Charity's sale and restricted grant of subsidiary stock avoid UBTI and excess-benefit treatment

Plain-English summary

A public charity proposed separating one charitable program into a newly formed nonprofit organization that it controlled as sole member. It would transfer program assets and stock of a wholly owned for-profit subsidiary to the new organization, partly through a fair-market-value sale and partly through a restricted grant. The IRS ruled that the one-time stock sale was not a regularly carried-on business activity and the stock was not debt-financed property, so the sale would not produce unrelated business taxable income. The restricted grant would further charitable purposes because the agreement limited use of the assets and stock proceeds and required reporting, records, return of unused funds, and expenditure responsibility. The new organization was not a disqualified person with respect to the charity because it did not exercise substantial influence over the charity, so neither the sale nor grant was an excess benefit transaction.

Ruling snapshot

• Question: Would the subsidiary-stock sale and restricted grant create UBTI, fail to further exempt purposes, or constitute an excess benefit transaction?
• Outcome: Approved on all three requested rulings.
• Key authorities: IRC §§ 501(c)(3), 512(a), 514, 4945(h), 4958; Rev. Rul. 68-489

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202133014 Third Party Communication: None
Release Date: 8/20/2021 Date of Communication: Not Applicable
Index Numbers: 501.03-00, 512.00-00,
4958.00-00 Person To Contact:
----------------------, ID No. -----------------
---------------------------------------- Telephone Number:
-------------------------- --------------------
----------------------------------------- Refer Reply To:
CC:EEE:EOET:EO2
PLR-104507-20
Date:
August 14, 2020

LEGEND:

Taxpayer = ----------------------------------------
Year 1 = -------
Subsidiary = ----------
Organization = -------------
Date 1 = ---------------------------
State = -------------
X = --------------

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

This letter ruling is in response to a request from your authorized representatives dated
January 13, 2020 and subsequent documentation dated June 16, 2020 requesting
rulings under sections 501(c)(3), 512, and 4958 of the Internal Revenue Code.

FACTS

Taxpayer is a State nonstock, nonprofit corporation described in section 501(c)(3)
and classified as a public charity under section 509(a)(2). Taxpayer’s purposes are to
engage exclusively in charitable activities within the meaning of section 501(c)(3),
including:

•   -------------- ---------------------------------------------------------------------------------------------
    ------------------------------------------------------------------------------------------------------------
    ----------------------------------------------------------------------------------------

PLR-104507-20 2

•    ------------------------------------------------------------------------------------------------------------
     ------------------
•    ------------------------------------------------------------------------------------------------------------
     ------------------------------------------------------------------------------------------------------------
     --------------------------------------------------------------------------------------------------------- --
     ------------------------------------------------------------------------------------------------------------
     -----------------.

Taxpayer’s members, consisting of ---------------------------------------------------------------------

--------------------------------------------------------------------- elect Taxpayer’s board of trustees.

Taxpayer engages ---------------------- activities in furtherance of its section 501(c)(3)
purposes. --------------------------------------- --------------------------------------------------------, -----

---------------------------------------- Through these activities, Taxpayer currently concentrates
its work in ------broad areas of focus - ------------------------------------------------------------------

Prior to Year 1, Taxpayer engaged in -------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------- ----

-----------------------------------------------------------------------.

Accordingly, following the receipt of a favorable private letter ruling from the Internal
Revenue Service in Year 1, Taxpayer transferred the assets and liabilities associated
with its ------------------------------------------------ activities to Subsidiary, a wholly owned for-
profit State stock corporation. Taxpayer did not incur any debt in connection with this
transaction and Taxpayer has represented that it has had no acquisition indebtedness,
within the meaning of section 514(c), with respect to its shares in Subsidiary. --------------

------------------------------.

Taxpayer has identified a pressing need for ---------------------------------------- -----------------
------------ --- -------------------------------------------------------------- -------- and intends to
significantly expand its -------------------------work to address that need. However,
Taxpayer recognizes that its ----------------------- activities must continue to serve as an
important tool in protecting --------------------------------------------------------------------------------
Many of Taxpayer’s ------------------------------------------------------------------------------------------

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------------------------------- Taxpayer has concluded that expanding its ---------------------------
program while maintaining the same quality and relevance of its -----------------------------
activities will be best accomplished by transferring its ------------------------operations to a
separate tax-exempt organization. This will allow each organization to be dedicated to
its mission-specific work.

To accomplish this separation, Taxpayer created Organization, a State nonstock,
nonprofit corporation, on Date 1. Taxpayer is the sole member of Organization and has
the power to elect the members of Organization’s board of directors. -------------------------

-------------------------------------------------------------. Organization’s purposes mirror those of
Taxpayer and Organization has applied for recognition as an organization described in -
----------------------- Taxpayer intends to transfer the assets associated with its ---------------
--------- activities to Organization as a restricted grant that will require Organization to
carry out such activities in a manner consistent with Taxpayer’s charitable mission.

Taxpayer has also determined that Subsidiary, as a --------------------------------------, is
more closely aligned with Taxpayer’s ------------------------activities than its --------------------
--------------- - activities. --------------------------------------------------------------------------------------

------------------------------- -------------------------------------------------------------------------------------

---------------------------------------------------------------------------------- --------. To that end,
Taxpayer proposes to transfer its Subsidiary stock to Organization, in part by restricted
grant and in part by sale to fund Taxpayer’s expanded-------------activities and its ----------
--------------- activities.

The amount of Subsidiary stock that Taxpayer will sell to Organization will be
determined based on Taxpayer’s projected funding needs and Taxpayer will receive fair
market value, as determined by an independent third party, for its sale of Subsidiary
stock. Taxpayer tentatively plans to sell enough Subsidiary stock to generate $X, which
Taxpayer expects will provide sufficient funding to support the expansion of its ------------

------------ activities and its --------------- activities following the transaction. Taxpayer
anticipates that it will accept a short-term note for the sale to allow Organization to
arrange for financing for its acquisition. Organization’s use of the proceeds of the
Subsidiary stock acquired by purchase will not be restricted.

Taxpayer will also make a restricted grant to Organization of the assets associated with
its ------------------------activities along with the remainder of the Subsidiary stock,

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pursuant to a written grant agreement. The grant agreement will restrict the use of the --
------------------------assets, ----------------------------------------------------------------------------------
--------------------- ------------------------ ------------ to carrying out ------------- activities
and engaging in other activities consistent with Taxpayer’s exempt purposes. Similarly,
the grant agreement will restrict the use of the Subsidiary stock transferred by grant to
carrying out ------------------------activities and engaging in other activities consistent with
Taxpayer’s exempt purposes. Specifically, the grant agreement will require Organization
to hold and apply all proceeds (e.g., dividends, income from disposition) from that stock
to further the ------------------------activities and other purposes consistent with Taxpayer’s
charitable mission. The grant agreement will also require Organization to provide
reports to Taxpayer --- ----------------------------------------------------------------------------and will
require Organization to maintain records showing that the grant proceeds are used in a
manner consistent with Taxpayer’s exempt purposes and pursuant to the terms of the
grant agreement.

The grant agreement will prohibit Organization from using the grant proceeds for any
purposes other than those set forth in the grant agreement and will require Organization
to return to Taxpayer any funds not used for the specified purposes. Taxpayer has
represented that its grant of Subsidiary stock and ------------------------assets to
Organization will be consistent with the requirements set forth in Rev. Rul. 68-489,
1968-2 C.B. 210, and the expenditure responsibility requirements of section 4945(h).

Taxpayer’s governance structure and the manner in which Taxpayer’s trustees are
elected will not change as a result of the restructuring. As Organization will be the sole
shareholder of Subsidiary after the restructuring, Organization will have the right to elect
Subsidiary’s board of directors. Taxpayer has further represented that after the
restructuring, Taxpayer’s president will not be an officer of Organization or Subsidiary,
and Organization’s executive director – who will oversee Organization’s
day-to-day management – will not be a director of Organization or an officer or director
of Taxpayer or Subsidiary. None of Taxpayer, Subsidiary, or Organization will control
the day-to-day management of any of the others.

Based on the documentation submitted and the facts and representations described
above, Taxpayer requested the following rulings.

RULINGS REQUESTED

1. Taxpayer’s sale of a portion of the Subsidiary shares to Organization will not
   result in unrelated business taxable income under section 512(a).
2. Taxpayer’s restricted grant to Organization of assets associated with its ------------
   ------------------------activities and the remainder of the Subsidiary shares will
   further exempt purposes under section 501(c)(3).
3. Taxpayer’s sale of the Subsidiary shares to Organization at fair market value and
   Taxpayer’s restricted grant to Organization of the ------------------------assets and

PLR-104507-20 5

   the remaining shares of Subsidiary will not result in an excess benefit transaction
   under section 4958(c)(1).

LAW

Ruling Request 1

Section 511(a)(1) imposes a tax for each taxable year on the unrelated business
taxable income (“UBTI”) of every corporation described in section 501(c)(3) and exempt
from taxation under Subtitle A by reason of section 501(a).

Section 512(a)(1) provides that UBTI consists of the gross income derived by any
organization from any unrelated trade or business regularly carried on by it, less the
deductions allowed by Chapter 1 that are directly connected with the carrying on of such
trade or business.

Treas. Reg. section 1.513-1(c)(1) states that for purposes of determining whether an
activity is “regularly carried on,” regard must be had to the frequency and continuity with
which the activities productive of the income are conducted and the manner in which
they are pursued. This requirement must be applied in light of the purpose of the
unrelated business income tax to place exempt organization business activities upon
the same tax basis as the nonexempt business endeavors with which they compete. For
example, specific business activities of an exempt organization will ordinarily be
deemed to be regularly carried on if they manifest a frequency and continuity, and are
pursued in a manner, generally similar to comparable commercial activities of
nonexempt organizations.

Treas. Reg. section 1.513-1(c)(2)(ii) provides that in determining whether or not
intermittently conducted activities are regularly carried on, the manner of conduct of the
activities must be compared with the manner in which commercial activities are normally
pursued by nonexempt organizations. In general, exempt organization business
activities that are engaged in only discontinuously or periodically will not be considered
regularly carried on if they are conducted without the competitive and promotional
efforts typical of commercial endeavors.

Treas. Reg. section 1.513-1(c)(2)(iii) provides that certain intermittent income-producing
activities occur so infrequently that neither their recurrence nor the manner of their
conduct will cause them to be regarded as trades or businesses regularly carried on.
For example, income-producing or fundraising activities lasting only a short period of
time will not ordinarily be treated as regularly carried on if they recur only occasionally
or sporadically.

The court in Museum of Flight Foundation v. United States, 63 F. Supp. 2d 1257 (W.D.
Wash. 1999), applied the regularly carried on requirement in the context of a one-time
lease of a donated Boeing 747 jet by the Museum of Flight Foundation to Boeing.

PLR-104507-20 6

Boeing donated the jet to the museum in 1990 and the museum began work to restore
the aircraft for permanent display. Shortly after Boeing donated the aircraft, Boeing
identified the need for a test bed airframe for new jet engines. Boeing did not have a
usable model of its own, nor could it obtain one from a commercial leasing company
because the aircraft would not have been airworthy after modifications that had to be
made for the testing. Boeing sought to lease the jet back from the museum, which
would not be concerned about the jet’s subsequent airworthiness, and the museum
agreed to lease the jet back to Boeing for a two-year term, which was extended slightly.
The museum had never before or since leased aircraft for testing or any other purpose.
The court concluded that the lease was not an activity that was regularly carried on
because it was a one-time, completely fortuitous lease of unique equipment that was
unavailable on the open market.

Section 512(b)(4) provides that in the case of debt-financed property (as defined in
section 514) there shall be included, as an item of gross income derived from an
unrelated trade or business, the amount ascertained under section 514(a)(1), and there
shall be allowed, as a deduction, the amount ascertained under section 514(a)(2).

Section 514(b)(1) defines “debt-financed property” as any property held to produce
income and with respect to which there is an acquisition indebtedness at any time
during the taxable year (or, if the property was disposed of during the taxable year, with
respect to which there was an acquisition indebtedness at any time during the 12-month
period ending with the date of such disposition).

Section 514(c)(1) provides that “acquisition indebtedness” means, with respect to any
debt-financed property, the unpaid amount of:
(A) The indebtedness incurred by the organization in acquiring or improving such
property;
(B) The indebtedness incurred before the acquisition or improvement of such
property if such indebtedness would not have been incurred but for such
acquisition or improvement; and
(C) The indebtedness incurred after the acquisition or improvement of such property
if such indebtedness would not have been incurred but for such acquisition or
improvement and the incurrence of such indebtedness was reasonably
foreseeable at the time of such acquisition or improvement.

Ruling Request 2

Rev. Rul. 68-489 provides that an organization exempt from federal income tax under
section 501(c)(3) will not jeopardize its tax-exempt status by distributing funds to
organizations not themselves described in section 501(c)(3), provided the organization:
• Retains control and discretion as to the use of the funds;
• Maintains records establishing the funds were used for section 501(c)(3)
purposes; and
• Limits distributions to specific projects that further its own exempt purposes.

PLR-104507-20 7

Rev. Rul. 68-489 was published before the enactment of the Tax Reform Act of 1969,
Pub. L. 91-172, which added certain provisions governing grantmaking by private
foundations, including section 4945.

Section 4945(a) imposes an excise tax on each taxable expenditure of a private
foundation.

Section 4945(d)(4) provides that the term “taxable expenditure” includes any amount
paid or incurred by a private foundation as a grant to a noncharitable organization
unless the foundation exercises expenditure responsibility with respect to such grant in
accordance with section 4945(h).

Section 4945(h) states that the term “expenditure responsibility” means that the private
foundation is responsible to exert all reasonable efforts and to establish adequate
procedures to see that the grant is spent solely for the purpose for which made, to
obtain full and complete reports from the grantee on how the funds are spent, and to
make full and detailed reports with respect to such expenditures to the Secretary. See
also Treas. Reg. section 53.4945-5.

Ruling Request 3

Section 4958(a)(1) imposes an excise tax on each excess business transaction
between an applicable tax-exempt organization and a disqualified person.

Section 4958(c)(1)(A) defines an “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,” in part, as any
organization that (without regard to any excess benefit) would be described in
paragraph (3), (4), or (29) of section 501(c) and exempt from tax under section 501(a).
Such term does not include a private foundation (as defined in section 509(a)).

Section 4958(f)(1)(A) defines a “disqualified person” with respect to any transaction as
including 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. Treas. Reg. section 53.4958-3(c) lists certain persons deemed to be in
a position to exercise substantial influence over the affairs of an organization, Treas.
Reg. section 53.4958-3(d) lists certain persons deemed not to be in a position to
exercise substantial influence over the affairs of an organization, and Treas. Reg.
section 53.4958-3(e)(1) provides that in all other cases, whether a person is in a
position to exercise substantial influence over an applicable tax-exempt

PLR-104507-20 8

organization depends upon all relevant facts and circumstances.

Treas. Reg. section 53.4958-3(c)(1), (2), and (3) provide, in relevant part, that the
following persons are deemed to be in a position to exercise substantial influence over
the affairs of an applicable tax-exempt organization:
(1) Voting members of the governing body;
(2) Presidents, chief executive officers, and chief operating officers, including any
person who, regardless of title, has ultimate responsibility for implementing the
decisions of the governing body or for supervising the management,
administration, or operation of the organization; and
(3) Treasurers and chief financial officers, including any person who, regardless of
title, has ultimate responsibility for managing the finances of the organization.

Treas. Reg. section 53.4958-3(e)(2) provides that facts and circumstances tending to
show that a person has substantial influence over the affairs of an organization include,
but are not limited to, the following:
(i) The person founded the organization;
(ii) The person is a substantial contributor to the organization (within the meaning
of section 507(d)(2)(A)), taking into account only contributions received by the
organization during its current taxable year and the four preceding taxable
years;
(iii) The person’s compensation is primarily based on revenues derived from
activities of the organization, or of a particular department or function of the
organization, that the person controls;
(iv) The person has or shares authority to control or determine a substantial portion
of the organization’s capital expenditures, operating budget, or compensation
for employees;
(v) The person manages a discrete segment or activity of the organization that
represents a substantial portion of the activities, assets, income, or expenses of
the organization, as compared to the organization as a whole;
(vi) The person owns a controlling interest (measured by either vote or value) in a
corporation, partnership, or trust that is a disqualified person; or
(vii) The person is a nonstock organization controlled, directly or indirectly, by one or
more disqualified persons.

Treas. Reg. section 53.4958-3(e)(3) provides that facts and circumstances tending to
show that a person does not have substantial influence over the affairs of an
organization include, but are not limited to, the following:
(i) The person has taken a bona fide vow of poverty as an employee, agent, or on
behalf, of a religious organization;
(ii) The person is a contractor (such as an attorney, accountant, or investment
manager or advisor) whose sole relationship to the organization is providing
professional advice (without having decision-making authority) with respect to
transactions from which the contractor will not economically benefit either

PLR-104507-20 9

     directly or indirectly (aside from customary fees received for the professional
     advice rendered);

(iii) The direct supervisor of the individual is not a disqualified person;
(iv) The person does not participate in any management decisions affecting the
organization as a whole or a discrete segment or activity of the organization that
represents a substantial portion of the activities, assets, income, or expenses of
the organization, as compared to the organization as a whole; or
(v) Any preferential treatment a person receives based on the size of that person's
contribution is also offered to all other donors making a comparable contribution
as part of a solicitation intended to attract a substantial number of contributions.

ANALYSIS

Ruling Request 1

Taxpayer is a corporation described in section 501(c)(3) and exempt from taxation
under Subtitle A by reason of section 501(a), and therefore is subject to the unrelated
business income tax imposed by section 511(a)(1) on its UBTI. Specifically, Taxpayer is
subject to the unrelated business income tax on gross income derived from any
unrelated trade or business regularly carried on, less certain allowable deductions
directly connected with that trade or business.

Taxpayer formed Subsidiary in Year 1 ------------------------------------------and owns 100
percent of Subsidiary’s stock. As part of a proposed restructuring, Taxpayer intends to
fully divest of Subsidiary by transferring the Subsidiary stock to Organization, in part by
restricted grant and in part by sale at fair market value.

The proposed sale does not manifest a frequency and continuity and is not being
pursued in a manner similar to comparable commercial activities of nonexempt
organizations. See Treas. Reg. section 1.513-1(c)(1). Instead, like in Museum of Flight
Foundation v. United States, Taxpayer’s sale will be a one-time, fortuitous event
involving a unique asset. See also Treas. Reg. section 1.513-1(c)(2)(iii). Further,
Taxpayer’s proposed sale does not feature the competitive and promotional efforts
typical of commercial endeavors. See Treas. Reg. section 1.513-1(c)(2)(ii). Accordingly,
Taxpayer’s sale of Subsidiary stock is not an activity that is regularly carried on.

Because Taxpayer’s sale of Subsidiary stock at fair market value is not an activity that is
regularly carried on, and because the Subsidiary stock is not debt-financed property,
gain or loss from Taxpayer’s sale of Subsidiary shares to Organization will not be
included in Taxpayer’s UBTI under section 512(a).

Ruling Request 2

Taxpayer’s grant to Organization will be subject to a written grant agreement restricting
the use of the ------------------------assets, the Subsidiary stock, and the proceeds from the

PLR-104507-20 10

Subsidiary stock (e.g., dividends, income from disposition) to activities consistent with
Taxpayer’s exempt purposes. Additionally, Taxpayer has represented that its grant will
be consistent with the requirements set forth in Rev. Rul. 68-489 and the expenditure
responsibility requirements of section 4945(h), both of which require that grants further
section 501(c)(3) purposes. Therefore, Taxpayer’s restricted grant of -------------------------
assets and the Subsidiary stock to Organization will further section 501(c)(3) purposes.

Ruling Request 3

As an organization described in section 501(c)(3) and classified as a public charity
under section 509(a)(2), Taxpayer is an applicable tax-exempt organization. See
section 4958(e)(1). Organization is not a person deemed to be in a position to exercise
substantial influence over the affairs of Taxpayer, nor is Organization deemed not to be
in a position to exercise substantial influence over the affairs of Taxpayer. See Treas.
Reg. section 53.4958-3(c), (d). Therefore, whether Organization is in a position to
exercise substantial influence over Taxpayer depends upon all relevant facts and
circumstances. See Treas. Reg. section 53.4958-3(e)(1). Taxpayer is Organization’s
sole member and has the power to elect the entirety of Organization’s board of
directors; as such Organization is not in a position to exercise substantial influence over
the affairs of Taxpayer. Accordingly, Organization is not a disqualified person with
respect to Taxpayer and Taxpayer’s sale of the Subsidiary shares to Organization at fair
market value and Taxpayer’s restricted grant to Organization of the ---------------------------
assets and the remaining shares of Subsidiary will not constitute excess benefit
transactions.

RULINGS

Based solely on the facts and representations submitted by Taxpayer, we rule as
follows:

1. Taxpayer’s sale of a portion of the Subsidiary shares to Organization will not
   result in unrelated business taxable income under section 512(a).
2. Taxpayer’s restricted grant to Organization of assets associated with its ------------
   ------------------------activities and the remainder of the Subsidiary shares will
   further exempt purposes under section 501(c)(3).
3. Taxpayer’s sale of the Subsidiary shares to Organization at fair market value and
   Taxpayer’s restricted grant to Organization of the ------------------------assets and
   the remaining shares of Subsidiary will not result in an excess benefit transaction
   under section 4958(c)(1).

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of Taxpayer and accompanied by penalty of perjury
statements executed by an individual with authority to bind Taxpayer and upon the
understanding that there will be no material changes in the facts. While this office has
not verified any of the material submitted in support of the request for these rulings, it is

PLR-104507-20 11

subject to verification on examination. The Associate Chief Counsel (Employee
Benefits, Exempt Organizations, and Employment Taxes) 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. 2020-1, 2020-1 I.R.B. 1,
section 11.05.

This letter does not address the applicability of any section of the Code or Regulations
to the facts submitted other than those sections specifically described. 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. For example, no opinion is expressed as to whether the short-term note that
Organization may issue in connection with its acquisition of Subsidiary stock is bona
fide debt, nor is any opinion expressed with respect to the implications of such a
characterization. Further, no opinion is expressed regarding the treatment or
consequences of any shared services or facilities agreements between Taxpayer,
Subsidiary, and/or Organization.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to Taxpayer’s authorized representatives.

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.

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.

PLR-104507-20 12

                                          Sincerely,


                                          James Zelasko
                                          Branch Chief
                                          Exempt Organizations Branch 2
                                          Employee Benefits, Exempt Organizations, and
                                          Employment Taxes

cc: ----------------------------------------------------------
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