Foundation could pay its founder's entity for charitable services

Plain-English summary

A private foundation proposed paying an entity owned by its founder for professional grant-making, program, charitable consulting, and investment services. Because the founder was a substantial contributor, payments through the disregarded entity were treated as compensation paid to a disqualified person. The IRS ruled that the payments would fit the personal-services exception to self-dealing if the services were reasonable and necessary to the foundation's exempt purposes and the compensation was not excessive. The related expenditures would be qualifying distributions under section 4942 and would not be taxable expenditures under section 4945. The IRS expressly did not decide whether the proposed compensation was excessive.

Ruling snapshot

• Question: May the private foundation pay its founder's disregarded entity for professional charitable and investment services?
• Outcome: approved, provided the services are reasonable and necessary and the compensation is not excessive
• Key authorities: IRC §§ 4941(d)(2)(E), 4942(g), and 4945(d)(5); Treas. Reg. §§ 53.4941(d)-3(c) and 53.4945-6(b)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201937004                                             [Third Party Communication:
Release Date: 9/13/2019                                       Date of Communication: Month DD, YYYY]
Index Number: 4941.00-00, 4942.03-05,
              4945.00-00                                      Person To Contact:
                                                              -----------------------, ID No. -------------------
-----------------------------------------------------         ---------------------------------------------------
------------------------------                                Telephone Number:
-------------------------                                     ----------------------
------------------------------                                Refer Reply To:
                                                              CC:EEE:EOET:EO3
                                                              PLR-119677-18
                                                              Date:
                                                              March 13, 2019




Founder          =    -------------------------------
Foundation       =    ------------------------------------------------------
A                =    -----------------------------
B                =    ----------------------------


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


        This is in response to your request for rulings dated June 19, 2018, as
        supplemented by information submitted in letters dated October 15, 2018 and
        January 29, 2019. The request involves rulings under §§ 4941, 4942, and
        49451 with respect to the payment of compensation for services provided by a
        disqualified person to a private foundation, as more fully set forth below.

        FACTS

        Foundation is a nonprofit corporation organized to conduct activities that are
        exclusively religious, charitable, scientific, literary, or educational under
        §§ 170(c)(2)(B) and 501(c)(3), including, but not limited to, making contributions
        and grants to organizations recognized as tax exempt under § 501(a) as
        organizations described in § 501(c)(3). Foundation is recognized as an


1
 Sections 4941, 4942, and 4945 of the Internal Revenue Code of 1986, as amended, to which all
subsequent “section” or “§” references are made unless otherwise indicated.
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    organization described in § 501(c)(3) and is classified under § 509 as a private
    foundation. Foundation engages primarily in both grant-making and providing
    consulting services to other charitable ------------------------- entities. Founder
    created Foundation and is its primary donor. Founder also is a “substantial
    contributor,” as defined in § 507(d)(2), to Foundation.

    Foundation is governed by a board of directors consisting of ----individuals, ----of
    whom are ”independent”—i.e., disqualified persons, as defined in § 4946(a), only
    because they are foundation managers described in § 4946(a)(1)(B) and (b). -----
    ----------------------------------------------------------------------------.

    ------------------------------------------------------------------------------------------------------------,
    Founder has donated services, through Founder’s wholly-owned disregarded
    entities, A and B, to Foundation to enable Foundation to carry out its activities.

    The personnel providing services directly to Foundation are employees of A,
    which is wholly owned by Founder and is disregarded as an entity separate from
    its owner within the meaning of Treas. Reg. § 301.7701-3. Currently, A provides
    various services described below to Foundation free of charge.

    Founder also is the sole owner of B, which is disregarded as an entity separate
    from its owner within the meaning of Treas. Reg. § 301.7701-3. B’s employees
    provide certain investment advisory services to Foundation and others, as
    described more fully below. Founder also pays all of B’s operating costs.

    In addition to Foundation, A and B provide services to Founder and to other tax-
    exempt organizations. A and B also provide services to Founder’s family
    members, and their separate donees/grantees. About one-third of A’s time is
    spent on non-Foundation work.

    A provides philanthropic program and grant-making services to Foundation.
    These services include developing initiatives, conducting due diligence on
    potential grantees, developing partnerships with other organizations, reviewing
    grant proposals, selecting grantees, working with grantees on initiatives, drafting
    grant recommendations, drafting grant agreements and monitoring grant
    performance. A’s employees facilitate and shepherd Foundation’s grant process;
    maintain and update all documentation relating to grants, grantees, and a grant
    database; ensure that due diligence files are complete; and monitor and
    document grantee compliance with the terms of the grant agreements.
PLR-119677-18                                         3

    Foundation’s charitable consulting activities include organizing meetings of
    experts and grant recipients and providing at no charge to other charities
    consulting services related to their philanthropic programs, which coordinate with
    Foundation’s programs, as well as to their investment activities. -----------------------
    ------------------------------------------------------------------------------------------------------------
    --------------.

    Foundation, utilizing the services of B’s employees, provides advice to a number
    of public charities regarding investment strategies, asset allocation, and liquidity
    needs for making grants.

    All entities that receive program-related, -------------------, or investment consulting
    services from Foundation are either public charities, foreign organizations that
    would be classified as non-private foundation tax-exempt charitable organizations
    if they were located in the United States, or entities with respect to which
    Foundation exercises expenditure responsibility, as defined by § 4945(h) and the
    regulations thereunder. None of them is controlled by Foundation or is a
    disqualified person with respect to Foundation.

    A has program teams that provide various services to Foundation, Founder, and
    others. Each of the teams that is dedicated to Foundation’s focus areas employs
    leaders with significant experience in each of those fields (each, a “Program
    Lead”). Program Leads are hired because they are considered leaders in their
    fields, each is highly credentialed, and many hold advanced degrees. Many of
    the team members also are highly credentialed, and hired with specific
    background and skills necessary to provide grant-making services. Some of A’s
    employees are not assigned to a specific focus area but, rather, provide other
    support services to the program teams.

    A also employs office and grants management staff necessary to permit the
    program teams to provide charitable services to Foundation in an efficient
    manner. A outsources such services as janitorial and maintenance services to
    unrelated parties.

    To date, Founder has paid the operating costs of A and B and allowed
    Foundation to use A’s and B’s services for free. To help Foundation better
    understand its operating expenses and plan for its future self-sufficiency,
    Foundation will enter into a services agreement with A and begin paying A for the
    (i) programmatic and grant-making services, (ii) services that allow Foundation to
    engage in charitable consulting activities, and (iii) investment management and
PLR-119677-18                              4

    advisory services to Foundation and to other entities at Foundation’s direction.

    Foundation’s independent directors will review and approve the services
    agreement and the fee to be paid to A for the services. The --------non-
    independent directors will not participate in the consideration of or the voting on
    adoption of the agreement. A will contract with B to assist A in delivering the
    investment management and advisory services to Foundation and to other
    entities at Foundation’s direction pursuant to the services agreement between
    Foundation and A.

    The fees to be paid by Foundation to A will be expected to cover all costs of
    providing to Foundation grant-making, consulting, and investment advisory
    services, including salaries, benefits, supplies and office equipment. Foundation
    will employ third-party compensation experts to ensure that the fees to be paid by
    Foundation will fall within the range of reasonableness for similar services
    provided by similar service providers to similar foundations and will not be
    excessive in amount, taking into account (a) the size of Foundation; (b) the
    amount and complexity of the grants made by Foundation and (c) the types of
    consulting services provided by Foundation to others.

    Foundation will maintain documentation of (i) the terms of the services agreement
    and the date approved, (ii) the independent directors who are present during
    debate on the services agreement and those who vote on it, (iii) data supporting
    the reasonableness of the fees that is obtained and relied upon by the
    independent directors and how the data is obtained and (iv) any actions taken
    with respect to consideration of a services agreement by anyone who is a director
    but who may have had an apparent conflict of interest with respect to the services
    agreement.

    Foundation will only pay for services provided to it and not for any services
    provided to Founder, Founder’s family members, or their donees/grantees.
    Founder will separately pay for all the services that A and B provide to Founder,
    Founder’s family members, and their donees/grantees.

    RULINGS REQUESTED

    Based on the statement of facts and representations submitted by Foundation
    and summarized above, the following rulings are requested:

    1. Payment by Foundation of a fee to Founder through A, a disregarded entity,
PLR-119677-18                                   5

       for programmatic and grant-making services shall not be an act of self-dealing
       between Foundation and Founder, a disqualified person, because it is the type
       of payment described in § 4941(d)(2)(E) and Treas. Reg. § 53.4941(d)-3(c)(1)
       for services which are reasonable and necessary to carrying out the exempt
       purposes of Foundation.

    2. Payment by Foundation of a fee to Founder through A, a disregarded entity,
       for services to enable Foundation to engage in charitable consulting activities,
       including (i) program-related consulting provided to other charities, (ii) -----------
       ------------------------------------------------------------ and (iii) investment consulting
       provided to other charities, shall not be an act of self-dealing between
       Foundation and Founder, a disqualified person, because it is the type of
       payment described in § 4941(d)(2)(E) and Treas. Reg. §53.4941(d)-3(c)(1) for
       services which are reasonable and necessary to carrying out the exempt
       purposes of Foundation.

    3. Foundation’s expenditures for the programmatic, grant-making and consulting
       services listed above will be considered qualifying distributions under § 4942.


    4. Foundation’s expenditures for the programmatic, grant-making and consulting
       services listed above will not constitute taxable expenditures under § 4945.

    LAW AND ANALYSIS

    Issues 1 and 2 – Whether payment by Foundation of a fee to A for programmatic
    grant-making services and its charitable consulting activities are excepted from
    self-dealing under § 4941(d)(2)((E) and the regulations.

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

    Section 4941(d)(1)(D) defines “self-dealing” as including any direct or indirect
    payment of compensation (or payment or reimbursement of expenses) by a
    private foundation to a disqualified person.

    Section 4941(d)(2)(E) provides that, except in the case of a government official
    (as defined in § 4946(c)), the payment of compensation (and the payment or
    reimbursement of expenses) by a private foundation to a disqualified person for
PLR-119677-18                              6

    personal services which are reasonable and necessary to carrying out the exempt
    purpose of the private foundation shall not be an act of self-dealing if the
    compensation (or payment or reimbursement) is not excessive.

    Section 4946(a)(1) defines the term “disqualified person” to include, with respect
    to a private foundation, a person who is a substantial contributor to the
    foundation, as defined in § 507(d)(2).

    Treas. Reg. § 53.4941(d)-3(c)(1) provides, in part, that under § 4941(d)(2)(E), the
    payment of compensation by a private foundation to a disqualified person for
    personal services which are reasonable and necessary to carry out the exempt
    purpose of the private foundation shall not be an act of self-dealing if the
    compensation is not excessive. This rule applies without regard to whether the
    person who receives the compensation is an individual.

    Treas. Reg. § 53.4941(d)-3(c)(2) provides examples of “personal services” for
    purposes of Treas. Reg. § 53.4941(d)-3(c)(1). These include legal services,
    investment counseling services, and general banking services.

    In Madden v. Commissioner, 74 T.C. Memo 1997-395, the Tax Court ruled that
    maintenance, janitorial, and security services provided by a disqualified person to
    a private foundation are not “personal services” that are necessary to carrying out
    the exempt purposes of a private foundation for purposes of the exception to self-
    dealing. Citing the legislative history of § 4941, the Court noted that one of
    Congress’s stated goals in enacting § 4941 was to minimize the need for an
    arm’s-length standard by generally prohibiting self-dealing transactions between
    private foundations and disqualified persons and that any exceptions to the self-
    dealing transaction rules should be construed narrowly. The Court characterized
    the services described in the regulations under § 4941 as essentially professional
    and managerial in nature, and concluded that maintenance, janitorial, and
    custodial services do not meet the definition of “personal services” allowed under
    § 4941.

    Founder is a substantial contributor, as defined in § 507(d)(2), and therefore, is a
    disqualified person with respect to Foundation as described in section
    4946(a)(1)(A). Thus, any direct or indirect payment of compensation to Founder
    by Foundation will constitute an act of self-dealing unless an exception applies.
    Because A and B are disregarded as entities separate from their owners within
PLR-119677-18                                7

    the meaning of Treas. Reg. § 301.7701-3, any payments of compensation by
    Foundation to either of them are considered to be payments to Founder.
    -----------------------------------------. Founder, through A, which is a disregarded
    entity, employs individuals who provide a variety of services to Foundation. In
    order to carry out its exempt purposes, Foundation requires the services of
    individuals such as those employed by Founder through A, who provide the
    services described above to Foundation.

    Payment of compensation by a private foundation to a disqualified person
    generally is an act of self-dealing under § 4941(d)(1)(D). However,
    § 4941(d)(2)(E) provides an exception to self-dealing for the payment of
    compensation by a private foundation to a disqualified person for personal
    services which are reasonable and necessary to carrying out the exempt
    purposes of the private foundation if the compensation is not excessive.

    Treas. Reg. § 53.4941(d)-3(c)(2) provides examples of allowable personal
    services that consist of legal services, investment counseling services, and
    general banking services. Additionally, Madden v. Commissioner, supra,
    indicates that services that are professional and managerial in nature are types of
    personal services that are permitted under § 4941.

    Foundation will enter into a services agreement to hire A to perform certain
    charitable program, grant-making and consulting services. Unlike the
    maintenance, janitorial, and custodial services described in Madden v.
    Commissioner, supra, the grant-making, consulting, investment, and
    management services that directly further charitable purposes are provided to
    Foundation by Founder through A (a disregarded entity) and are professional and
    managerial services. The programmatic, grant-making and consulting services
    are reasonable and necessary services that enable Foundation to carry out its
    charitable purposes. As such, they fall within the exception to the self-dealing
    rules for “personal services” described in § 4941(d)(2)(E) as long as the
    compensation is not excessive in relation to the services provided.

    The services agreement also will include a provision that permits A to hire B to
    provide investment services. This situation is similar to the example in Treas.
    Reg. § 53.4941(d)-3(c)(2), Example (2), in which a manager of a private
    foundation who owned an investment counseling business provided investment
    services directly to the private foundation and was paid compensation for those
PLR-119677-18                               8

    services. Consequently, payments by Foundation to A for B’s investment
    services provided to Foundation will be payment for reasonable expenses
    necessary to carry out the exempt purposes of Foundation as long as the
    compensation is necessary and reasonable to carrying out Foundation’s
    investment program and not excessive under § 4941(d)(2)(E).

    Accordingly, payment to A by Foundation of a reasonable fee for the described
    services will not constitute a prohibited act of self-dealing within the meaning of
    § 4941 as long as the amount of the payment is not excessive.

    Issue 3 – Whether payment by Foundation of a fee to A for programmatic, grant-
    making, and charitable consulting services will be considered a qualifying
    distribution under § 4942.

    Section 4942(a) imposes a tax on the undistributed income of a private foundation
    for any taxable year.

    Section 4942(g)(1)(A) defines “qualifying distribution” to mean, in part, any
    amount (including that portion of reasonable and necessary administrative
    expenses) paid to accomplish one or more purposes described in § 170(c)(2)(B).
    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 . . ., or for the prevention of cruelty to children or animals.”
    These purposes are the same purposes listed in § 501(c)(3).

    Assuming that Foundation’s payment to A for programmatic, grant-making,
    consulting, and other expenses listed above will be paid to accomplish one or
    more purposes described in § 170(c)(2)(B), such expenses will be considered
    qualifying distributions under § 4942.

    Issue 4 – Whether expenditures by Foundation for the programmatic, grant-
    making and charitable consulting services listed above will constitute taxable
    expenditures under § 4945.

    Section 4945 generally imposes a tax on taxable expenditures made by a private
    foundation.

    Section 4945(d)(5) provides that a “taxable expenditure” includes any amount
PLR-119677-18                                 9

    paid or incurred by a private foundation for any purpose other than one specified
    in § 170(c)(2)(B).

    Treas. Reg. § 53.4945-6(b)(1)(v) provides, in part, that any payment that
    constitutes a qualifying distribution under § 4942(g) ordinarily will not be treated
    as a taxable expenditure under § 4945(d)(5).

    As determined above (see Issue 3), funds expended by Foundation for
    programmatic, grant-making, and charitable consulting services will be qualifying
    distributions under § 4942. As qualifying distributions, these expenditures will not
    be treated as taxable expenditures under § 4945(d)(5), and will not subject
    Foundation to excise tax under § 4945.

    RULINGS

    Based on the information submitted and the representations contained in the
    request for rulings and supplemental submissions, we rule that:

       1. Payment by Foundation of a fee to Founder through A, a disregarded
          entity, for programmatic and grant-making services will not be an act of
          self-dealing between Foundation and Founder, a disqualified person,
          because it is the type of payment described in § 4941(d)(2)(E) and Treas.
          Reg. § 53.4941(d)-3(c)(1) for services that are reasonable and necessary
          to carrying out the exempt purposes of Foundation if the amount of each
          such payment is not excessive.

       2. Payment by Foundation of a fee to Founder through A, a disregarded
          entity, for services to enable Foundation to engage in charitable consulting
          activities, including (i) program-related consulting provided to other
          charities, (ii) ------------------------------------------------------------, and (iii)
          investment consulting provided to other charities will not be an act of self-
          dealing between Foundation and Founder, a disqualified person, because
          it is the type of payment described in § 4941(d)(2)(E) and Treas. Reg.
          § 53.4941(d)-3(c)(1) for services that are reasonable and necessary to
          carrying out the exempt purposes of Foundation if the amount of each such
          payment is not excessive.

       3. Foundation’s expenditures for the programmatic, grant-making, and
PLR-119677-18                               10

           consulting services listed above will be considered qualifying distributions
           under §4942(g).

       4. Foundation’s expenditures for the programmatic, grant-making, and
          consulting services listed above will not constitute taxable expenditures
          described in § 4945.

    The rulings contained in this letter are based upon information and
    representations submitted by the taxpayer and accompanied by penalty of perjury
    statements executed by an individual with authority to bind the taxpayer, and
    upon the understanding that there will be no material changes in the facts.

    No opinion is expressed or implied concerning whether the proposed payments
    for services will be excessive.

    This office has not verified any of the material submitted in support of the request
    for rulings, and such material is subject to verification on examination. The
    Associate office will revoke or modify a ruling and apply the revocation
    retroactively if there has been a misstatement or omission of controlling facts; if
    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, if the controlling facts change during the
    course of the transaction. See Rev. Proc. 2019-1, § 11.05.

    No ruling is granted as to whether Foundation qualifies as an organization
    described in § 501(c) or § 509(a).

    This letter does not address the applicability of any section of the Code or
    Regulations to the facts submitted other than with respect to the sections
    specifically described, and, except as expressly provided above, no opinion is
    expressed or implied concerning the federal income or excise tax consequences
    of any other aspects of any transaction or item of income set forth in this letter.
    Because it could help resolve questions concerning federal income tax status, this
    letter should be kept in Foundation’s permanent records.

    A copy of this letter must be attached to any tax or information return to which it is
    relevant. Alternatively, if Foundation files its return electronically, this requirement
    may be satisfied by attaching a statement to the return that provides the date and
PLR-119677-18                              11

    control number of this letter.

    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 Foundation’s authorized representatives.

    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.

    Sincerely,




    Mike Repass
    Senior Technician Reviewer
    Exempt Organizations Branch 3
    (Employee Benefits, Exempt Organizations, and Employment Taxes)