Foundation conversion allowed beneficiary payments and split-year reporting

Plain-English summary

A non-functionally integrated Type III supporting organization planned to become a private foundation and combine two asset funds after a court-approved trust modification. Under a settlement, smaller designated public-charity beneficiaries would accept calculated payments and give up future mandatory shares, while the remaining beneficiaries would receive recalculated shares intended to preserve their economics. The IRS declined to rule on whether the conversion or settlement affected the organization's exempt status or classification, which required a Form 8940 determination process. It ruled that the beneficiary payments would not be excess benefit transactions or self-dealing because the recipients were not disqualified persons. When paid, the amounts would be qualifying distributions and not taxable expenditures, and they would not terminate private-foundation status absent the statutory termination conditions. For the conversion year, Section 4940 and Section 4942 would apply only to the post-conversion short period, with Form 990 reporting before reclassification and Form 990-PF reporting afterward.

Ruling snapshot

• Question: What Chapter 42 and filing consequences would follow the supporting organization's conversion and beneficiary settlement payments?
• Outcome: Mixed: the IRS declined to rule on exemption or classification but granted the seven requested excise-tax, distribution, termination, and reporting rulings.
• Key authorities: IRC §§ 507, 509, 4940, 4941, 4942, 4945, and 4958; Treas. Reg. §§ 1.507-1, 53.4942(a)-3, and 53.4946-1

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201825004                                             Third Party Communication: None
Release Date: 6/22/2018                                       Date of Communication: Not Applicable
Index Number: 501.03-02, 507.00-00,
              509.01-01, 4940.00-00,                          Person To Contact:
              4941.00-00, 4942.00-00,                         ----------------------------, ID No. --------------
              4945.00-00, 4958.00-00                          -----------------
                                                              Telephone Number:
----------------------------------------------                ----------------------
-----------------------------------                           Refer Reply To:
-------------------------                                     CC:TEGE:EOEG:EO3
---------------                                               PLR-128836-17
----------------------------------                            Date:
                                                              March 20, 2018




Legend

Foundation       =    -----------------------------------
Trust            =    ---------------------------------------
Date 1           =    -------------------
State            =    ---------
A                =    --------------------------
B                =    --------------------------
Will             =    --------------------------------------------------------------
Date 2           =    --------------------------
Court            =    ---------------------------------------------------




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

This is in response to the letter dated September 20, 2017, in which your representative
requested rulings under sections 501, 507, 509, 4940, 4941, 4942, 4945, and 4958 of
the Internal Revenue Code with respect to the change in your foundation status from a
non-functionally integrated Type III supporting organization to a private foundation.1

Facts and Representations



1
 The Internal Revenue Code of 1986, as amended, to which all subsequent section references are made
unless otherwise indicated.
PLR-128836-17                                2

Foundation was established on Date 1 in State as a non-profit corporation by A and B.
Foundation was recognized as a tax-exempt organization described under § 501(c)(3),
and was classified as a supporting organization pursuant to § 509(a)(3)(B)(iii). In its
role as a Type III supporting organization, Foundation provides grants to nine
designated beneficiary organizations. Foundation’s articles of incorporation provide that
in order to receive distributions from Foundation, an organization must be “an
organization exempt from federal income tax under section 501(c)(3) which is not a
private foundation by reason of being described in section 509(a)(1) or 509(a)(2) of the
Code, or an organization described in sections 170(c)(1), 2055(a)(1) and 2522(a)(1) of
the Code.” None of the beneficiaries can be disqualified persons within the meaning of
Treas. Reg. § 53.4958-3(a)(1) and (d)(1). Foundation’s nine designated beneficiary
organizations are all described in § 170(b)(1)(A) and in either § 509(a)(1) or § 509(a)(2).

Foundation’s board of directors is made up of nine individuals. Three of the directors
must be selected by the governing bodies of the designated beneficiaries. Three of the
remaining six directors are individuals who would not be disqualified persons, as
described in section 4946(b)(1). The remaining three directors are members of A and
B’s family within the meaning of § 4946(d).

Foundation’s assets are mostly made up of cash and investments. Foundation’s assets
are held in two separate funds. The first fund contains assets that were initially
contributed to Foundation by A and B and any undistributed earnings. There are no
specific restrictions placed on this general fund. Foundation’s second fund contains
assets assigned to Foundation by B from Trust. The assets in the second fund from the
trust are subject to the restrictions from A’s will (Will) and must be kept separate from
the assets contained in the first general fund.

Pursuant to Will, Trust was created for the benefit of B during B’s lifetime. Will provides
that upon the death of B, a portion of Trust’s remaining assets will be transferred to
Foundation. Will also provides that distributions in any year from Trust are limited to the
greater of the residuary estate income from that year or five percent of the residuary
estate total as of the first day of that year, and that any distribution from Trust must be
specifically divided with a particular percentage of the distribution going to each of the
nine designated beneficiaries. Will also provides that any assets assigned from Trust to
Foundation by B that are in Foundation’s second fund are subject to these same
distribution requirements listed in Will. Accordingly, any distributions made by
Foundation from the second fund are subject to the distribution requirements provided
in Will.

The IRS issued final regulations in 2012 for Type III supporting organizations. Among
other things, the final regulations provide additional notice requirements that a Type III
supporting organization must provide to each of its supported organizations. After
considering the new requirements that Type III supporting organizations are subject to,
Foundation determined that it could be run more efficiently as a private foundation
PLR-128836-17                                3

instead of as a supporting organization. After Foundation is reclassified as a private
foundation, it will no longer meet the notice and other requirements under § 509(a)(3)
and Treas. Reg. § 1.509(a)-4.

Foundation sought a judicial modification of Trust in State to allow for Foundation’s
change in status to a private foundation. As part of the judicial proceedings, Foundation
also sought to modify Trust to eliminate the restrictions placed on distributions from
Trust by Will. Pursuant to the distribution provisions provided in Will, some of the nine
designated beneficiaries receive 2.5% or less of the annual distributions from the
Foundation’s second fund. Foundation believes it can further its exempt purpose better
by focusing the annual distributions on the designated beneficiaries that receive the
larger portions of the annual distribution provisions pursuant to Will. However, this
adjustment requires the modification to Trust. Foundation provided notice of these
proceedings to the Attorney General of State, and the Attorney General declined to
participate in them.

As part of the judicial proceedings, Foundation offered to each of the designated
beneficiaries receiving the smaller percentage shares of the annual distributions a
series of payments in exchange for the smaller designated beneficiaries relinquishing
their rights to the mandatory distributions from Foundation’s second fund. Most of the
smaller designated beneficiaries accepted this offer. The smaller designated
beneficiaries that accepted the payout offer are referred to as the “relinquishing
beneficiaries”. All the remaining designated beneficiaries that will continue to receive
annual distributions from Foundation will be referred to as the “remaining beneficiaries.”
Foundation entered into a settlement agreement with all the designated beneficiaries
outlining the terms of the payments to the relinquishing beneficiaries and the continued
distribution of funds to the remaining beneficiaries.

Pursuant to the settlement agreement, the relinquishing beneficiaries agree that they
will no longer be designated beneficiaries of Foundation’s second fund in exchange for
two payment amounts, determined from the relinquishing beneficiaries’ percentage
amount given under Trust and the fair market value of Foundation’s second fund as of
the trust conversion date and as of the final distribution date. The calculations of the
payment amounts were made to provide a reasonable estimate of the amount that the
relinquishing beneficiaries would have otherwise received from Foundation’s second
fund. Foundation represents that it does not wish to terminate its private foundation
status in tandem with any of the grants to the relinquishing beneficiaries pursuant to the
settlement agreement and has not indicated any contrary intent to the Secretary.
Foundation further represents that no portion of any payment amount may be used for
lobbying, influencing the outcome of elections, for grants to individuals other than for
education scholarships, or in any other manner for non-charitable purposes.

Pursuant to the settlement agreement, the remaining beneficiaries agree that their
percentage shares of Foundation’s second fund will be recalculated to reflect the
PLR-128836-17                                4

equivalent shares of distributions made after Foundation’s first and second funds are
combined. These shares will be recalculated again when Trust terminates upon B’s
death. The calculations for the new distribution amounts are based on the remaining
beneficiaries’ percentage amounts given under Trust and the fair market value of
Foundation’s second fund as of the trust conversion date and the final distribution date
and the fair market value of all the net assets held by Foundation as of the trust
conversion date and the final distribution date. These calculations are intended to
represent the same distributions that the remaining beneficiaries would have received if
Foundation did not combine its first and second funds.

On Date 2, the Court granted Foundation’s request to modify Trust. The date of the
Court’s judgment is effective upon the receipt by Foundation of a private letter ruling
from the IRS.

Rulings Requested, Law, and Analysis

Requested Ruling 1:

      Both the proposed conversion of Foundation to a private foundation and the
transactions discussed in the settlement agreement will further one or more exempt
purposes described in § 501(c)(3).


Revenue Procedure 2017-3, 2017-1 I.R.B. 130, section 3.01(32) provides that the
Internal Revenue Service will not issue a ruling on whether an organization is or
continues to be described in § 170(b)(1)(A) (other than clause (v)) or § 170(c)(2),
including, for example, whether changes in an organization’s activities or operations will
affect or jeopardize the organization’s status as an organization described in those
sections. Section 3.01(71) provides that the Internal Revenue Service will not issue a
ruling on whether an organization is or continues to be exempt from taxation under
§ 501(a) as an organization described in §§ 501(c) or 501(d), including, for example,
whether changes in an organization’s activities or operations will affect or jeopardize the
organization’s exempt status. Section 3.01(74) provides that the Internal Revenue
Service will not issue a ruling on whether an organization is or continues to be
described in § 509(a) including, for example, whether changes in an organization’s
activities or operations will affect or jeopardize the organization’s status as a public
charity described in § 509(a)(1)-(4).

Rev. Proc. 2017-5, 2017-1 I.R.B. 230, provides procedures for obtaining determination
letters on public charity status. Section 7 provides that a tax-exempt organization
should file Form 8940 for miscellaneous determinations, including a reclassification of
foundation status from public charity to private foundation.
PLR-128836-17                                 5

Accordingly, because Foundation is required to file Form 8940 to change its
classification, we are not ruling regarding whether the proposed conversion of
Foundation or the transactions discussed in the settlement agreement affect
Foundation’s status or classification.

Requested Ruling 2:

       Neither the proposed conversion of the Foundation to a private foundation nor
the transactions discussed in the settlement agreement will give rise to excise taxes
under § 4958 to Foundation.

Section 4958(a)(1) imposes on each excess benefit transaction a tax equal to 25
percent of the excess benefit (the “first tier tax”). This tax must be paid by any
disqualified person, as defined in § 4958 (f)(1), with respect to such transaction.

Section 4958(a)(2) provides that if a tax is imposed by § 4958(a)(1), and there is
knowing participation in the excess benefit transaction by an organization manager,
there shall be imposed on such manager an excise tax equal to 10 percent of the
excess benefit, unless such participation is not willful and is due to reasonable cause.

Section 4958(b) provides that where an initial tax is imposed, but the excess benefit
involved in such transaction is not corrected within the taxable period, an additional tax
equal to 200 percent of the excess benefit involved is imposed and must be paid by any
disqualified person with respect to such transaction (the “second tier tax”). There is no
corresponding additional tax imposed on a foundation manager.

Section 4958(c), in part, defines “excess benefit transaction” as any transaction in which
an economic benefit is provided by an “applicable tax-exempt organization” directly or
indirectly to or for the use of any disqualified person if the value of the economic benefit
provided exceeds the value of the consideration (including the performance of services)
received for providing such benefit.

Section 4958(e) defines “applicable tax-exempt organization” as an organization
described in either § 501(c)(3) or § 501(c)(4) of the Code or an organization which was
so described at any time during the five-year period ending on the date of the excess
benefit transaction. Such term does not include a private foundation as defined in
§ 509(a).

Section 4958(f)(1) defines “disqualified person” to include (A) any person who was, at
any time during the five-year period ending on the date of such transaction, in a position
to exercise substantial influence over the affairs of the organization, (B) a member of
the family of a disqualified person, and (C) a 35-percent controlled entity.
PLR-128836-17                                   6

Treas. Reg. § 53.4958-3(a)(1) defines “disqualified person” as any person who was in a
position to exercise substantial influence over the affairs of the applicable tax-exempt
organization at any time during the five-year period ending on the date of the
transaction.

Treas. Reg. § 53.4958-3(d)(1) provides that a person is deemed not to be in a position
to exercise substantial influence over the affairs of an applicable tax-exempt
organization if the organization is described in § 501(c)(3) and exempt from tax under
§ 501(a).

An excess benefit transaction occurs when a charity provides an economic benefit
directly or indirectly to or for the use of any disqualified person. Foundation states that
none of the beneficiaries are disqualified persons within the meaning of Treas. Reg.
§ 53.4958-3(a)(1) and (d)(1). Therefore, because none of the beneficiaries are
disqualified persons, the proposed reclassification and payments to be made pursuant
to the settlement agreement will not give rise to an excise tax liability to Foundation
pursuant to § 4958.

Requested Ruling 3:

       Payments made to the relinquishing beneficiaries and the remaining beneficiaries
pursuant to the settlement agreement after Foundation’s conversion date will not be
self-dealing under § 4941.

Section 4941(a)(1) imposes taxes on each act of self-dealing between a disqualified
person (as defined in § 4946(a)) and a private foundation. Taxes are imposed on both the
self-dealers involved in an act of self-dealing and on any foundation managers who
knowingly participate in an act of self-dealing. Even though § 4941 does not impose a tax
on a private foundation when an act of self-dealing occurs, a foundation with respect to
which there has been an act of self-dealing is required to report it to the IRS on its annual
information return, which is the Form 990-PF in this case.

Section 4941(d)(1)(E) provides that the term “self-dealing” includes any 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.

Section 4946(a)(1) defines the term “disqualified person” as a person who is a substantial
contributor to the private foundation, a foundation manager, an owner of more than 20
percent of the total combined voting power of either a corporation, the profit interest of a
partnership, or the beneficial interest of a trust or unincorporated enterprise which is a
substantial contributor to the private foundation, a member of the family of any individual
described previously, a corporation, partnership, or trust of which persons described
previously own more than 35 percent, or a government official.
PLR-128836-17                                  7

Section 509(a)(1) provides that the term “private foundation” means a domestic or foreign
organization described in § 501(c)(3) other than an organization described in
§ 170(b)(1)(A) (other than in clauses (vii) and (viii));

Section 170(b)(1)(A)(ii) includes an educational organization which normally maintains a
regular facility and curriculum and normally has a regularly enrolled body of pupils or
students in attendance at the place where its educational activities are regularly carried on.

Treas. Reg. § 1.509(a)-2(a) provides that organizations described in § 170(b)(1)(A) (other
than in clauses (vii) and (viii) are excluded from the definition of “private foundation” by
§ 509(a)(1).

Treas. Reg. § 53.4946-1(a)(7) provides that for purposes of chapter 42 and certain other
purposes, an organization described in § 509(a)(1), (2), or (3) is not a disqualified person.
Treas. Reg. § 53.4946-1(a)(8) provides that for purposes of section 4941, the term
“disqualified person” does not include organizations that are described under § 501(c)(3).

Foundation states that all of its beneficiaries are described under § 509(a)(1) or
§ 509(a)(2). Accordingly, the relinquishing and the remaining beneficiaries are not
disqualified persons to Foundation, and transfers to them are not subject to the self-
dealing tax of § 4941.

Requested Ruling 4:

      Payments made by Foundation to the relinquishing beneficiaries and the
remaining beneficiaries pursuant to the settlement agreement after the date Foundation
converts to a private foundation will be treated as qualifying distributions under
§ 4942(g) at such times as the payments are actually paid to the beneficiary.

Section 4942(a) generally imposes a tax on the undistributed income of a private
foundation (other than an operating foundation under § 4942(j)(3)) for any taxable year,
that has not been distributed before the first day of the second (or any succeeding)
taxable year following such taxable year.

Section 4942(c) defines undistributed income for any taxable year as the amount by
which the distributable amount for such taxable year exceeds the qualifying distributions
made out of such distributable amount for such taxable year.

Section 4942(g)(1) defines qualifying distribution as (A) any amount paid to accomplish
one or more purposes described in § 170(c)(2)(B), other than any contribution to (i) an
organization controlled by the foundation or one or more disqualified persons, or (ii) a
private foundation which is not an operating foundation, except as otherwise provided;
or (B) any amount paid to acquire an asset used directly in carrying out one or more
purposes described in § 170(c)(2)(B).
PLR-128836-17                                8


Section 170(c)(1) provides that the term “charitable contribution” means a contribution
or gift to or for the use of a state, a possession of the United States, or any political
subdivision of any of the foregoing, or the United States or the District of Columbia, but
only if the contribution or gift is made for exclusively public purposes. Section
170(c)(2)(B) further defines a charitable contribution to include a contribution to a
corporation, trust or community chest, fund or foundation that is organized and operated
exclusively for religious, charitable, scientific, literary, or educational purposes.

Treas. Reg. § 53.4942(a)-3(a)(1) provides that the amount of a qualifying distribution of
property is the fair market value of such property as of the date such qualifying
distribution is made. The amount of an organization’s qualifying distribution will be
determined solely on the cash receipts and disbursements method of accounting
described in § 446.

Treas. Reg. § 53.4942(a)-3(a)(2) defines the term qualifying distribution, in relevant
part, as any amount (including program related investments and reasonable and
necessary administrative expenses) paid to accomplish one or more purposes
described in § 170(c)(1) or § 170(c)(2)(B), other than any contribution to a private
foundation which is not an operating foundation or to an organization controlled (directly
or indirectly) by the contributing private foundation or one or more disqualified persons
with respect to such foundation.

Under § 4942, a qualifying distribution includes any amount paid to accomplish one or
more purposes described in § 170(c)(1) or § 170(c)(2)(B) other than a distribution to a
private foundation. All of the beneficiaries to the settlement agreement payments are
organizations that are described under § 170(c)(1) or § 170(c)(2)(B). Furthermore,
Foundation’s articles of incorporation specifically provide that in order to receive
distributions from Foundation, an organization must be an organization exempt under
§ 501(c)(3) and described in § 509(a)(1) or § 509(a)(2), or is an organization described
in § 170(c)(1). Accordingly, because all of the payments made by Foundation pursuant
to the settlement agreement are paid to accomplish purposes described in § 170(c)(1)
or § 170(c)(2)(B), the payments would constitute qualifying distributions as of the dates
that the payments are actually made to the beneficiaries.

Requested Ruling 5:

      Payments made by Foundation to the relinquishing beneficiaries and the
remaining beneficiaries pursuant to the settlement agreement after the date Foundation
converts to a private foundation will not constitute taxable expenditures under
§ 4945(d).

Section 4945(a) imposes a tax on each “taxable expenditure” of a private foundation.
PLR-128836-17                                9

Section 4945(d) provides that the term “taxable expenditure” means any amount paid or
incurred by a private foundation to carry on propaganda, or otherwise to attempt, to
influence legislation, to influence the outcome of any specific public election or to carry
on any voter registration drive, or as a grant to an individual for travel, study, or other
similar purposes by such individual, or as a grant to an organization unless said
organization is described in paragraph (1), (2), or (3) of § 509(a) or an exempt operating
foundation (as defined in § 4940(d)(2)), or the private foundation exercises expenditure
responsibility with respect to such grants in accordance with § 4945(h), or for any
purpose other than one specified in § 170(c)(2)(B).

Section 509(a)(1) provides that the term “private foundation” means a domestic or
foreign organization described in § 501(c)(3) other than an organization described in
§ 170(b)(1)(A) (other than in clauses (vii) and (viii));

Treas. Reg. § 53.4945-5(a)(1) provides that the term taxable expenditure includes any
amount paid or incurred by a private foundation as a grant to an organization (other
than an organization described in § 509(a)(1), (2), or (3) (other than one described in
§ 4942(g)(4)(A)), unless the private foundation exercises expenditure responsibility with
respect to such grant.

Treas. Reg. § 53.4545-5(a)(4) provides that for purposes of § 4945, an organization will
be treated as a § 509(a)(1) organization if it is an organization described in § 170(c)(1)
or § 511(a)(2)(B), even if it is not described in § 501(c)(3).

Foundation states all of the beneficiary organizations to the settlement agreement
payments are described under § 509(a)(1) or § 509(a)(2). The settlement agreement
further provides that no portion of any payment amount made pursuant to the
agreement may be used for lobbying, influencing the outcome of elections, for grants to
individuals other than for education scholarships, or in any other manner for non-
charitable purposes. Accordingly, payments made to the relinquishing and the
remaining beneficiaries pursuant to the settlement agreement are not taxable
expenditures that are subject to tax under § 4945.

Requested Ruling 6:

       Payments made by Foundation to the relinquishing beneficiaries and the
remaining beneficiaries pursuant to the settlement agreement after the date Foundation
converts to private foundation status will not result in a termination of Foundation’s
private foundation status under § 507(a), and will not subject Foundation to any
termination tax liability under § 507(c) of the Code.

Section 507(a) provides that, except as provided in subsection (b), the status of any
organization as a private foundation shall be terminated only if (1) it notifies the
Secretary of its intent to accomplish such a termination or (2) with respect to such
PLR-128836-17                                     10

organization, there have been either willful repeated acts (or failures to act), or a willful
and flagrant act (or failure to act), giving rise to liability for tax under Chapter 42, and the
Secretary notifies such organization that it is liable for the tax imposed by § 507(c), and
either such organization pays the tax (or any portion not abated under § 507(g)) or the
entire amount of such tax is abated under § 507(g).

Section 507(b)(2) says that in the case of a transfer of assets of any private foundation
to another private foundation pursuant to any liquidation or other adjustment,
organization, or reorganization, the transferee foundation shall not be treated as a newly
created organization.

Treas. Reg. § 1.507-1(a) provides that except as provided in § 1.507-2, the status of
any organization as a private foundation shall be terminated only if: (1) such
organization notifies the district director of its intent to accomplish such termination, or
(2)(i) with respect to such organization, there have been either willful repeated acts (or
failures to act), or a willful and flagrant act (or failure to act), giving rise to a liability for
tax under Chapter 42, and (ii) the Commissioner notifies such organization that, by
reason of subdivision (i) of this subparagraph, such organization is liable for the tax
imposed by § 507(c), and either such organization pays the tax imposed by § 507(c) or
the entire amount of such tax is abated under § 507(g).

Treas. Reg. § 1.507-1(b)(6) provides that a transfer of all or part of a private
foundation’s assets to one or more private foundations pursuant to a transfer described
in § 507(b)(2), such transferor foundation will not be deemed to have terminated its
private foundation status under § 507(a)(1).

Treas. Reg. § 1.507(b)(7) provides that neither a transfer of all the assets of a private
foundation nor a significant disposition of assets by a private foundation shall be
deemed to result in a termination of the transferor private foundation under § 507(a)
unless the transferor private foundation elects to terminate pursuant to §§ 507(a)(1) or
507(a)(2).

Treas. Reg. § 1.507-3(c)(2) provides that the term “significant disposition of assets to
one or more private foundations” shall include any disposition for a taxable year where
the aggregate of the dispositions to one or more private foundations for the taxable year
is twenty-five percent or more of the fair market value of the net assets of the foundation
at the beginning of the taxable year.

Foundation represents that it does not intend to terminate its private foundation status
under either § 507(a) or (b) even if the distributions it makes to the beneficiaries
exceeds twenty-five percent or more of the fair market value of Foundation’s net assets,
nor is there any indication that Foundation committed any willful repeated acts (or
failures to act), or a willful and flagrant act (or failure to act), giving rise to a liability for
tax under Chapter 42. Since Foundation will not elect to terminate pursuant to
PLR-128836-17                                  11

§ 507(a) or (b), Foundation’s private foundation status will not be terminated under
§ 507, and Foundation is not subject to a termination tax pursuant to § 507(c), provided
that Foundation does not commit any willful repeated acts (or failures to act), or a willful
and flagrant act (or failure to act) that gives rise to a liability for tax under Chapter 42.

Requested Ruling 7:

        For the calendar year that includes the date that Foundation converts to a private
foundation, Foundation’s liability for the excise tax under § 4940 will apply only to net
investment income earned during the part of that year during which Foundation was
classified as a private foundation, and Foundation’s distributable amount under § 4942
will be computed on the basis of only such part of that year.

Section 4940(a) imposes an excise tax on a private foundation’s net investment income
for the taxable year. Section 4940(c)(1) 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 under § 4940(c)(3). Section 4940(c)(2) provides, in
part, that for purposes of § 4940, the term “gross investment income” means the gross
amount of income from interest, dividends, rents, payments with respect to securities
loans, and royalties.

Section 4942(a) generally imposes a tax on the undistributed income of a private
foundation (other than an operating foundation under § 4942(j)(3)) for any taxable year,
that has not been distributed before the first day of the second (or any succeeding)
taxable year following such taxable year.

Section 4942(c) defines undistributed income for any taxable year as the amount by
which the distributable amount for such taxable year, exceeds the qualifying
distributions made out of such distributable amount for such taxable year.

Section 4942(d) provides that the term distributable amount means, with respect to any
private foundation for any taxable year, an amount equal to the sum of the minimum
investment return plus the income modifications described in § 4942(f)(2)(C), reduced
by the sum of the taxes imposed on such private foundation for the taxable year under
subtitle A and § 4940.

Section 4942(e)(1) defines the term ‘minimum investment return’ as 5 percent of the
excess of the aggregate fair market value of a private foundation’s assets other than
those which are used (or held for use) directly in carrying out the foundation’s exempt
purpose, over the acquisition indebtedness with respect to assets whose fair market
values are included in the calculation.

Treas. Reg. § 53.4942(a)-2(c)(5)(iii) provides that in any case in which a taxable year is
a period less than 12 months, the applicable percentage to be applied under
PLR-128836-17                                12

§ 4942(e)(1) shall be equal to 5 percent multiplied by a fraction, the numerator of which
is the number of days in such short taxable period and the denominator of which is 365.

Prior to Foundation’s reclassification, Foundation is a public charity supporting
organization described in § 509(a)(3). Excise taxes under § 4940 and § 4942 are
applicable only to private foundations. Consequently, Foundation will only be subject to
§ 4940 and § 4942 taxes after it is reclassified as a private foundation. Thus, § 4940
taxes will apply only to the net investment income that Foundation receives after the
reclassification. Furthermore, the distributable amount under § 4942 will be computed
based on the short taxable period following Foundation’s reclassification to private
foundation status.

Requested Ruling 8:

        Foundation will be required to file both a Form 990 to report activity occurring
during the portion of the conversion year before the reclassification while Foundation is
a Type III supporting organization, and a Form 990-PF to report activity occurring during
the portion of the conversion year beginning after the reclassification when Foundation
will be a private foundation.

Section 6001 provides that every person liable for a tax imposed by the Code, or for
collection thereof, shall keep adequate records as the Secretary of the Treasury or his
delegate may from time to time prescribe.

Section 6033(a)(1) provides that except as provided in § 6033(a)(2), every organization
exempt from tax under § 501(a) shall file an annual return, stating specifically the items
of gross income, receipts and disbursements, and such other information for the
purposes of carrying out the internal revenue laws as the Secretary may by forms or
regulations prescribe, and keep such records, render under oath such statements,
make such other returns, and comply with such rules and regulations as the Secretary
may from time to time prescribe.

The instructions for the Form 990, “Return of Organization Exempt From Income Tax”,
provide that the Form 990 is filed by organizations described in section 501(c)(3) (other
than private foundations). The instructions for the Form 990-PF, “Return of Private
Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private
Foundation”, provide that the Form 990-PF is filed by tax-exempt private foundations.

During the tax year that Foundation is reclassified, Foundation will be classified as a
public charity under § 509(a)(3) for the portion of the year prior to the reclassification,
and as a private foundation for the portion of the year after the reclassification. Public
charities are required to file a Form 990. Private foundations are required to file a Form
990-PF. Accordingly, Foundation should file a Form 990 reflecting its activities for the
portion of the tax year that it is a public charity under § 509(a)(3), and Foundation
PLR-128836-17                                  13

should file a Form 990-PF reflecting its activities for the portion of the year after the
reclassification when it is a private foundation.

Conclusion

Based on the foregoing, and assuming the accuracy of the facts and representations
described herein, we rule as follows with respect to Foundation:

    1. Pursuant to Rev. Proc. 2017-3 and Rev. Proc. 2017-5, we are not ruling
      regarding whether the proposed conversion of Foundation or the transactions
      discussed in the settlement agreement affect Foundation’s tax-exempt status or
      classification.

    2. Foundation’s reclassification to a private foundation and the payments made to
      the beneficiaries pursuant to the settlement agreement will not constitute an
      excess benefit transaction under § 4958 to Foundation.

    3. Foundation’s reclassification to a private foundation and the payments made to
      the beneficiaries pursuant to the settlement agreement will not constitute self-
      dealing under § 4941.

    4. Payments made by Foundation to the beneficiaries pursuant to the settlement
      agreement will be qualified distributions for Foundation under § 4942(g).

    5. Payments made by Foundation to the beneficiaries pursuant to the settlement
      agreement will not constitute taxable expenditures under § 4945(d).

    6. Payments made by Foundation to the beneficiaries pursuant to the settlement
      agreement will not result in a termination of Foundation’s private foundation
      status under § 507(a), and will not subject Foundation to any termination tax
      liability under § 507(c).

    7. For the tax year that Foundation reclassifies to a private foundation, Foundation’s
      liability for § 4940 taxes will only apply to the net investment income that
      Foundation receives after the reclassification. Furthermore, the distributable
      amount of Foundation’s income under § 4942 will be computed based on the
      short taxable period following Foundation’s reclassification to a private
      foundation.

    8. For the tax year that Foundation reclassifies to a private foundation, Foundation
      should file a Form 990, reflecting its activities for the portion of the tax year that it
      is a public charity under § 509(a)(3), and Foundation should file a Form 990-PF,
      reflecting its activities for the portion of the tax year after the reclassification when
      it is a private foundation.
PLR-128836-17                                  14


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, as specified in Rev. Proc. 2017-1, 2017-1 I.R.B. 1. This office
has not verified any of the material submitted in support of the request for ruling, and
such material is subject to verification on examination. The Associate office will revoke
or modify a letter ruling and apply the revocation retroactively if there has been a
misstatement or omission of controlling facts; the facts at the time of the transaction are
materially different from the controlling facts on which the ruling was based; or, in the
case of a transaction involving a continuing action or series of actions, the controlling
facts change during the course of the transaction. See Rev. Proc. 2017-1.

No ruling is granted as to whether Foundation qualifies as an organization described in
§ 501(c), and, except as expressly provided above, no opinion is expressed or implied
concerning the federal income tax consequences of any other aspects of any
transaction or item of income described in this letter ruling.

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

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

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


                                       Sincerely,



                                       Don Spellmann
                                       Senior Counsel
                                       Exempt Organization Branch 3
                                       (Tax Exempt & Government Entities)



Enclosure:    Notice 437, Notice of Intention to Disclose
              Redacted copy of this letter


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