PLR 201007065: Private foundation transfer approved with limits on attributes and expenditure responsibility

Plain-English summary

The IRS approved a private foundation’s plan to transfer cash and marketable securities worth about one-third of its assets to a newly recognized private foundation. The transfer qualified as a significant distribution under section 507(b)(2), so it would not terminate the transferor’s private foundation status or trigger the section 507(c) termination tax. The ruling addressed the transferee’s tax attributes, investment income, self-dealing, qualifying distributions, taxable expenditures, and expenditure responsibility. The transferee would not receive the transferor’s excess qualifying distribution carryovers, and the transferor was required to exercise expenditure responsibility for the transferred capital-endowment assets. Some requested tax consequences were limited or conditional.

Ruling snapshot

• Question: Could the foundation transfer roughly one-third of its assets to another private foundation under IRC § 507(b)(2), with the stated tax consequences?
• Outcome: Mixed: the transfer was approved, but some requested tax consequences were denied, limited, or made conditional.
• Key authorities: IRC §§ 4940, 4941, 4942, 4943, 4945, 4946, 501(c)(3), 507, and 509; Treas. Reg. §§ 1.507-3 and 1.507-4; Foundation Reg. §§ 53.4945-5 and 53.4946-1.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201007065 Contact Person:
Release Date: 2/19/10

Date: November 25, 2009 Identification Number:

Telephone Number:

Employer Identification Number:
UIL Code: 507.00-00, 4940.01-00,4941.00-00
4942.00-00, 4945.00-00
SE: T-EO:RA:T:2

Legend:

M =
B =
C =
D =
E =
F =
X =

Dear

This is in response to your ruling request regarding the proper treatment of a transfer of part of
your assets to another private foundation under sections 507, 509, 4940, 4941, 4942, 4945, and
4946 of the Internal Revenue Code (“Code”).

Facts:

You have been recognized as an organization described in section 501(c)(3) of the Code and
classified as a private foundation under section 509(a). Your founder died several years ago and
your directors are B, C, D, E, and F. B is the founder’s daughter. C and D are the founder's
grandchildren. E and F are your professional advisors. Administering the founder's large estate
was a complex process, due in part to the nature of the estate’s assets and because of litigation
(“estate litigation”) in the local probate court among B, C, D, and various other family members
contemporaneous with, but unrelated to, the administration of the founder’s estate, litigation
(“foundation litigation”) developed in the local circuit court over the membership of your board of
directors.

You are a membership non-profit corporation and your members elect the directors who are
responsible for your general operations. There are two categories of members: full and associate,
with each having different privileges. Until his death, the founder was a full member and

designated B, C, and D as associate members. After the founder’s death, a dispute arose among
B, C, and D, over the interpretation of the corporate governance provisions relating to who is
actually a member, what kind of member, and what authority each might have. Due to the
irreconcilable conflicts between your members, your operations became paralyzed. Approximately
X million dollars of your charitable pledges have been suspended. Several years ago, the parties
to both litigations resolved their differences with a global settlement.

Pursuant to the litigated settlement agreement, the parties agreed that you would transfer cash and
marketable securities equal to approximately one-third of the total value of your assets to a new
organization, M. M has been recognized as an organization described under section 501(c)(3) of
the Code and classified as a private foundation under section 509(a). M will provide no
consideration for the transferred assets. After the transfer, M plans to immediately make two large
grants to public charities, and D will resign as your full member and director. Initially, D will be M’s
president and sole director, but expects to appoint additional directors in the future. B and C will
continue as your full members while B, C, E, and F will continue as your directors. Thereafter, you
and M will operate as separate private foundations, with separate boards of directors. The
formation of M with separate directors will facilitate the foundations’ divergent grant making
objectives.

You state that you have not and will not notify the IRS of your intent to terminate your status
pursuant to section 507(a)(1) of the Code. You further state that you have never either willfully
repeated acts (or failures to act) or committed a willful and flagrant act (or failure to act) which gives
rise to tax under chapter 42. You also state that currently and at the time of the proposed
distribution of assets from you to M, there are not and will not be any willful repeated act (or failure
to act) or willful flagrant act (or failure to act) which would give rise to liability for taxes under
chapter 42. You also represent that you have no expenditure responsibility grants outstanding
under section 4945(h).

Rulings Requested:

You have requested the following rulings:

1. Your transfer, without consideration, of cash and marketable securities equal to approximately
one-third of your total value to M will constitute a significant distribution of assets to one or more
private foundations within the meaning of section 1.507-3(c)(1) of the Income Tax Regulations
(“regulations”) and, therefore, as a transfer described in section 507(b)(2) of the Code, will not
be subject to tax under section 507(c).

2. Your transfer to M will not result in termination of your private foundation status under section
507(a) of the Code but, instead, will constitute a reorganization between those private
foundations under section 507(b)(2).

3. Your transfer to M will not constitute notification of your intent to terminate your private
foundation status under section 507(a)(1) of the Code, or any willful repeated acts (or failures to
act) or any willful and flagrant act (or failure to act) under section 507(a)(2) by you. Thus, you
will not be liable for any tax imposed by section 507(c).

4. Pursuant to section 507(b)(2) of the Code, M will not be treated as a newly-created
organization.

5. M will be treated as possessing your tax attributes and characteristics pursuant to section
1.507-3(a)(2), (3), and (4) of the regulations.

6. Your transfer to M will not give rise to any net investment income or constitute any other
taxable sale or disposition under section 4940 of the Code.

7. Your transfer to M will not constitute any act of self-dealing under section 4941 of the Code by
you, M or any of their foundation managers as defined in section 4946.

8. Upon your transfer to M, M will succeed to a portion of your excess qualifying distributions
under section 4942 of the Code, if any, based upon M's proportionate share of your total assets
received.

9. Your transfer to M will not constitute taxable expenditures under section 4945 of the Code.

10. You will not be required to exercise any expenditure responsibility under section 4945(h) of the
Code with respect to your transfer of assets to M.

11. Pursuant to section 1.507-3(a)(9) of the regulations, and for purposes of chapter 42 and
sections 507 through 509 of the Code, M will be treated as if it were you in the proportion that
the fair market value of your assets (less encumbrances) transferred to M bears to the fair
market value of your assets (less encumbrances) immediately before your transfer of the
assets.

Law:

Section 501(c)(3) of the Code provides an exemption from federal tax for organizations that are
organized and operated exclusively for religious, charitable, scientific, testing for public safety,
literary, or educational purposes, no part of the net earnings of which inures to the benefit of any
private shareholder or individual.

Section 507(a)(1) of the Code states that a private foundation may voluntarily terminate its private
foundation status by submitting to the Internal Revenue Service a statement of its intention to
voluntarily terminate its private foundation status pursuant to section 507(a)(1) and by paying any
termination tax under section 507(c).

Section 507(b)(2) of the Code states that when one private foundation transfers assets to one or
more other private foundations, each transferee private foundation shall not be treated as a newly
created organization.

Section 507(c) of the Code imposes an excise tax equal to the lower of: (1) the aggregate tax
benefits that have resulted from the private foundation's exempt status under section 501(c)(3), or
(2) the value of the net assets of the private foundation on an organization that voluntarily
terminates its private foundation status.

Section 4940(a) of the Code imposes an annual tax on the net investment income of private
foundations.

Section 4940(c) of the Code defines net investment income as the amount by which the sum of the
gross investment income and the capital gain net income exceeds the deductions allowed by
paragraph (3).

Section 4941(a) of the Code imposes an excise tax on acts of self-dealing between a private
foundation and any of its disqualified persons as defined in section 4946.

Section 4942(a) of the Code imposes on the undistributed income of a private foundation for any
taxable year, which has not been distributed before the first day of the second (or any succeeding)
taxable year following such taxable year (if such first day falls within the taxable period), a tax equal
to 30 percent of the amount of such income remaining undistributed at the beginning of such
second (or succeeding) taxable year.

Section 4942(g)(3) of the Code states that, for purposes of this section, the term “qualifying
distribution” includes a contribution to a section 501(c)(3) organization described in paragraph
(1)(A)(ii) if (A) not later than the close of the first taxable year after its taxable year in which such
contribution is received, such organization makes a distribution (within the meaning of paragraph
(1) or (2), without regard to this paragraph) which is treated under subsection (h) as a distribution
out of corpus (or would be so treated if such section 501(c)(3) organization were a private
foundation which is not an operating foundation), and (B) the private foundation making the
contribution obtains adequate records or other sufficient evidence from such organization showing
that the qualifying distribution described in subparagraph (A) has been made by such organization.

Section 4945(a) of the Code imposes a tax on the taxable expenditures of a private foundation.

Section 4945(d)(4) of the Code states, in part, that for purposes of this section, the term “taxable
expenditure” means any amount paid or incurred by a private foundation as a grant to an
organization unless such organization is described in paragraph (1) or (2) of section 509(a), is an
organization described in section 509(a)(3), or is an exempt operating foundation, or the private
foundation exercises expenditure responsibility with respect to such grant in accordance with
subsection (h).

Section 4945(h) of the Code defines the term “expenditure responsibility” to mean that a private
foundation is responsible to exert all reasonable efforts and to establish adequate procedures to
see that the grant is spent solely for the purpose for which made, to obtain full and complete
reports from the grantee on how the funds are spent, and to make full and detailed reports with
respect to such expenditures to the Secretary.

Section 1.507-3(a)(1) of the Treasury Regulations (regulations) states that in the case of a
significant disposition of assets to one or more private foundations, within the meaning of
paragraph (c) which describes a section 507(b)(2) of the Code transfer, the transferee
organization shall not be treated as a newly created organization, but shall succeed to those
attributes and characteristics of the transferor organization described in section 1.507-3(a)(2),
(3), and (4), which include its aggregate tax benefit, substantial contributors, and chapter 42 tax
and penalty liabilities.

Section 1.507-3(a)(2) of the regulations states, in part, that a transferee organization to which
this paragraph applies shall succeed to the aggregate tax benefit of the transferor organization.

Section 1.507-3(a)(3) of the regulations states that, for purposes of section 507(d)(2), in the
event of a transfer of assets described in section 507(b)(2), any person who is a “substantial
contributor” (within the meaning of section 507(d)(2)) with respect to the transferor foundation
will be treated as a “substantial contributor” with respect to the transferee foundation, regardless
of whether such person meets the $5,000-two percent test with respect to the transferee
organization at any time.

Section 1.507-3(a)(4) of the regulations states that if a private foundation incurs a liability for
one or more of the taxes imposed under chapter 42 (or any penalty resulting therefrom) prior to,
or as a result of, making a transfer of assets described in section 507(b)(2)to one or more
private foundations, in any case where transferee liability applies, each transferee foundation
shall be treated as receiving the transferred assets subject to such liability to the extent that the
transferor foundation does not satisfy such liability.

Section 1.507-3(a)(5) of the regulations states that, except as provided in subparagraph (9) of
this paragraph, a private foundation is required to meet the distribution requirements of section
4942 for any taxable year in which it makes a section 507(b)(2) transfer of all or part of its net
assets to another private foundation.

Section 1.507-3(a)(6) of the regulations provides that when a private foundation makes a section
507(b)(2) transfer of all or part of its net assets to another private foundation, the applicable
period of time described in section 4943(c)(4), (5), or (6) shall include both the period during
which the transferor foundation held such assets and the period during which the transferee
foundation holds such assets.

Section 1.507-3(a)(8)(ii) sets forth certain rules that apply to the transferee foundation with
respect to the assets transferred in a section 507(b)(2) transfer to the same extent and in the
same manner that they would have applied to the transferor foundation had the 507(b)(2)
transfer not been effected, mostly in the nature of transitional rules of limited scope for the Tax
Reform Act of 1969.

Section 1.507-3(a)(9)(i) of the regulations provides that if a private foundation transfers all of its
net assets to one or more private foundations which are effectively controlled (within the
meaning of Sec. 1.482-1(a)(3)), directly or indirectly, by the same person or persons which
effectively controlled the transferor private foundation, for purposes of chapter 42 (section 4940
et seq.) and part II of subchapter F of chapter 1 of the Code (sections 507 through 509) such a
transferee private foundation shall be treated as if it were the transferor.

Section 1.507-3(c)(1) of the regulations states that a transfer of assets is described in section
507(b)(2) if it is made by a private foundation to another private foundation pursuant to any
liquidation, merger, redemption, recapitalization, or other adjustment, organization, or
reorganization.

Section 1.507-3(c)(2) of the regulations defines the term “significant disposition of assets to one
or more private foundations” as any disposition or series of dispositions where the cumulative
total of dispositions is 25 percent or more of the fair market value of the net assets of the
foundation at the beginning of the taxable year.

Section 1.507-4(b) of the regulations states that private foundations which make transfers
described in section 507(b)(2) are not subject to the tax imposed under section 507(c) with
respect to such transfers unless the provisions of section 507(a) become applicable.

Section 53.4945-5(c)(2) of the Foundation Regulations (foundation regulations) provides that, with
regard to capital endowment grants made to private foundations, if a private foundation makes a
grant to another private foundation for endowment or for other capital purposes, the grantor
foundation must require reports from the grantee foundation on the uses of the principal and the
income (if any) from the grant funds. The grantee must make such reports annually for the tax
year in which the grant was made and for the immediately succeeding two tax years. Only if it is
reasonably apparent to the grantor, before the end of such grantee’s second succeeding tax year,
that neither the principal nor the income from the grant funds has been used for any purpose
which would result in liability for tax under section 4945(d) of the Code, may the grantor then allow
the grantee's reports to be discontinued.

Section 53.4946-1(a)(8) of the foundation regulations states that, for purposes of section 4941 of
the Code only, the term “disqualified person” shall not include any organization which is described
in section 501(c)(3) (other than an organization described in section 509(a)(4)).

Analysis:
Ruling 1:

Section 507(b)(2) of the Code describes a transfer from one private foundation to another
private foundation according to any liquidation, merger, redemption, recapitalization, or other
adjustment, organization, or reorganization. Section 1.507-3(c)(1) of the regulations describes
the terms “other adjustment, organization, or reorganization” as including any partial liquidation or
any other significant distribution of assets to one or more private foundations, other than transfers
for full and adequate consideration or distributions out of current income. The term “significant
disposition of assets to one or more private foundations” is defined by section 1.507-3(c)(2) as
any disposition or series of dispositions where the aggregate value transferred is 25 percent or
more of the fair market value of the net assets of the foundation at the beginning of the taxable
year. Since you are transferring more than 25 percent of the fair market value of your net assets
to M, a private foundation, for no consideration, your proposed transfer is a significant disposition of
assets that qualifies as a transfer under section 507(b)(2).

Rulings 2 and 3:

Pursuant to section 1.507-4(b) of the regulations, a private foundation that makes a transfer
described in section 507(b)(2) of the Code is not subject to the tax imposed under section
507(c) with respect to such transfer unless the provisions of section 507(a) become applicable.
As discussed in Ruling 1 above, your transfer will constitute a significant distribution of assets
described in section 507(b)(2). You have stated that you have not and will not notify the Secretary

of your intent to terminate your status as a private foundation and that you have not ever either
committed willful repeated acts (or failures to act) or committed a willful and flagrant act (or failure
to act) which gives rise to tax under chapter 42 of the Code. Therefore, your proposed transfer of
assets to M under section 507(b)(2) will not terminate your private foundation status under section
507(a) and does not result in a termination tax imposed by section 507(c).

Ruling 4:

When a private foundation makes a transfer described in section 507(b)(2) of the Code, the
transferee foundation is not treated as a newly created organization under section 1.507-3(a)(1) of
the regulations. Since your transfer is described in section 507(b)(2), as discussed in Ruling 1
above, M will not be treated as a newly created organization.

Ruling 5:

In the case of a significant disposition of assets to one or more private foundations within the
meaning of section 507(b)(2) of the Code, the transferee organization shall be treated as
possessing those attributes and characteristics of the transferor organization which are described
in subparagraphs (2), (3), and (4) of section 1.507-3(a) of the regulations. As discussed in Ruling 1
above, your transfer is described in section 507(b)(2). Accordingly, M will be treated as possessing
your attributes and characteristics as described in sections 1.507-3(a)(2), (3), and (4) of the
regulations.

Ruling 6:

Section 4940(c) of the Code imposes an excise tax on investment income received by private
foundations. Investment income includes capital gains from the sale or other disposition of
property. The transfer of assets by you to M, which lacks consideration, does not constitute a “sale
or other disposition of property” that would generate capital gains subject to excise tax under
section 4940. Therefore, the transfer will not be treated as a taxable sale or disposition of property
within the meaning of section 4940.

Ruling 7:

Section 4941(a) of the Code imposes an excise tax on each act of self-dealing between a
disqualified person and a private foundation. Sections 4941 and 1.507-3(a) of the regulations
determine whether the proposed transfer of part of your assets to M will constitute an act of self-
dealing between a private foundation and its disqualified persons, as defined in section 4946.
Under section 53.4946-1(a)(8) of the foundation regulations, a “disqualified person” does not
include organizations that are exempt under section 501(c)(3). Therefore, your transfer of assets
to M is not an act of self-dealing because M is recognized by the Service as an organization
exempt from tax under section 501(c)(3).

Ruling 8 and 11:
Under section 1.507-3(a)(9)(i) of the regulations, if a private foundation transfers all of its net

assets to another private foundation which is effectively controlled by the same person or
persons which effectively controlled the transferor private foundation, the transferee private

foundation is treated as if it were the transferor. Here, you are transferring less than all of your
net assets, so M is not treated as you for all private foundation purposes. Instead, M will be
treated as possessing your attributes and characteristics which are described in sections 1.507-
3(a)(2), (3), (4), and, to the extent applicable, (6) and (8)(ii), and none of your excess qualifying
distribution carryovers under section 4942 will transfer to M.

Under section 1.507-3(a)(5) of the regulations, except as provided in subparagraph (9) of section
1.507-3(a), a private foundation must meet the distribution requirements of section 4942 of the
Code for any taxable year in which it makes a section 507(b)(2) transfer of all or part of its net
assets to another private foundation. The transfer itself shall be counted toward satisfaction of
such requirements to the extent the amount transferred meets the requirements of section
4942(g)(3), which states that the term “qualifying distribution” includes a contribution to a section
501(c)(3) organization if the redistribution requirements are met. Therefore, your proposed transfer
shall be counted toward the satisfaction of your distribution requirements to the extent the amount
transferred meets the redistribution requirements of section 4942(g)(3).

Rulings 9 and 10:

Your section 507(b)(2) transfer of assets to M is a grant to M for capital endowment purposes.
Because M is not treated as you under section 1.507-3(a)(9), the transfer is a taxable
expenditure under section 4945(d)(4) of the Code unless you comply with the expenditure
responsibility requirements of section 4945(h). Your transfer to M will not be considered a
taxable expenditure as long as you exercise expenditure responsibility over the transfer in
accordance with sections 4945(h) and section 53.4945-5(c)(2) of the foundation regulations.
Section 53.4945-5(c)(2) requires the grantee to make annual reports for the year in which the grant
is made and the immediately succeeding two years.

Conclusion:
Based on the foregoing, we rule as follows:

1. Your transfer, without consideration, of cash and marketable securities equal to
approximately one-third of your total value to M will constitute a significant distribution of
assets to one or more private foundations within the meaning of section 1.507-3(c)(1) of the
regulations and, therefore, as a transfer described in section 507(b)(2) of the Code, will not
be subject to tax under section 507(c).

2. Your transfer to M will not result in termination of your private foundation status under
section 507(a) of the Code but, instead, will constitute a reorganization between those
private foundations under section 507(b)(2).

3. Your transfer to M will not constitute notification of your intent to terminate your private
foundation status under section 507(a)(1) of the Code, or any willful repeated acts (or
failures to act) or any willful and flagrant act (or failure to act) under section 507(a)(2) by
you. Thus, you will not be liable for any tax imposed by section 507(c).

4. Pursuant to section 507(b)(2) of the Code, M will not be treated as a newly-created
organization.

5. M will be treated as possessing your tax attributes and characteristics as described in
section 1.507-3(a)(2), (3), and (4) of the regulations.

6. Your transfer to M will not give rise to any net investment income or constitute any other
taxable sale or disposition under section 4940 of the Code.

7. Your transfer to M will not constitute any act of self-dealing under section 4941 of the Code
by you, M or any of their foundation managers as defined in section 4946.

8. Upon your transfer to M, M will not succeed to any of your excess qualifying distributions
under section 4942 of the Code.

9. Your transfer to M will not constitute a taxable expenditure as long as you follow the
expenditure responsibility requirements of section 4945(h) of the Code and section
53.4945-5 of the foundation regulations with respect to capital endowment grants.

10. You will be required to exercise expenditure responsibility with respect to the transferred
assets under section 4945(h) of the Code and section 53.4945-5 of the foundation
regulations with respect to capital endowment grants.

11. M will be treated as possessing your tax attributes prior to the transfer only to the extent
provided in section 1.507-3(a)(2), (3), (4), (6) and 8(ii) of the regulations.

This ruling will be made available for public inspection under section 6110 of the Code after
certain deletions of identifying information are made. For details, see enclosed Notice 437,
Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make
available for public inspection is attached to Notice 437. If you disagree with our proposed
deletions, you should follow the instructions in Notice 437.

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 by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will
be no material changes in these facts. This ruling does not address the applicability of any
section of the Code or regulations to the facts submitted other than with respect to the sections
described. Because it could help resolved questions concerning your federal income tax status,
this ruling should be kept in your permanent records.

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

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we
are sending a copy of this letter to your authorized representative.

Sincerely,

Ronald J. Shoemaker
Manager, Exempt Organizations
Technical Group 2

Enclosure
Notice 437

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