IRS approves a school-construction set-aside

Plain-English summary

A private foundation requested approval to set aside funds for construction of a school building serving minority and underprivileged children. The multi-year project included classrooms, a welcome center, a sensory gym, a playground, offices, and related construction and professional costs. The foundation explained that immediate payment was impractical because construction would span several years, contractor payments would depend on progress, and the amount was large compared with its historical assets and income. The IRS found that the project satisfied the Section 4942 suitability test for a set-aside and approved the program. The foundation must pay the set-aside amount within 60 months after the first set-aside.

Ruling snapshot

• Question: Could the private foundation treat funds reserved for a multi-year school construction project as a qualifying set-aside?
• Outcome: Approved.
• Key authorities: IRC §§ 170(c)(2)(B) and 4942(g)(2); Treas. Reg. § 53.4942(a)-3(b); Rev. Rul. 74-450

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
P.O. Box 2508
Cincinnati, OH 45201

Number: 202126030
Release Date: 7/2/2021

Employer Identification Number:

Date: April 5, 2021

Contact Person - ID Number:

Contact Telephone Number:

LEGEND:

B = Date
C = Location
x dollars = Amount
y = Number

UIL: 4942.03-07

Dear [redacted]:

Why you are receiving this letter

This is our response to your June 30, 2020 letter requesting approval of a set-
aside under Internal Revenue Code Section 4942(g)(2). You’ve been recognized
as tax-exempt under Section 501(c)(3) of the Code and have been determined to
be a private foundation under Section 509(a).

Our determination

Based on the information furnished, your set-aside program is approved under
Internal Revenue Code Section 4942(g)(2). As required under Section 4942(g)(2),
the set aside amount must be paid within the 60-month period after the date of the
first set-aside.

Description of set-aside request

You have requested a set-aside of x dollars for the tax year ending B. Your
mission is to support the education and the general betterment of the quality of life
for minority and underprivileged children.

The purpose of the set aside is to provide funding for the construction of a school
building in order to further your mission by providing a physical location in which
high-quality early education programs can operate and support families primarily in
the city of C. The school building will have more than y thousand square feet of
space, including numerous oversized classrooms, a welcome center, a sensory
gym, an outdoor playground and administrative offices. Final plans have already
been approved by C.

The set amount will be used primarily to pay the primary contractor and
construction expenses, but also will be used to pay for construction services and
consulting services, surveys and studies including environmental, soil, and traffic,
accounting and legal expenses, insurance, furniture and other needed
miscellaneous services and supplies.

The construction of the educational building can be better accomplished by a set-
aside rather than by an immediate payment of funds because the construction of
the school building will span multiple years. In addition, for these types of
construction projects, it is generally not customary and feasible to make all
payments required within a single year. It would also not be prudent to pay the
construction contractors the total amount prior to the completion of the entire job.

The set-aside approach will allow you to maximize control over the project, with
the goal of achieving a better result. Additionally, the set aside amount is a very
large sum in relation to your historical assets and income.

You provided a statement indicating that the set-aside will actually be paid within a
specified time period not to exceed 60 months from the date of the first set aside.

Basis for our determination

Internal Revenue Code Section 4942(g)(2)(A) states that an amount set aside for
a specific project, which includes one or more purposes described in Section
170(c)(2)(B), may be treated as a qualifying distribution if it meets the
requirements of Section 4942(g)(2)(B).

Section 4942(g)(2)(B) of the Code states that an amount set aside for a specific
project will meet the requirements of this subparagraph if, at the time of the set-
aside, the foundation establishes that the amount will be paid within five years and
either clause (i) or (ii) are satisfied.

Section 4942(g)(2)(B)(i) of the Code is satisfied if, at the time of the set-aside, the
private foundation establishes that the project can better be accomplished using
the set-aside than by making an immediate payment.

Section 53.4942(a)-3(b)(1) of the Foundations and Similar Excise Taxes
Regulations provides that a private foundation may establish a project as better
accomplished by a set-aside than by immediate payment if the set-aside satisfies
the suitability test described in Section 53.4942(a)-3(b)(2).

Section 53.4942(a)-3(b)(2) of the Foundations and Similar Excise Taxes
Regulations provides that specific projects better accomplished using a set-aside
include, but are not limited to, projects where relatively long-term expenditures
must be made requiring more than one year’s income to assure their continuity.

In Revenue Ruling 74-450, 1974-2 C.B. 388, an operating foundation converted a
portion of newly acquired land into a public park under a four-year construction
contract. The construction contract payments were to be made mainly during the
final two years. This constituted a “specific project.” The foundation’s set-aside of
all its excess earnings for four years was treated as a qualifying distribution under
Internal Revenue Code Section 4942(g)(2).

What you must do

Your approved set-aside(s) will be documented on your records as pledges or
obligations to be paid by the date specified. The amounts set aside will be taken
into account to determine your minimum investment return under Internal Revenue
Code Section 4942(e)(1)(A), and the income attributable to your set aside(s) will
also be taken into account in computing your adjusted net income under Section
4942(f) of the Code.

Additional information

This determination is directed only to the organization that requested it. Internal
Revenue Code Section 6110(k)(3) provides that it may not be used or cited as a
precedent.

Please keep a copy of this letter in your records. We have sent a copy of this letter
to your representative as indicated in your power of attorney.

If you have any questions, please contact the person listed in the heading of this
letter.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosure