A foundation may indemnify trustees for accelerated trust distributions

Plain-English summary

A private foundation was the sole remaining beneficiary of an irrevocable trust and wanted the trustees to distribute trust assets before all potential liabilities were resolved. The foundation proposed an agreement requiring it to return distributions if needed for trust liabilities and to indemnify the trustees for administration-related costs. The IRS treated any required repayment as the return of assets the foundation was not entitled to keep, rather than a payment for a noncharitable purpose. It ruled that repayments under the agreement would not be taxable expenditures under section 4945. It also ruled that entering into and performing the agreement would not be self-dealing under section 4941 because neither trustee was a disqualified person with respect to the foundation.

Ruling snapshot

• Question: Would the indemnity and repayment agreement create taxable expenditures or self-dealing?
• Outcome: Approved: neither consequence would arise on the stated facts.
• Key authorities: IRC §§ 4941, 4945, 4946; Underwood v. United States

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201745001                                             Third Party Communication: None
Release Date: 11/9/2017                                       Date of Communication: Not Applicable
Index Number: 4941.04-00, 4945.04-00
                                                              Person To Contact:
------------------------------                                ---------------------, ID No. ------------------
------------------------------------                          Telephone Number:
------------------------------                                ----------------------
                                                              Refer Reply To:
                                                              CC:TEGE:EOEG:EO2
                                                              PLR-103051-17
                                                              Date:
                                                              July 24, 2017


Legend:

Foundation       =    ------------------------------
Trustee 1        =    ------------------------
Trustee 2        =    ------------------------
State            =    --------------
Year 1           =    -------
Trust            =    -------------------------------------
Grantor          =    ---------------
Agreement        =    --------------------------------------------------


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

This letter responds to a letter from your authorized representative dated January 23,
2017, and subsequent correspondence submitted on behalf of Foundation, requesting
rulings concerning whether the entering into and making or receiving payments under
the Agreement with Trustee 1 and Trustee 2 will result in an act of self-dealing under
Internal Revenue Code (“IRC”) § 4941 and whether any refunds or payments pursuant
to the Agreement will constitute taxable expenditures under § 4945.

Foundation is a nonprofit public benefit corporation incorporated under the laws of
State. Grantor established and was principal donor to Foundation. In Year 1,
Foundation received a determination from the Internal Revenue Service (IRS) that it
was exempt from Federal income tax under IRC § 501(a) and described as a private
foundation under § 509(a).

Trust was created by Grantor and is a trust subject to the laws of State. Pursuant to the
terms of the Trust, Foundation is the sole remaining beneficiary of Trust, which became
irrevocable upon the death of Grantor. Trustee 1 and Trustee 2 are the successor co-
trustees of the Trust.
PLR-103051-17                                  2


You represent that Trust and Foundation are seeking to fulfill Grantor’s intent that the
Trust distribute the maximum value of Trust to the Foundation at the earliest
opportunity. You further represent that the administration of Trust has not been
completed and is ongoing. Pursuant to the provisions of Trust instrument, assets
remaining to be distributed to the Foundation may be or become subject to expenses,
losses or liabilities sustained in the administration of Trust. You state that under State
law, Trustee 1 and Trustee 2 may be personally liable for expenses, losses and
liabilities sustained in the administration of the Trust. Given the potential exposure to
future claims and liabilities against Trust, Trustee 1 and Trustee 2 believe it would be
prudent to retain until the completion of trust administration a sufficient reserve to satisfy
any such claims. You represent that there is a risk that liabilities will likely extend well
beyond the termination of Trust.

The transfer of the remaining assets of Trust to the Foundation is within the powers of
Trustee 1 and Trustee2. Foundation has requested that Trustee 1 and Trustee 2
accelerate distributions of the assets of the Trust to Foundation before Trustee 1 and
Trustee 2 know the full extent of potential claims and liabilities. In order to induce
Trustee 1 and Trustee 2 to make substantial distributions to Foundation sooner than
they otherwise would make them, Foundation has proposed to execute and deliver to
Trustee 1 and Trustee 2 the Agreement.

Under the Agreement, Foundation acknowledges that Trustee 1 and Trustee 2 would
normally defer a substantial portion of the distributions to Foundation until a final
resolution of all liabilities and claims. Trustee 1 and Trustee 2 would only make a final
distribution of the remaining assets of the Trust when they are satisfied that all liabilities
of the Trust have been determined and discharged. Trustee 1 and Trustee 2 are willing
to consider accelerating the distribution of assets to the Foundation, provided that the
Foundation obligates itself to indemnify Trustee 1 and Trustee 2. Further, under the
Agreement, Foundation agrees to return any distribution required to be refunded under
the Agreement to either Trustee 1 or Trustee 2 should claims and liabilities arise. Under
the Agreement, the distribution of assets to the Foundation will include cash or in kind
assets whether investment securities, real property or other assets. Pursuant to the
Agreement, Trustee 1 and Trustee 2 can be assured that the Foundation will pay such
amounts or return such portion of distributions that Trustee 1 and Trustee 2 determine
in their sole and absolute discretion are needed or desirable to pay all such liabilities.

In addition, under the Agreement, Foundation agrees to indemnify and hold harmless
Trustee 1 and Trustee 2 from any and all liabilities and expenses sustained in the
administration of the Trust. Further, nothing in the Agreement requires Trustee 1 or
Trustee 2 to make any distributions to Foundation at any particular time and Trustee 1
and Trustee 2 shall determine the amounts of and whether to make distributions in their
sole and absolute discretion.
PLR-103051-17                                   3



RULINGS REQUESTED

1. Payments made under the Agreement to either Trustee 1 or Trustee 2 will not be a
taxable expenditure under IRC § 4945.

2. That no act of self-dealing under IRC § 4941 will arise solely on account of
Foundation’s entering into the Agreement, making or receiving payments pursuant to
the Agreement, or any other return by the Foundation of property distributed by the
Trust under the Agreement.

LAW

IRC § 4941(a)(1) imposes a tax on each act of self-dealing between a disqualified
person and a private foundation.

IRC § 4941(d)(1) provides, in part, that the term self-dealing means any direct or
indirect -- (A) sale or exchange, or leasing, of property between a private foundation and
a disqualified person; (B) lending of money or any other extension of credit between a
private foundation and a disqualified person; (C) furnishing of goods, services, or
facilities between a private foundation and a disqualified person; (D) payment of
compensation (or payment or reimbursement of expenses) by a private foundation to a
disqualified person; and (E) transfer to, or use by or for the benefit of, a disqualified
person of the income or assets of a private foundation.

IRC § 4945(a)(1) imposes on each taxable expenditure (as defined in subsection (d)) a
tax equal to 20 percent of the amount thereof. The tax imposed by this paragraph shall
be paid by the private foundation.

IRC § 4945(d) provides that the term taxable expenditure means any amount paid or
incurred by a private foundation -- (1) to carry on propaganda, or otherwise to attempt,
to influence legislation, within the meaning of subsection (e); (2) except as provided in
subsection (f), to influence the outcome of any specific public election, or to carry on,
directly or indirectly, any voter registration drive; (3) as a grant to an individual for travel,
study, or other similar purposes by such individual, unless such grant satisfies the
requirements of subsection (g); (4) as a grant to an organization unless (A) such
organization (i) is described in paragraph (1) or (2) of § 509(a), (ii) is an organization
described in § 509(a)(3) (other than an organization described in clause (i) or (ii) of
section 4942(g)(4)(A)), or (iii) 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), or; (5) for any purpose
other than one specified in § 170(c)(2)(B).
PLR-103051-17                                   4

IRC § 4946(a)(1) provides, in part, that the term disqualified person means, with respect
to a private foundation, a person who is -- (A) a substantial contributor to the foundation;
(B) a foundation manager (within the meaning of subsection (b)(1)); (C) an owner of
more than 20 percent of (i) the total combined voting power of a corporation, (ii) the
profits interest of a partnership, or (iii) the beneficial interest of a trust or unincorporated
enterprise, which is a substantial contributor to the foundation; (D) a member of the
family of any individual described in subparagraph (A), (B), or (C); (E) a corporation in
which persons described in subparagraph (A), (B), (C), or (D) hold more than 35
percent of the total combined voting power; (F) a partnership in which persons
described in subparagraph (A), (B), (C), or (D) hold more than 35 percent of the profits
interest; or (G) a trust or estate in which persons described in subparagraph (A), (B),
(C), or (D) hold more than 35 percent of the beneficial interest,

IRC § 4946(b)(1) provides, in part, that the term foundation manager means, with
respect to any private foundation an officer, director, or trustee of a foundation (or an
individual having powers or responsibilities similar to those of officers, directors, or
trustees of the foundation).

In Underwood v. United States, 461 F. Supp. 1382 (N.D. Texas 1978), an individual
agreed to contribute money to a law school on the condition that the contribution would
be fully deductible by him for federal income tax purposes. The individual set up a
private foundation for this purpose and contributed money to the foundation. Upon
audit, the IRS determined that the individual’s contributions exceeded the maximum
permissible percentages and disallowed part of his claimed deductions. Thereafter, the
foundation returned to the individual the amount of the contributions disallowed by the
IRS. The IRS claimed that the refund to the individual was an act of self-dealing under
IRC § 4941(d)(1)(E) and a taxable expenditure under § 4945. The Court held that
because the individual’s commitment was conditioned upon his being able to deduct all
of his contributions for federal income tax purposes, when it was subsequently
determined by the IRS that the contributions made by the individual to the foundation
were not so deductible, the return by the foundation of the amount of those contributions
to which the foundation should not have received and which it was not entitled to keep
is not an amount paid or incurred by a private foundation within the meaning of § 4945.

ANALYSIS

1. Ruling Under IRC § 4945

Any payments made by the Foundation through the return of distributions in accordance
with the Agreement are similar to the return of contributions in Underwood. The Court in
Underwood, supra, considered whether a foundation’s return of a conditional
contribution was a taxable expenditure within the meaning of § 4945. The Court stated
that the amounts returned were assets that the foundation should not have received and
PLR-103051-17                                 5

which it was not entitled to keep. Such amounts are not an “amount paid or incurred by
a private foundation” within the meaning of § 4945.

Under the Agreement, Trustee 1 and Trustee 2 will make a conditional distribution of
Trust assets to Foundation. Should a liability arise triggering the terms of the
Agreement, the return of distributions by the Foundation under the terms of the
Agreement is a return of assets that Foundation would not have received had the final
distributions not occurred until all liabilities and expenses of the Trust had been
administered and are assets which it was not entitled to keep. Accordingly, such
payments through the return of assets will not constitute amounts paid or incurred for a
non-charitable purpose by a private foundation within the meaning of § 4945(d)(5).
Therefore, payments made under the Agreement to either Trustee 1 or Trustee 2 will
not be a taxable expenditure under § 4945(d).

2. Ruling under IRC § 4941

Generally, IRC § 4941(a)(1) imposes a tax on any act of self-dealing between a
disqualified person as defined in § 4946(a)(1) and a private foundation.

IRC § 4941(d)(1) defines self- dealing as any direct or indirect transaction described
above, including any transfer to, or use by or for the benefit of, a disqualified person of
the income or assets of a private foundation. However, § 4941 does not apply to any
transactions between a private foundation and a person who is not a disqualified
person.

In this case, neither Trustee 1 nor Trustee 2 will be treated as a disqualified person as
described in § 4946(a)(1) with respect to Foundation. Therefore, no act of self-dealing
will arise on account of entering into the Agreement with Trustee 1 and Trustee 2,
making or receiving payments pursuant to the Agreement or any return of property by
the Foundation pursuant to the Agreement.

RULINGS

Based solely on the facts and representations submitted by Foundation we rule:

1. Payments made under the Agreement to either Trustee 1 or Trustee 2 will not
constitute taxable expenditures under IRC § 4945.

2. That no act of self-dealing under IRC § 4941 will arise solely on account of
Foundation’s entering into the Agreement, making or receiving payments pursuant to
the Agreement, or any other return by the Foundation of property distributed by the
Trust under the Agreement.
PLR-103051-17                                  6

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.

Except as expressly provided herein, no opinion is expressed or implied as to the
federal tax consequences of the facts described above under any other provision of the
IRC.

This ruling is directed only to the taxpayer requesting it. IRC § 6110(k)(3) provides that it
may not be used or cited as precedent. This ruling is directed only to Foundation. IRC §
6110(k)(3) provides that it may not be used or cited as precedent by any other taxpayer,
including Trustee 1, Trustee 2, or Trust.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

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

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. 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.

                                       Sincerely,


                                       Taina Edlund
                                       Senior Technical Reviewer
                                       (TEGE Associate Chief Counsel - EO)



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