Determination 1021029: IRS revoked a private foundation's exemption after it engaged only in stock trading

Plain-English summary

The IRS revoked a private foundation's exemption under IRC § 501(c)(3), effective July 1, 20XX. The foundation did not make charitable grants or conduct other charitable activities, and the records it provided showed that its only activity was stock trading. The IRS concluded that the foundation failed the operational test because it was not operated exclusively for exempt purposes. The release also discusses proposed excise taxes on undistributed income and income tax consequences after the foundation became nonexempt.

Ruling snapshot

• Question: Did the foundation qualify for exemption under IRC § 501(c)(3), and what tax consequences followed from its failure to make charitable distributions?
• Outcome: Revocation
• Key authorities: IRC §§ 61, 170, 501(c)(3), 4940, 4942, 4944(c), 507(a)(2), 511, 514(c)(1), 6104(c), and 7428(b)(2); Treas. Reg. §§ 1.501(c)(3)-1, 53.4940-1, 53.4942(a)-1, 53.4942(a)-2, and 53.4942(a)-3

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

Internal Revenue Service
TE/GE EO Examinations

1100 Commerce Street

Dallas, TX 75424 501-03-00
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Release Number: 201021029
Release Date: 5/28/10 February 24, 2010
LEGEND
ORG = Organization name Identification Number:
Address = address XX = Date Contact Telephone Number:
ORG In Reply Refer to: TE/GE Review Staff
ADDRESS EIN:

LAST DATE FOR FILING A PETITION
WITH THE TAX COURT: May 25, 20XX

Dear

This is a Final Adverse Determination Letter as to your exempt status under section
501(c)(3) of the Internal Revenue Code. Your exemption from Federal income tax under
section 501(c)(3) of the code is hereby revoked effective July 1, 20XX. You have agreed to
this adverse determination, per signed Form 6018, on November 5, 20XX.

Our adverse determination was made for the following reasons:

1. The ORG is not operated for an exclusive exempt purpose, as is required by IRC
   section 501(c)(3) and Treas. Reg. section 1.501(c)(3)-1(d).

2. A substantial part of the activities of ORG furthers non-charitable activities rather
   than public interests, which is prohibited by Treas. Reg. section 1.501(c)(3)-
   1(d)(1)(ii). The foundation failed to make financial distributions or provide any
   activity as a supporting organization to a specified organization.

3. The organization did not operate exclusively for exempt purposes because it was
   organized and operated for the purpose of stock trading and investment activities,
   which are not charitable activities and is prohibited by IRC section 501(c)(3).

Contributions to your organization are no longer deductible under section 170 of the
Internal Revenue Code. You are required to file Federal income tax returns on Form 1041
and 990-PF. These returns should be filed with the appropriate Service Center for the year
ending June 30, 20XX, and for all years thereafter.

Processing of income tax returns and assessment of any taxes due will not be delayed should
a petition for declaratory judgment be filed under section 7428 of the Internal Revenue
Code.

If you decide to contest this determination in court, you must initiate a suit for declaratory
judgment in the United States Tax Court, the United States Claims Court or the District
Court of the United States for the District of Columbia before the 91st day after the date this
determination was mailed to you. Contact the clerk of the appropriate court for the rules for
initiating suits for declaratory judgment.

You also have the right to contact the office of the Taxpayer Advocate. However, you
should first contact the person whose name and telephone number are shown above since
this person can access your tax information and can help you get answers. You can call and
ask for Taxpayer Advocate assistance. Or you can contact the Taxpayer Advocate from the
site where the tax deficiency was determined by calling: or writing to: Internal Revenue
Service

Taxpayer Advocate assistance cannot be used as a substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or
technically correct tax determinations, nor extend the time fixed by law that you have to file
a petition in the United States Tax Court. The Taxpayer Advocate can, however, see that a
tax matter that may not have been resolved through normal channels gets prompt and
proper handling.

We will notify the appropriate State Officials of this action, as required by section 6104(c) of
the Internal Revenue Code.

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

Sincerely yours,

Nanette M. Downing
Acting Director, EO Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street
SOVERNITE SHC CTiTIES Dallas, TX 75242
DIVISION

February 24, 2010

Taxpayer Identification Number:

ORG
ADDRESS Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:
Dear

We are sending the enclosed material under the provisions of your power of attorney or
other authorization on file with us. For your convenience, we have listed the name of
the taxpayer to whom this material relates.

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number and
the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Acting Director, EO Examinations

Enclosures:
Letter - Final

Taxpayer name: ORG

Letter 3597 (04-2002)
Catalog Number: 34786R

If we do not hear from you within 30 days from the date of this letter, we will process your case based on the
recommendations shown in the report of examination. If you do not protest this proposed determination within
30 days from the date of this letter, the IRS will consider it to be a failure to exhaust your available
administrative remedies. Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree
under this section shall not be issued in any proceeding unless the Tax Court, the Claims Court, or the District
Court of the United States for the District of Columbia determines that the organization involved has exhausted
its administrative remedies within the Internal Revenue Service." We will then issue a final revocation letter.
We will also notify the appropriate state officials of the revocation in accordance with section 6104(c) of the
Code.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer Advocate cannot
reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a
United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been
resolved through normal channels gets prompt and proper handling. You may call toll-free 1-877-777-4778 and
ask for Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

Taxpayer Advocate
1301 Clay Street #1540S
Oakland, CA 94612-2715
Tel: (510)637-2703
Fax: (510)637-2715

If you have any questions, please call the contact person at the telephone number shown in the heading of this
letter. If you write, please provide a telephone number and the most convenient time to call if we need to
contact you.

Thank you for your cooperation.

Sincerely,

Marsha A. Ramirez
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498

Report of Examination

Letter 3618 (Rev. 11-2003)
Catalog Number: 34809F

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG EIN: 20XX06 & 20XX06

LEGEND
ORG = Organization name XX = Date State = State President =
President Treasurer = treasurer DIR-1 = 1st Director
ISSUE:

1. Whether ORG. Qualifies for exemption under Internal Revenue Code (IRC) Section
   501(c)(3)?

2. Whether ORG is liable for Chapter 42 taxes on undistributed income under section 4942
   of the Internal Revenue Code?

3. Whether ORG is liable for Income tax once it becomes non exempt private foundation
   and at what amount?

FACTS

ORG (the “Foundation”) was incorporated in State on July 18, 20XX and received
exemption as a private foundation exempt under Section 501(c)(3) on April 15, 20XX.

The Form 1023 “Application for Recognition of Exemption Under Section 501(c)(3) of
the Internal Revenue Code” was mailed to IRS on Dec. 19, 20XX but it was not signed. In an
attachment to Form 1023 the President explained that he and his wife decided to start a
foundation and that the primary strategy for the foundation was to sell calls against stocks it
owns. President stated that he used this strategy before and he expected to earn around 15%
without ever having to sell the Foundation’s primary holdings. President explained that using this
strategy in 20XX and 20XX caused the Foundation’s initial contribution of $ to drop to about $
at the time the Form 1023 was filed.

Other Information on Form 1023 included the following:
Activities: “The organization’s primary activity will be making charitable contributions to
selected individuals and organizations involved in community development... the activity will be
initiated in 20XX, with the first donations being made at the end of the first quarter of 20XX.
The activity will be conducted exclusively by the board. “

Sources of financial support: “Initial contributions by President & Treasurer, investment
income... and ongoing contributions from President & Treasurer.” The Applicant stated that no
fund raising will be conducted by the Foundation.

Foundation’s governing body: the officers and directors will be President,
President/Secretary and Treasurer, Treasurer.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 1-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

Although on Form 1023 the applicant requested private foundation status, attached was
also a Schedule D “Section 509(a)(3) Supporting Organizations”. IRS requested clarifications
regarding the foundation’s status on IRS Letter 1312. The applicant replied to those questions on
March 28, 20XX and provided a properly signed Page 1 of Form 1023 — signed by President
President. The applicant also stated that the Foundation is not a not a 509(a)(3) supporting
organization but is a private foundation. IRS’ Exemption Letter 1076 advised the Foundation
that it is required to file annual information returns Form 990-PF by the 15 days of the fifth
month after the end of the annual accounting period and that there is a $ daily delinquency
penalty for failure to do so.

During the organization’s existence the Foundation made no charitable grants;
accordingly, the Foundation’s forms 990-PF reported no distributions for charitable purposes.
Further, Foundation’s Form 990-PF as was filed for the period ending June 30, 20XX reported
that $ of excise tax under Section 4940(a) was due and payable but Foundation failed to pay the
tax due.

The Foundation filed the annual information returns Forms 990-PF for Foundation’s
fiscal years ending June 30, 20XX, June 30, 20XX and June 30, 20XX late (the first two returns
were filed on May 19, 20XX and the return for year ending June 30, 20XX was filed on May 23,
20XX. Since those returns were filed late IRS assessed late filing penalties on the Foundation in
the respective amounts of $, $ and $. The Foundation has not paid those penalties.

IRS specialist contacted the Foundation on 1/12/20XX and asked for clarifications what
action the Foundation has taken to restore its corporate status that was suspended by the State
Secretary of State after the Foundation failed to pay the State Franchise Tax Board (the “FTB”)
the balance due of $ and has failed to take any action in the matter.

Additionally, the Foundation failed to respond to State Attorney General’s Second Notice dated
October 19, 20XX requesting that the Foundation pay a $ fee and provide specific documentation
including Foundation’s Articles of Incorporation, current Bylaws, and IRS Exemption letter.

The Foundation failed to provide records that IRS specialist requested such as:
Foundation’s minutes, contracts, statement of officers as were filed with the Secretary of State,
and any records of its disbursements. The records that the Foundation provided were TD
Waterhouse investments statements for the period starting March 1, 20XX through June 30,
20XX. Those records show that during the Foundation’s existence the only activity was that of
stock trading.

The Foundation reported the following income (reported in US Dollars) on Forms 990-PF for
years 20XX06 (fiscal year ending June 30 20XX) through 20XX06:

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 2-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06
YEAR 20XX06 20XX06 20XX06 20XX06 20XX06
Not filed yet
Investment Income
Interest 0 7 4 17
Dividends 0
Capital Gain(loss) 0
Total Investment Income 0
YEAR 20XX06 20XX06 20XX06 20XX06 20XX06
Balance Sheet Not filed yet

Cash
Investments-stmt 1 FMV

Total Assets

Stmt 1-FYE 20XX06:
Shares’ cost: $

Assets per Audit:

IRS agent prepared a schedule of the Foundation’s assets and average monthly balances of these
assets using the records that were available that included the investment statements and the
information on Form 990-PF (if no investments statements were available).

These are summarized below:

LAW

Issue 1: Whether Foundation qualifies for exemption under Internal Revenue Code
(IRC) Section 501(c)(3)?
Requirements for Exemption under IRC 501(c)(3):

FINAL-REG, TAX-REGS. §1.501(c)(3)-1(a)(1). Organizational and operational tests. (1) In
order to be exempt as an organization described in section 501(c)(3), an organization must be
both organized and operated exclusively for one or more of the purposes specified in such
section. If an organization fails to meet either the organizational test or the operational test, it is
not exempt.

(2) The term “exempt purpose or purposes”, as used in this section, means any purpose or
purposes specified in section 501(c)(3), as defined and elaborated in paragraph (d) of this section.

(d) Exempt purposes--(1) In general. (1) An organization may be exempt as an

Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 3-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

organization described in section 501(c)(3) if it is organized and operated exclusively for one
or more of the following purposes:

(a) Religious,

(b ) Charitable,

(c) Scientific,

(d) Testing for public safety,

(e) Literary,

(f.) Educational, or

(g) Prevention of cruelty to children or animals.

FINAL-REG, TAX-REGS , §1.501(c)(3)-1(c)(1) Operational test --(1) Primary activities. An
organization will be regarded as “operated exclusively” for one or more exempt purposes only if
it engages primarily in activities which accomplish one or more of such exempt purposes
specified in section 501(c)(3).

COMPUTATION: AVERAGE MONTHLY BALANCES

20XX06 20XX06 20XX06 20XX06 20XX06
beginning FMV
Ending FMV
Comments no stmts provided
data used from F. 990-PF 990-PF/stmts statements statements statements

Average Mo. Balance

TAXPAYER'S POSITION:

An Explanation of Issue was sent to Foundation and its Representative DIR-1, on July... 20XX.
Taxpayer’s rebuttal is yet to be received.

GOVERNMENT'S POSITION:

The government contends that ORG failed to meet the “operational test” under Regulations
Section 1.501(c)(3)-1(a)(1) and 1.501(c)(3)-1(c)(1) because it had not operated for
501(c)(3) charitable purposes and it was not engaged primarily in activities that
accomplish one or more of such exempt purposes specified in Section 501(c)(3).

The audit of the activities conducted during the year ending June 30, 20XX determined
that the Foundation does not meet the “operational test” under IRC 501(c)(3) because it
conducts no charitable activities. The Foundation’s primary activities were stock trading
and investment activities which are not charitable activity per se. Therefore, revocation of
ORG exempt status is proposed effective July 1st, 20XX.

LAW:

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 4-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06
Issue 2: Whether Foundation is liable for Chapter 42 taxes on undistributed income

under section 4942 of the Internal Revenue Code?

Internal Revenue Code 4942 imposes a two tier set of excise taxes, an "initial" tax and an
"additional" tax, on the undistributed income of a private foundation.

Section 4942(a) of the Code imposes an initial tax on the undistributed income of a private
foundation - tax equal to 15 percent of the amount of such income remaining undistributed at the
beginning of such second (or succeeding) taxable year.

Second, 4942(b) provides for an "additional’ tax equal to 100 percent of any portion of the
undistributed income remaining undistributed at the close of the correction period as defined in

Code section 4942(j)(2).

Section 4942(c) of the Code provides that the term “undistributed income” means, with respect
to any private foundation for any taxable year as of any time, the amount by which the distributable
amount for such taxable year exceeds the qualifying distributions made before such time out of such
distributable amount.

Section 4942(d) defines “distributable amount” as the amount equal to the sum of the minimum
investment return, plus certain other amounts, reduced by the sum of the taxes imposed on such
private foundation for the taxable year under subtitle A and section 4940.

Section 4942(j)(2) of the Code states “allowable distribution period” means, with respect to any
private foundation, the period beginning with the first day of the first taxable year following the
taxable year in which the incorrect valuation (described in subsection (a)(2)) occurred and ending 90
days after the date of mailing of a notice of deficiency (with respect to the tax imposed by
subsection (a).

Section 53.4942(a)-3(a)(2)(i) (a) of the Foundation and Similar Excise Taxes Regulations
(regulations) provides, in pertinent part, that the term “qualifying distribution” means any amount
(including program-related investments, as defined in section 4944(c), and reasonable and necessary
administrative expenses) paid to accomplish one or more purposes described in section 170(c)(1) or
(2)(B), other than any contribution to a private foundation which is not an operating foundation (as
defined in section 4942(j)(3) ).

Computation of Minimum Investment Return

The minimum investment return of a private foundation for any taxable year is the amount
determined by multiplying the excess of the aggregate fair market value of all assets of the
foundation over the amount of the acquisition indebtedness with respect to such assets (determined
under IRC 514(c)(1), but without regard to the taxable year in which the indebtedness was incurred),
by the applicable percentage for such year. For years beginning after December 31, 1975, the
applicable percentage is five percent. Reg. 53.4942(a)-2(c)(5).

Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 5-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

The aggregate fair market value of all assets of the foundation includes--
The fair market value of all other assets except assets used (or held for use) directly in carrying out
the foundation’s exempt purpose. Reg. 53.4942(a)-2(c)(2):

Applicable Percentage
For purposes of determining the minimum investment return the applicable percentage is five
percent; See Reg. 53.4942(a)-2(c)(5)(c).

In the case of a taxable year shorter than 12 months, the applicable percentage for the taxable
year is computed by multiplying the applicable percentage for the calendar year on which the short
taxable year began by a fraction the numerator of which is the number of days in the short taxable
year and the denominator of which is 365. Reg. 53.4942(a)-2(c)(5)(iii).

Accounting Principles Applicable to Qualifying Distributions
An organization’s qualifying distributions will be determined solely on the cash receipts and
disbursements method of accounting. Reg. 53.4942(a)-3(a)(1).

Minimum Distribution Required During Start-Up Period

1. For private foundations created after December 31, 1971 (or for organizations that first
   become foundations after that date), the “start-up period” is the four taxable years following the
   taxable year in which the foundation was created or became a foundation. For these purposes, a
   foundation will be considered created in the taxable year in which its distributable amount (IRC
   4942(d)) first exceeds $500.

2. Start-up period minimum amount. This is the amount that a foundation must distribute in its
   start-up period and cannot be less than the sum of:
   a. 20% of its distributable amount for the first taxable year of the start-up period,
   b. 40% of its distributable amount for the second taxable year of the start-up period,
   c. 60% of its distributable amount for the third taxable year of the start-up period, and
   d. 80% of its distributable amount for the fourth taxable year of the start-up period.

3. The above requirement means that the total amount must be distributed before the end of the
   start-up period, and is not a requirement that any portion of this amount be distributed in any
   particular year of the start-up period.

4. Examples. Reg. 53.4942(a)-3(b)(4) (iv) provides the following examples to illustrate this

principle:

a. Example (1). F, a private foundation created on January 1, 1975, uses the calendar year as its
taxable year. The start-up period for F is January 1, 1976, through December 31, 1979. F has
distributable amounts under section 4942(d) for taxable years 1976 through 1979 in the following
amounts: 1976, $100,000; 1977, $120,000; 1978, $150,000; 1979, $200,000. F’s start-up period
minimum amount is the sum of the following amounts: 20% of $100,000 ($20,000); 40% of
$120,000 ($48,000); 60% of $150,000 ($90,000); and 80% of $200,000 ($160,000); which equals

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: 6-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

$318,000. Thus, F is required to actually distribute at least $318,000 in cash or its equivalent during
the start-up period.

FINAL-REG, TAX-REGS, §53.4942(a)-1. Taxes for failure to distribute income

(3) Payment of tax. —Payment of the excise taxes imposed by section 4942(a) or (b) is in addition
to, and not in lieu of, making the distribution of such undistributed income as required by section
4942. See section 507(a)(2) and the regulations thereunder.

TAXPAYER'S POSITION

An Explanation of Issue was sent to Foundation and its Representative DIR-1. Taxpayer’s
rebuttal is yet to be received.

GOVERNMENT'S POSITION:

The Government contends that Section 4942 requires private foundations to distribute the
distributable amount of each taxable year by the end of the succeeding taxable year. To the extent
that a private foundation holds undistributed income of a taxable year at the beginning of the
second succeeding taxable year, it is subject to an initial excise tax equal to 15 percent of the amount
of that undistributed income. A second tier tax of 100% is assessed for any portion of the
undistributed income remaining undistributed at the close of the correction period defined as ending
90 days after the date of mailing of a notice of deficiency.

Thus, as explained, ORG is required to distribute the distributable amount for each taxable year by
the end of the succeeding taxable year. Therefore, the excise tax on its failure to distribute income is
being proposed for tax years ended June 30, 20XX, and June 30, 20XX as ORG’s distributable
income remained undistributed by the end of the succeeding taxable years: the respective years

ending June 30, 20XX and June 30, 20XX.

The calculation for the second tier tax is being provided as it would be imposed if Foundation failed
to correct during the correction period. The excise taxes being proposed, under Section 4942 are

computed and are listed on the enclosed “ATTACHMENT A”.

Issue 3: Whether ORG is liable for Income tax once it becomes non exempt private foundation
and at what amount?

LAW
Applicable Tax and Rates

Section 61 of the Internal Revenue Code provides that, except as otherwise provided in
subtitle A (relating to income taxes), gross income means all income from whatever source
derived.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 7-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

Section 4940(a) currently imposes a tax equal to two percent of the net investment income,
for the taxable year, of private foundations which are exempt from taxation under section 501 (a)
for the taxable year with respect to the carrying on of their activities.

Section 4940(b) imposes a tax on private foundations which are not exempt from taxation
under section 501(a). This tax is equal to the amount (if any) by which the sum of (A) the tax
imposed by section 4940(a), computed as if 4940(a) had applied to this taxable foundation, and
(B) the amount of tax which would have been imposed under section 511 (tax on unrelated
business income of tax-exempt organizations) if this private foundation had been exempt from
taxation under section 501(a), exceeds the federal income tax imposed on such foundation for
that taxable year under subtitle A of the Code.

Section 4940(c) defined "net investment income” to include interest and states that, with
specified exceptions, net investment income shall be determined under the principles of subtitle
A of the Code, which relates to income taxes.

Section 4940(c)(1) of the Internal Revenue Code defines “net investment income” as the
amount by which (A) the sum of the gross investment income and the capital gain net income
exceeds (B) the deductions allowed by paragraph (3).

Section 4940(c)(2) of the Code defines “gross investment income” as the gross amount of
income from interest, dividends, rents, payments with respect to securities loans, and royalties,
but not including any such income to the extent it is included in computing the tax imposed by
section 511.

Regulations section 53. 4940-1(b) states, “the excise tax imposed under section 4940 on
private foundations which are not exempt from taxation under section 501(a) is equal to:
(i) The amount (if any) by which the sum of:
(A) The tax on net investment income imposed under section 4940(a), computed
as if such private foundation were exempt from taxation under section 501 (a)
and described in section 501(c)(3) for the taxable year, plus
(B) The amount of the tax which would have been imposed under section 511 for
such taxable year if such private foundation had been exempt from taxation
under section 501(a), exceeds
(11) The tax imposed under subtitle A of such private foundation for the
taxable year.

Regulation Section 53.4940-1(b) excise tax on net investment income provides the following
guidance:
“Example (2). Assume the facts stated in Example (1), except that the tax liability under subtitle
A is $15,000 rather than $10,000. Because the sum of the taxes which would have been imposed
under sections 4940(a) and 511 ($11,000) does not exceed the tax that was imposed under

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 8-9

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN: 20XX06 & 20XX06

subtitle A ($15,000), there is no tax imposed under section 4940(b) with respect to such
foundation.”

TAXPAYER'S POSITION

An Explanation of Issue was sent to Foundation and its Representative DIR-1. Taxpayer’s
rebuttal is yet to be received.

GOVERNMENT’S POSITION

The government contends that the Foundation is a non exempt private foundation effective July 1*,
20XX and therefore it is subject to income tax for that year and subsequent years. Further, as
explained in Section 4940(b) if the income tax computed under Subtitle A exceeds the tax that is
computed under Section 4940(a) and 511 then no excise tax under Section 4940(b) is due. In this
case the tax computed under Subtitle A for the year ending June 30, 20XX is $ and it exceeds the tax
computed under Section 4940(a) of $. The income tax under Subtitle A is computed based on
corporation’s tax rate which is 15% for corporate taxable income that is less than $ (corporations are
taxed on their net capital gain at the regular tax rates). The income tax for the year is $. The income
tax for the year ending June 30, 20XX is $. The interest is not included in this computation.

The Foundation’s income tax is therefore:

Income Source 20XX06 20XX06

Interest
Capital Gains

Total taxable income

Tax Rate: 15% (Corp. Rates)

Total Tax due:

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 9-9