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What's New With Private Foundations?

This series of articles will discuss what’s new in the private foundation tax world, common missteps that occur and complex rules that are easily misunderstood. Having this knowledge will help you and your family avoid the risks and embarrassment, time and money to defend and explain and correct, should your foundation receive the spotlight.

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This series of articles will discuss what’s new in the private foundation tax world, common missteps that occur and complex rules that are easily misunderstood. Having this knowledge will help you and your family avoid the risks and embarrassment, time and money to defend and explain and correct, should your foundation receive the spotlight.

Private foundations are charitable entities that have long flown under the radar screen at the IRS. Some current events may change all that.

Recently there’s been tax publicity regarding some high-profile foundations, such as the Donald J. Trump Foundation, The Clinton Foundation and Newman’s Own Foundation founded by Paul Newman. The Internal Revenue Service (the “IRS”) also issued guidance at the end of 2017. There was a proposed tax reform provision to change the private foundation tax to a single rate of 1.4%. Additionally, the IRS’s fiscal year 2018 workplan says that now every Form 990-PF, Return of Private Foundation, will go through data screening.

All of these events mean that private foundations are getting more attention and are becoming less private.

This series of articles will discuss what’s new in the private foundation tax world, common missteps that occur and complex rules that are easily misunderstood. Having this knowledge will help you and your family avoid the risks and embarrassment, time and money to defend and explain and correct, should your foundation receive the spotlight.

The type of foundation we’re addressing in this article series is simply the typical grant-making family or company foundation. But the rules are anything but simple.

Tax savings; maintaining control of the gifting; bunching tax deductions; and nurturing, expressing and passing along a legacy of charitable values to children, grandchildren, or employees are all motivations for establishing private foundations. But the primary reason for having a private foundation is philanthropy – otherwise they would just keep the money or do something else with it. Founders want to do good, support charitable causes and make the world a better place.

Private foundations and public charities are both Section 501(c)(3) entities, but private foundations are different than public charities. Private foundations receive their funding, their support, from just a few people, sometimes just one funder, a family, one person or one company. These founders, funders, foundation managers, as well as their family members and related companies, are called “disqualified persons.”

Grant-making or “non-operating” private foundations, the subject of this article series, make grants and have an annual grant-making requirement. Public charities and “operating” private foundations (“public charities”) usually operate charitable activities and programs. Public charities may make grants and may have the word “foundation” in their names, but unlike grant-making private foundations, public charities are not required to make grants.

Although private foundations are also tax exempt under Section 501(c)(3) of the Internal Revenue Code, they will often have tax due. Private foundations are subject to an excise tax requirement – and need to pay 2% excise tax on their net investment income. If they meet a certain test, the 2% excise tax rate is reduced to 1%.

What’s new with private foundations?

The IRS continues to post private foundation “Snapshots” on its Tax Exempt and Government Entities (TEGE) website, which are summaries of specific private foundation tax issues. There are currently approximately ten private foundation snapshots you can find by clicking here. The IRS has also posted its Audit Technique Guide (ATG) for private foundations that can be found here. These are very useful tools for private foundation management and their tax advisors, but they’re meant to be resources for IRS examiners to use in their audits of private foundations.

The IRS also issued private foundation tax guidance in September and December of 2017 that made the tax news.

In September, the IRS outlined in Revenue Procedure 2017-53 how private foundations may apply the “equivalency” test for making grants to foreign grantees. Foreign grants continue to be administratively very burdensome for private foundations to make. The equivalency test is used to determine if the foreign grantee is equivalent to a qualified U.S. public charity.

In December, the IRS described in Notice 2017-73 how a foundation’s payment for tickets to a fundraising event, for example, a dinner or gala, may result in impermissible benefit for the foundation – even if the foundation manager personally pays for the dinner and the foundation pays the charitable contribution portion of the ticket. The notice also indicated that tax commentators consider a private foundation’s grant made in satisfaction of a disqualified person’s pledge to a charity to be prohibited.

The philanthropic and tax worlds buzz constantly about the similarities and differences between donor-advised funds (“DAFs”) and private foundations – and even more so now.

A donor-advised fund is sponsored by a public charity that generally allows donors to make grant recommendations for amounts they’ve donated to the sponsoring charity. Some very large financial institutions have set up sponsoring charities that run DAF programs.

DAFs have become wildly popular, in particular because of tax reform legislation that increased the standard deduction for individual taxpayers. Taxpayers use DAFs to bunch their charitable contributions in one year, so they may receive tax benefits for their donations that would otherwise fall below the standard deduction if contributions are over more than one year.

Donors recommend DAFs to pay out charitable contributions to charities over time. Private foundations can also be used for bunching donations, and can pay out grants over time, but private foundations are required to make specific annual grant distributions.

IRS Notice 2017-73 requested comments on various private foundation and donor-advised fund issues, including how private foundations use donor-advised funds in support of their purposes and if a private foundation should be allowed to treat a grant to a DAF as a qualifying distribution only if the DAF is paid out to other charities within a certain timeframe. These issues shine more light on both types of charities.

One popular tax proposal for 2017 tax reform that did not pass, likely because of budgetary balancing, was to allow a flat 1.4% net investment excise tax rate for all private foundations, rather than the 2% or 1% rate. This has been a popular proposal in the past, too, with little contesting. So hopefully at some point it will pass.

The “Newman’s Own” exception is another private foundation tax proposal that didn’t originally pass with the December 2017 tax legislation. But it passed in February with the Bipartisan Budget Act of 2018. Private foundations have several strict tax rules, including the prohibition on having excess business holdings. If the private foundation’s excess business holdings are not sold or disposed of within a certain amount of time, generally five years, the excess business holdings rule can result in a 200% excise tax!

Luckily, Newman’s Own and other private foundations that own 100% of voting stock of for-profit businesses, if acquired by gifts or bequests, can now continue to hold the stock if the business enterprises have independent board members and managers and they distribute all net operating income to the foundations shortly after year end.

Lastly, the IRS’s FY 2018 Workplan for tax exempt entities includes a compliance program using data-driven approaches. The IRS plans to continue to improve its 990-PF compliance models, among others, and plans to “continue to examine private foundations based on potential anomalies found on their Form 990-PF filings.”

It’s a new era – with the IRS’s data-driven algorithms for selection for examination, tax guidance and legislation for private foundations – foundations may find themselves front and center.

So that’s what’s new with private foundations.

In the next section of this private foundation series, we will discuss what can go wrong, and how some of the rules are anything but simple. All of this will help you and your foundation avoid unfavorable attention and be more at ease finding enjoyment in your foundation’s philanthropic accomplishments.

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