Recycling grant qualifies, but free transfers cause self-dealing

Plain-English summary

A private foundation proposed an unrestricted grant to a public charity controlled by the foundation founder's granddaughter. The charity planned to buy recycling containers, collect waste, and transfer the waste without payment to a business substantially owned by the granddaughter. The IRS ruled that buying the containers and collecting waste furthered environmental charitable purposes, and the grant could count as a qualifying distribution if the controlled charity met the section 4942 pass-through and reporting rules. However, transferring the waste to the related business would indirectly use foundation assets for a disqualified person's benefit and therefore constitute self-dealing under IRC § 4941. The economic benefit was not incidental or tenuous because the granddaughter controlled the intermediary and her business was the primary beneficiary.

Ruling snapshot

• Question: Is the recycling grant a qualifying distribution, and would the charity's free transfer of collected waste to a related business avoid self-dealing?
• Outcome: Mixed. The grant qualifies under section 4942, but the transfers to the related business are indirect self-dealing under section 4941.
• Key authorities: IRC §§ 4941(d)(1)(E), 4942(g), 4946; Treas. Reg. §§ 53.4941(d)-1, 53.4941(d)-2, 53.4942(a)-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201719004 Third Party Communication: None
Release Date: 5/12/2017 Date of Communication: Not Applicable
Index Number: 4941.04-00, 4942.03-05
Person To Contact:
------------------------------------------ ----------------------, ID No. -----------------
-------------------------------------------------- Telephone Number:
------------------------------------------------------ ---------------------
------------------------------------------- Refer Reply To:
--------------------------------------- CC:TEGE:EOEG:EO3
PLR-124355-16
Date:
February 1, 2017

              TY: --------------------------------------------------------------------

Legend:

Founder = -------------------------------
Intermediary = ---------------------------------------------------------------------------
LLC = ----------------------------------------------------------------
State = ------------
X = -----
Waste = --------

Dear ----------------:

This letter responds to the letter dated July 28, 2016, in which Foundation requested
rulings under sections 4941 and 4942 of the Internal Revenue Code.

Facts:

Foundation is a nonprofit corporation recognized as an organization described in
section 501(c)(3) that is a private foundation under section 509(a). Foundation’s
directors are Founder, his wife, and their attorney.

The granddaughter (“Disqualified Person”) of Founder and his wife formed Intermediary,
which has been recognized as an organization described in section 501(c)(3) that is not
a private foundation under section 509. Disqualified Person is represented to have the
vested power to cause Intermediary to make expenditures and prevent Intermediary
from making expenditures. Disqualified Person owns substantially all of the interests in
LLC, a limited liability company taxed as a partnership. Disqualified Person and LLC
are disqualified persons with respect to Foundation within the meaning of section 4946.
PLR-124355-16 2

Foundation proposes to make a grant to Intermediary. Foundation states that
Intermediary will use the proposed grant funds to purchase X Waste recycling collection
containers that Intermediary will place in various locations across State. Foundation
also states that Intermediary periodically will collect Waste from the recycling collection
containers and transfer it to LLC, after which LLC will recycle the Waste and seek to
profit from its sales of the recycled Waste in the ordinary course of LLC’s business. The
proposed grant is unrestricted, however, and does not require Intermediary to transfer
any Waste to LLC, and another, unrelated, entity could purchase the Waste and
process it, rather than LLC. During the teleconference conducted on December 14,
2016, we asked whether LLC will pay anything for any Waste that it receives from
Intermediary. Counsel for Foundation said that he did not know the answer and would
have to inquire. Counsel never supplied an answer. Accordingly, for purposes of the
request for rulings, we assume that LLC will pay nothing for any Waste that
Intermediary transfers to LLC. In addition, Foundation represented that Disqualified
Person will cause Intermediary to use the full amount of Foundation’s proposed grant no
later than the end of Intermediary’s taxable year after the taxable year of receipt to
purchase containers to collect Waste for recycling and provide to Foundation adequate
records or other sufficient evidence showing that such purchases were made and that
they would be treated under Treas. Reg. Sec. 53.4942(a)-3(d) as a distribution out of
corpus if Intermediary were a private foundation that is not an operating foundation in a
manner that is compliant with the reporting requirements of section 4942(g)(3).

Rulings Requested, Law, and Analysis:

1. Section 4942 Ruling Requested: Foundation’s proposed grant to Intermediary will
   constitute a qualifying distribution under sections 4942(g)(1) and (3).

Section 4942(g)(1)(A) and Treas. Reg. Sec. 53.4942(a)-3(a)(2)(i) provide, in part, that
the term “qualifying distribution” means any amount paid to accomplish one or more
purposes described in section 170(c)(1) or (2)(B), other than any contribution to an
organization controlled (directly or indirectly) by the foundation or disqualified persons
with respect to the foundation, except as provided in section 4942(g)(3). Section
170(c)(2)(B) lists the following purposes: “religious, charitable, scientific, literary, or
educational purposes, or to foster national or international amateur sports competition
(but only if no part of its activities involve the provision of athletic facilities or equipment),
or for the prevention of cruelty to children or animals.” These purposes are the same as
the purposes listed in section 501(c)(3). Thus, a grant by a private foundation to
another organization described in section 501(c)(3) ordinarily is an amount paid to
accomplish a purpose described in section 170(c)(2)(B) and may be considered to be a
qualifying distribution.

Section 4942(g)(3) provides, in part, that the term “qualifying distribution” includes a
contribution to another charitable organization controlled directly or indirectly by the
transferor foundation or one or more disqualified persons with respect to the transferor if
PLR-124355-16 3

two requirements are satisfied. The first such requirement is that the transferee
organization must satisfy certain “pass-through” requirements. See, section
4942(g)(3)(A). The second requirement is that the transferor must obtain adequate
records or other sufficient evidence from the transferee organization showing that the
required pass-through requirements were satisfied. See, section 4942(g)(3)(B).

Generally, preserving the environment can further a charitable purpose. See Rev. Rul.
76-204, 1976-1 C.B. 152, (preserving the natural environment furthers an exempt
purpose); Rev. Rul. 80-278, 1980-2 C.B. 175 (litigation to preserve the environment
furthers an exempt purpose); Rev. Rul. 80-279, 1980-2 C.B. 176 (legal research
concerning resolving international environmental disputes and participating in
environmental dispute resolution furthers an exempt purpose); but see, Rev. Rul. 78-
384, 1978-2 C.B. 174 (preservation of land without any distinctive ecological
significance does not further exempt purposes).

Recycling waste materials to prevent pollution also can further a section 170(c)(2)(B)
exempt purpose. In Rev. Rul. 72-560, 1972-2 C.B. 248, the IRS held that recycling
waste materials was an essential element in the organization's efforts to combat
environmental deterioration because it prevents the pollution of the environment caused
by the usual disposition of these materials. Likewise, purchasing and using containers
to collect waste for recycling can help prevent pollution by diverting the waste from
disposal in landfills and, thereby, further an exempt purpose. See also, Treas. Reg.
Sec. 53.4944–3(b) Example 12 (collecting recyclable solid waste materials and
delivering those materials to recycling centers that are inaccessible to a majority of the
population “significantly furthers the accomplishment of [the private foundation
investor’s] exempt activities”).

As stated above, Intermediary will use the proposed grant to purchase Waste collection
containers, place them around State in various locations, and periodically collect for
recycling the Waste that would otherwise be discarded in landfills. Accordingly,
Foundation’s grant will be used to further a section 170(c)(2)(B) exempt purpose under
section 4942(g)(1). However, also as stated above, section 4942(g)(1)(A) and Treas.
Reg. Sec. 53.4942(a)-3(a)(2)(i) provide that any contribution to an organization
controlled (directly or indirectly) by disqualified persons with respect to the transferor
foundation will not be considered to be a qualifying distribution unless the requirements
of section 4942(g)(3) are satisfied.

As explained in more detail above, section 4942(g)(3) provides, in part, that the term
“qualifying distribution” includes a contribution to another charitable organization
controlled directly or indirectly by one or more disqualified persons with respect to the
transferor only if the transferee organization satisfies certain “pass-through”
requirements and the transferor obtains in a timely manner adequate records or other
sufficient evidence from the transferee organization showing that the required pass-
through distributions were made.
PLR-124355-16 4

Treas. Reg. Sec. 53.4942(a)-3(a)(3) provides that an organization is a controlled
organization if one or more disqualified persons with respect to a granting private
foundation can require the grantee to make an expenditure, or prevent it from making
an expenditure, regardless of the method by which the control is exercised or
exercisable. Intermediary is a controlled organization because Disqualified Person can
cause or prevent its making expenditures. Foundation represented that Disqualified
Person will cause Intermediary to use the full amount of Foundation’s proposed grant no
later than the end of the taxable year after the taxable year of receipt to purchase
containers to collect Waste for recycling. Foundation also represented that Foundation
will obtain adequate records or other sufficient evidence from Intermediary showing that
such purchases were made and that they would be treated under Treas. Reg. Sec.
53.4942(a)-3(d) as a distribution out of corpus if Intermediary were a private foundation
that is not an operating foundation, thereby satisfying the section 4942(g)(3) pass-
through distribution and reporting requirements for a qualifying distribution to a
controlled organization. Accordingly, Foundation may count the proposed grant to
Intermediary as a qualifying distribution.

2. Section 4941 Ruling Requested: Intermediary’s use of the proposed grant proceeds
   will not result in any act of self-dealing under section 4941; particularly, that the
   proposed grant will not constitute an act of self-dealing because Disqualified Person
   and/or LLC, disqualified persons with respect to Foundation, may benefit from the
   availability of increased revenue opportunities arising out of the Intermediary
   recycling program.

Section 4941(a) imposes a tax on each act of self-dealing between a disqualified person
and a private foundation, whether direct or indirect. Section 4941(d)(1)(E) defines self-
dealing to include the direct or indirect transfer to, or use by or for the benefit of, a
disqualified person of the income or assets of a private foundation.

Neither the Internal Revenue Code nor the regulations contain a definition of “indirect
self-dealing.” Rather, the regulations define indirect self-dealing by means of express
exceptions or exclusions. For example, Treas. Reg. Sec. 53.4941(d)-1(b)(7) excludes
from indirect self-dealing certain transactions between one or more disqualified persons
to which a private foundation is not a party where the private foundation could itself
directly engage in the transaction without committing an act of self-dealing. Conversely,
if a private foundation cannot directly engage in a transaction without committing an act
of self-dealing, then it cannot indirectly engage in the transaction without committing an
act of self-dealing. If Foundation were to purchase the Waste collection containers and
collect and transfer the Waste to LLC, which is a disqualified person with respect to
Foundation, then the transfer of Waste by Foundation to LLC would be a direct act of
self-dealing under section 4941(d)(1)(E). Therefore, interposing a public charity
(Intermediary) between Foundation and LLC will not prevent the proposed transfer of
Waste to LLC from constituting an indirect act of self-dealing.
PLR-124355-16 5

Foundation’s representative has argued that the exception from direct or indirect self-
dealing under Treas. Reg. Sec. 53.4941(d)-2(f)(2) for benefits that are incidental or
tenuous should apply to the proposed transfer of Waste to LLC. Examples of incidental
or tenuous benefits include the public recognition a person may receive arising from the
charitable activities of a private foundation to which such person is a substantial
contributor, the benefit to a substantial contributor from a public charity’s performing
slum revitalization in the same area as the substantial contributor, or naming a public
recreation center or public charity after a substantial contributor. See Treas. Reg. Sec.
53.4941(d)-2(f)(9), Example 4, and Rev. Rul. 73-407, 1973-2 C.B. 383 (naming a public
charity after a substantial contributor as a condition of a grant is incidental or tenuous).
Non-economic benefits such as public recognition are distinguishable from the
economic benefits conferred upon LLC when Intermediary uses Foundation’s grant to
collect and transfer Waste to LLC.

The authorities holding that specified indirect economic benefits are incidental or
tenuous also are distinguishable from Foundation’s facts and circumstances. In Rev.
Rul. 80-310, 1980-2 C.B. 319, a private foundation made a grant to a section 501(c)(3)
public university to establish an engineering program. A substantial contributor
encouraged its employees to apply for the program and it recruited graduates of the
program. The substantial contributor’s employees did not receive any preferential
treatment in admissions nor did the substantial contributor receive any preferential
treatment in recruiting. Competitors likewise benefitted from the program. The IRS
found that the substantial contributor would “receive only an incidental or tenuous
benefit from the grant.”

In Rev. Rul. 85-162, 1985-2 C.B. 275, the IRS held that an indirect economic benefit to
a disqualified person was incidental and tenuous where the private foundation made
loans to various independent public charities for their construction projects in
disadvantaged areas. The disqualified person was a bank. The public charities used
the loans to purchase certificates of deposit to secure construction financing. They
were prohibited from purchasing the CDs from the disqualified person bank and were
prohibited from obtaining the construction or permanent financing from the disqualified
person bank. The terms of the private foundation’s loans barred it or any disqualified
person from participating in the selection of vendors and suppliers. However, some of
the selected vendors had ordinary banking or business relationships with the
disqualified person bank or its affiliates but did not receive any preferential treatment.
The IRS concluded that if any benefit to the disqualified person bank or some other
disqualified person would result from an ordinary banking and business relation with a
contractor, subcontractor, supplier, or an employee of those parties in the described
construction projects, such benefit would be incidental or tenuous within the
contemplation of section 53.4941(d)-2(f)(2).
PLR-124355-16 6

These authorities do not imply that interposing a public charity controlled by a
disqualified person between a private foundation and the disqualified person beneficiary
will cause an indirect act of self-dealing to be incidental or tenuous. In every case in
which a possible indirect act of self-dealing has been found not to constitute self-dealing
because the benefit to the disqualified person was incidental and tenuous, the
interposed public charity was fully independent of the foundation and its disqualified
persons.

While Treas. Reg. Sec. 53.4941(d)-2(f)(2) does state that a proposed grant to a public
charity will not be an act of self-dealing ‘merely’ because one director of the public
charity also is a disqualified person with respect to the grantor private foundation, here
Disqualified Person is more than merely a director of Intermediary. In this case,
Disqualified Person has the power to cause Intermediary to make expenditures and
prevent Intermediary from making expenditures. Accordingly, this regulation does not
require Intermediary’s proposed transfer of Waste to LLC to be considered incidental or
tenuous.

In both of the revenue rulings discussed above, the independent intermediary selected
the students, vendors, and suppliers free of influence by the private foundation or
disqualified persons, and the students, vendors, and suppliers received the primary
benefits of the grants. In this case, a disqualified person with respect to Foundation will
cause Intermediary to transfer to LLC the Waste that will be collected by Intermediary,
which will be made possible by the proposed grant from Foundation. In both of the
referenced revenue rulings, the primary beneficiaries were independent of the
disqualified persons. In Rev. Rul. 80-130, the primary economic beneficiaries were
students who learned engineering but were not disqualified persons. In Rev. Rul. 85-
162, the primary economic beneficiaries were independent vendors and suppliers that
were not disqualified persons. In this case, LLC will be the primary beneficiary and a
disqualified person.

Intermediary’s use of Foundation’s proposed grant to acquire the Waste recycling
collection containers that will be used to collect Waste to be transferred to LLC, would
provide benefits described in section 4941(d)(1)(E) indirectly to LLC that would not be
incidental or tenuous.

Rulings:

Section 4942: Foundation’s proposed grant to Intermediary will constitute a qualifying
distribution under sections 4942(g)(1) and (3).

Section 4941: Intermediary’s proposed transfers of Waste to LLC to be made possible
by Intermediary’s use of the proposed grant proceeds will result in indirect acts of self-
dealing under section 4941.
PLR-124355-16 7

The rulings contained in this letter are based upon information and representations
submitted on behalf of Foundation and accompanied by a penalty of perjury statement
executed by you as President of Foundation. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Without limiting the generality of the foregoing, we express no opinion as to
whether Intermediary’s proposed transfer of Waste to LLC constitutes inurement,
private benefit, or an excess benefit transaction described in section 4958.

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

In accordance with the Power of Attorney on file with this office, we are sending a copy
of this letter to Foundation’s authorized representative.

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

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.

A copy of this letter must be attached to any information, income tax, or other return to
which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy
this requirement by attaching a statement to their returns that provides the date and
control number of the letter ruling.

                                    Sincerely,



                                    David M. Repass
                                    Senior Technician Reviewer, Branch 3
                                    (Tax Exempt & Government Entities)

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