the Code. R's only office is located in the
City of W.

T is an agency and instrumentality of the State of U that meets the definition of a governmental unit
under sections 170(c)(1), 170(b)(1)(A)(v), and 509(a)(1) of the Code, and is an educational organization
described in sections 170(b)(1)(A)(ii) and 509(a)(1) of the Code.

S is a nonprofit corporation also organized under the laws of the State of U. S is described in
sections 501(c)(3), 170(b)(1)(A)(iv), and 509(a)(1) of the Code, and is organized and operated exclusively
to receive, hold, invest, and administer property and to make expenditures to or for the benefit of the T. S is
the preferred vehicle for private gifts and grants for the benefit of T. S has F members on its board of
directors. One of its directors, formerly the president of T and now T’s chancellor, also serves as a non-
voting, emeritus director of R. There is no other direct or indirect relationship between R and S or between
R and T.

V is a U nonprofit corporation established exclusively for the benefit of, to provide service and
support for, and to carry out the purposes of T, primarily as a vehicle to develop, license, and promote
research discoveries and innovations from T. V is a supporting organization of T described in sections
501(c)(3) and 509(a)(3) of the Code. There is no direct or indirect relationship between R and V.

T has for years played a critical educational and research role in the field of information technology
(both the collection and refinement of computer data and the ability to access and distribute such data),
participating in initiatives sponsored by the National Science Foundation, the United States Department of
Energy, the Defense Advanced Research Projects Agency, the National Aeronautics and Space
Administration, and other governmental, educational, research, and business institutions. The Internet is a
product of these and similar collaborations, and computer and communications advancements into the next
century will likely follow the same collaborative path. T's primary goal for the Project is to continue its role
in the development of educational and research of information technology by developing in the State of U a
world-class educational and research capability in the fundamental computer and communications
technologies that will drive the 21st century information economy.

With the Project, T has announced its goal of becoming a national leader in the creation and use of
information technology. It will pursue this goal through education, research, and development in the area of
“pervasive computing.” Pervasive computing refers to a wide-reaching network of intelligent computer
instruments, appliances, information sources, and information analysis tools all linked together by high-
speed wired and wireless communications systems. Pervasive computing also includes individual (and
personal) software service agents that constantly search for, gather, and analyze information important to
the user, even when the user is not "logged on.”

There remains a great deal of learning (i.e., science and research) and teaching (i.e., education)
before the vision of pervasive computing becomes a reality. T conceived the Project as a means of
propelling its students and faculty, and the State of U, to the vanguard of this evolution. S has requested
financial support from R to further T's effort.

S has emphasized that R's support is critical because the State of U ranks among the lowest in the
nation in terms of the proportion of residents with a baccalaureate or higher educational degree and in the
percentage of its workforce in professional specialty occupations, including high-technology careers. For T
to become the leader in pervasive computing, significant changes in environment, infrastructure, and
opportunity in the State must occur. The budget submitted to R by S divides the requested grant into six
categories of expenditures.

The first category will be funds used to establish six world-class research laboratories at T
addressing different aspects of the pervasive computing equation. Each laboratory will be headed by a
distinguished scientist, who will be a researcher of international standing in a particular field of computer or
communications technologies. In addition, each laboratory will be staffed, on average, with two junior
tenure-track researchers, two postdoctoral fellows, and six graduate students. The laboratories will focus
on two broad fields of study regarding pervasive computing — computer software technology and advanced
telecommunications.

The laboratories will be located geographically to leverage T's existing facilities and resources in
computer and communications technologies. T's campus in W is being established as the center of T's
extensive telecommunications infrastructure, so three laboratories in the telecommunications field will be
located there. T's main campus at X is already home to the university's core computing and information
facilities, so the remaining three laboratories, focused on computer software technology, will be established
on that campus. These physical facilities are or will be funded primarily by T and the State of U.

The second category of grant expenditures will support the position of science director of T for five
years. The science director is expected to be a distinguished T faculty member who will serve on the
steering committee for the entire Project and will be responsible for oversight and direction of the six
laboratories. The grant funds will be used to pay a portion of the science director's salary, thus relieving her
or him from other faculty and administrative responsibilities.

The third category will assist T in the creation of a new school within the university (the first in 25
years) to develop new courses and curricula emphasizing the practical application of information
technology across a wide variety of academic disciplines. In addition, businesses and industries in U are
expected to co-sponsor course development for undergraduate and graduate students and to incorporate
the school's offerings into their own workforce training and development programs. Many of the school's
teaching functions will be conducted in “virtual classrooms,” utilizing the very computer and
communications technologies about which the students will learn. The school will award a bachelor of
science degree and offer a minor or a certificate to non-majors. In addition, there will be four specialized
master of science degrees. Other specialized master's degrees likely will be added over time, and there is
substantial faculty interest in soon adding a Ph.D.

The fourth category of expenditures will be funds to support a small portion of the capital cost of the
three telecommunications laboratories and space for the new economic development office (discussed
below) that will be included in T's already-planned building construction and expansion initiative for the W
campus. T expects to finance this cost through educational bonds, but S has asked R for funds to service
the bonds during the first five years of the Project. T itself will guarantee the bond payments following this
start-up period, as well as providing comparable space for the three separate software computer
technology laboratories that will be located on the X campus.

The fifth category of expenditures will fund T's plans to establish a new administrative department
focusing on the business impact of research conducted at T, the economic development office. The office
will build on the work conducted at the pervasive computing laboratories to:

1) greatly expand the number of T graduates trained in all areas of information technology, and
retain graduates of all colleges and universities in the State of U by taking advantage of
increased employment opportunities in information technology careers arising out of the
Project;

2) identify State resources that could be allocated to leverage federal and private sponsorship of
T research;

3) attract new academic and corporate information technology researchers to T and to the State
of U generally;

4) assist with the establishment of promising start-up and spin-off companies employing the
technologies developed at T's laboratories;

5) provide and coordinate the use of laboratory facilities for business research and development
of discoveries, inventions, and innovations at T; and

6) aid in the formation of information technology incubators at T, to provide basic computer,
communications, and infrastructure support and management consulting services to small
businesses that stem from research at the laboratories or to enterprises that complement and
expand upon that research.
These activities of the economic development office will promote and support the scientific research and
teaching conducted in T's Project laboratories by identifying and filling gaps between technological
development and deployment in real-world situations.

In conjunction with V (as discussed below), the economic development office also will facilitate the
eventual transfer of T technology to public uses and private enterprises. It will work to align T's educational
disciplines with industry needs to address more effectively regional employment issues and to reduce the
number of skilled graduates from the State of U who leave the State for advanced careers elsewhere.
Furthermore, business leaders will be consulted and actively engaged in curricular design, the creation of
internship opportunities for undergraduates, funding of graduate research fellowships, and mentoring
programs. Moreover, the economic development office will collaborate with local governments and the
State to ensure that T's research and development efforts complement the public policy and economic
growth objectives supported directly by tax dollars.

R is being asked by S to fund the staff and operating expenses of T's economic development office
for five years, at a total estimated cost of Y dollars.

Finally, the sixth category is S's request for approximately Z dollars to support the technology
transfer activities of V on behalf of T. This funding will support the salary and benefits of a technology
transfer officer at V for five years, will pay for technology transfer and business start-up seminars that will be
coordinated by V during this same time period, and will establish a capital seed fund (i.e., a revolving venture
capital fund providing loans or equity to information technology businesses) to be administered by V.

In support of T's Project, V's mission is to develop a broad technology transfer assistance program
that includes top flight graduate students from a number of T's schools and departments, in addition to
undergraduate interns and part-time graduate students. V will develop and conduct seminars and training
programs for University researchers and faculty inventors (such as the technology transfer and business
start-up seminars) to teach them how to prepare patent and trademark disclosures and similar related
skills. V's technology transfer officer will assist T in the technology licensing process and in evaluating new
high technology business opportunities created by virtue of T's leadership in the area of pervasive
computing.

V also will establish the capital seed fund to provide early stage financing for promising technology
successfully developed at the Project laboratories and for related businesses that complement the work
and goals of T. V will make loans or equity investments from the fund only with new companies that have a
real chance for success in the competitive information technology sector. Prior to making a seed capital
investment, V will use knowledge gathered at its seminars and by start-up assistance teams (staffed by
graduate students) to assess and qualify the prospects for successful use of technologies developed
through the Project and other T research and to assist the businesses that seek to cultivate and advance
those technologies in the marketplace. Through V, T will be able to seek outside investment funding,
support extended research and development of pervasive computing and other technologies, hold equity in
or extend credit to start-up businesses, and engage in other activities that support and enhance the core
educational and research efforts of the Project.

R seeks rulings that disbursement of grant proceeds to S targeted for the economic development
office and to V's activities:

1) Will not be treated as a taxable expenditure under section 4945(d)(4) or (5) of the Code; and
2) Will constitute a qualifying distribution that satisfies the requirements of section 4942(g).

LAW
Section 4945(d)(4) of the Code defines the term “taxable expenditure" to include amounts paid by a
private foundation — as a grant to an organization unless—
(A) such organization is described in paragraph (1), (2), or (3) of section 509(a) or is an exempt
operating foundation (as defined in section 4940(d)(2)), or
(B) the private foundation exercises expenditure responsibility with respect to such grant in
accordance with subsection (h)....

Section 53.4945-5(a)(6)(i) of the Foundation and Similar Excise Taxes Regulations explains that a grant by
a private foundation to a grantee organization which the grantee uses to make payments to another organization
(the secondary grantee) shall not be regarded as a grant by the private foundation to the secondary grantee if the
foundation does not earmark the use of the grant for any named secondary grantee and there does not exist an
agreement, oral or written, whereby such grantor foundation may cause the selection of the secondary grantee by
the organization to which the foundation makes the grant. To avoid earmarking to the secondary grantee, the
original grantee organization must exercise control, in fact, over the selection process and actually make the
selection completely independently of the private foundation.

Section 4945(d)(5) of the Code states that a taxable expenditure is any amount paid by a private foundation
"for any purpose other than one specified in section 170(c)(2)(B)." Among the purposes recognized as exempt and
described in section 170(c)(2)(B) are “exclusively . . . religious, charitable, scientific, literary, or educational
purposes.”

Section 4942(g)(1) of the Code defines the term "qualifying distribution” as “any amount . . . paid to
accomplish one or more purposes described in section 170(c)(2)(B), other than any contribution to (i) an
organization controlled (directly or indirectly) by the foundation or one or more disqualified persons . . ., or (ii) a
private foundation which is not an operating foundation.”

Section 53.4945-6(b)(1)(v) of the regulations states that an expenditure that "constitutes a qualifying
distribution under section 4942(g) [of the Code]" ordinarily will not be treated as a taxable expenditure.

ANALYSIS

S is a publicly supported organization raising and administering funds to benefit T, a state
university. Neither S nor T are private foundations within the meaning of section 509(a) of the Code. S has
requested a grant from R to support T's Project, including funding of T's economic development office and
its supporting organization, V which is also not a private foundation. This request is related directly to the
exempt purposes and mission of S. No part of the grant will be earmarked for particular secondary
grantees or other recipients, and S will make all investment and similar decisions completely independently.

Our analysis shows that the grant is being made to an organization which is exempt under section
501(c)(3) and which is not a private foundation. Therefore, R’s proposed grant to S for T's economic
development office and V will not be a taxable expenditure under section 4945(d)(4)(A) of the Code, even
though R will not exercise expenditure responsibility under sections 4945(d)(4)(B) and 4945(h).

For the reasons delineated in the above discussion relating to taxable expenditures, and
considering section 53.4945-6(b)(1)(v) of the regulations, the portions of R's grant under consideration, by
furthering educational, scientific, and charitable purposes under section 170(c)(2)(B) of the Code, also
satisfy the initial requirement of section 4942(g)(1). Neither R nor any of its disqualified persons exercises
control, directly or indirectly, over S, and S is not a private foundation. Therefore, the requirement of section
4942(g)(1)(A) are met. Accordingly, R's support of S's proposal to fund T’s economic development office
and V constitutes a qualifying distribution.

Based on the information you have submitted and as the distributee organization is recognized as
exempt under section 501(c)(3) of the Code, under the facts described above we rule that the disbursement
of grant proceeds to S targeted for the economic development office and to V's activities:

1) Will not be treated as a taxable expenditure under section 4945(d)(4) or (5) of the Code; and
2) Will constitute a qualifying distribution that satisfies the requirements of section 4942(g).

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely,

(signed) Gerald V. Sack

Gerald V. Sack
Manager, Exempt Organizations
Technical Group 4