Nonprofit Law Matters

New IRS Notification Requirement for Section 501(c)(4) Social Welfare Organizations

Posted in Formation & Tax Exempt Status, IRS, IRS, FTB & Attorney General Controversies, Unions, Associations, Clubs & Other Tax-Exempt Organizations

On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”).  The PATH Act contains several provisions of note for tax-exempt organizations.  This post focuses on a new notification requirement for organizations operating as social welfare organizations under Section 501(c)(4) of the Internal Revenue Code (“Code”).  (See our earlier post for information about PATH Act provisions addressing gift tax and certain charitable contribution incentives.)

Social welfare organizations exempt under Section 501(c)(4) are not organized for profit and are operated primarily to promote social welfare. They do not receive tax-deductible contributions and can lobby without limit, but partisan political activities (combined with any other non-social-welfare activities) must not be their primary activities.  (The IRS has embarked on an effort to produce new regulations clarifying the boundaries of political activity by social welfare and other non-charitable exempt organizations.  However, Section 127 of the PATH Act prohibits the IRS from using any funds appropriated during FY 2016 (Oct. 2015 – Sep. 2016) to “issue, revise, or finalize any regulation, revenue ruling, or other guidance . . . related to” the qualifications for exemption under Section 501(c)(4).)

Under prior law, an organization organized and operating as a 501(c)(4) organization could “self-declare” its tax-exempt status and begin filing annual returns on Form 990, without submitting a Form 1024 application for exemption and obtaining an IRS determination letter explicitly recognizing the organization’s qualification for such status, or otherwise notifying the IRS.

The PATH Act added new Code Section 506, which requires a social welfare organization to notify the IRS within 60 days of formation that it is operating under Section 501(c)(4). The new provision authorizes the IRS to establish a fee for filing the notice, although the IRS has not yet done so.

Section 506 states that the notice must include:

(1) The name, address and taxpayer identification number of the organization.

(2) The date on which, and the State under the laws of which, the organization was organized.

(3) A statement of the purpose of the organization.

The IRS must acknowledge receipt of the notice within 60 days. Both the notice and the IRS acknowledgement of receipt are subject to public disclosure under Section 6104.

Section 506 provides that organizations that are organized after the date of enactment, December 18, 2015, are subject to the new notice requirement. Organizations that were organized before the date of enactment but that have not yet applied for exemption or filed an annual return are also subject to the notice requirement, but have 180 days from the date of enactment to submit the notice.

However, as of the date of this post, the IRS has provided only minimal guidance regarding the manner of notice, stating that “Until these regulations are issued, organizations need not submit any notification.”  In addition, the statement indicates that the regulations, once issued, will include “transition rules that extend the 60- or 180-day period, as may be applicable, in order to comply with the regulations.”  We will monitor the IRS’s progress on the implementation of Section 506, and will post updates as more information becomes available.

Under Section 506, an organization that fails to submit the notice will be fined $20 per day until the notice is filed, up to $5,000. An individual manager of an organization that fails to submit notice after receiving a written demand from the IRS specifying a reasonable future date for submission will also be fined, personally, $20 per day up to $5,000.

As under existing law, 501(c)(4) organizations that want the additional certainty of an IRS determination may apply for recognition of exemption. Under the new law, however, such applications do not take the place of the required notice described in new Code Section 506. The Joint Committee on Taxation’s explanation of provisions (page 241) indicates that the application for determination of 501(c)(4) status will be “submitted on a new form (separate from Form 1024) that clearly states that filing such a request is optional.” As of the date of this post, this new form has not yet been released.

New Year, New Ventures: Keeping Up With Charitable Sales Promotions

Posted in IRS, FTB & Attorney General Controversies, Public Charities, Revenue Generating Activities

Readers may remember our blog post from 2012, Are You in a Commercial Co-Venture?, in which we described common scenarios that trigger state requirements for charities and companies engaged in commercial co-ventures (also known as charitable sales promotions, or cause marketing).  Over the years, we have seen the popularity of such ventures continue to rise, with state regulatory agencies challenged to monitor and enforce the rules applicable to commercial co-ventures.

A few significant changes have taken place since our 2012 post on this topic: Maine repealed its commercial co-venture statutes effective October 2013 (as reported here) and South Carolina introduced new registration requirements effective March 2014 (as reported here).  In addition, in late 2012, the New York Attorney General issued Five Best Practices for Transparent Cause Marketing. While the issued statement did not constitute a legislative change to New York’s existing statutes, it set forth the guidelines and principles by which the New York Attorney General would be monitoring promotions in its state.

The issuance of New York’s Best Practices guidelines was particularly effective, garnering the attention of a number of national charities. Notably, the best practices include guidance on “maintaining transparency in social media” – a concept generally lacking in state regulatory regimes. In fact, to date, state regulatory agencies have largely not kept up with charities and businesses in accommodating and regulating the ever-changing and innovative landscape of commercial co-venture campaigns, many of which reside entirely on the Internet.

We offer the following tips to companies and charities considering, or already engaging in, a charitable sales promotion. This list is not comprehensive and, of course, does not constitute legal advice.  For legal guidance on the rules and registration requirements applicable to your particular situation, we suggest you consult legal counsel.

Tips for companies and charities in commercial co-ventures:

  • Consider whether you can avoid qualifying as a commercial co-venturer subject to state registration and reporting requirements by de-linking the contribution from the consumer purchase. For example, if a company’s products solely state that the company is a “proud supporter of xyz charity,” without implying that a consumer’s use or purchase of the product triggers a donation, the promotion may be excluded from statutory definitions of a commercial co-venture. (Note, however, that public references to a charity’s name may require the charity’s advance consent.)
  • Start planning early! Most states regulating commercial co-ventures require that the promotion be registered in advance of its launch. This often means leaving at least several weeks to negotiate and execute a contract, obtain the appropriate signatures on the forms, and complete the filings.
  • If the promotion is on the Internet, available to purchasers across the U.S., then the promotion may be subject to the rules of all states regulating commercial co-ventures, even if the company or charity is not otherwise operating there.  A promotion can be limited to a specific geographic area, or can exclude certain states, by including an express statement to that effect.
  • Registration and reporting requirements can apply to both charities and commercial co-venturers. If you’re a charity benefiting from a promotion, don’t assume that the company is completing all of the paperwork. In fact, many of the forms require counter-signature by the charity before submission (including Hawaii, Massachusetts, New Hampshire, and South Carolina). In addition, the charity itself may need to be registered in certain states where the promotion is occurring.
  • For promotions in California, commercial co-venturer registration with the California Attorney General may be avoided if the company and charity/ies have a contract in place, in advance of the promotion, that includes certain specific obligations. (See California Government Code section 12599.2(b).)
  • The Illinois Attorney General requires registration and reporting by charities and co-venturers, despite the fact that neither Illinois’ statutes nor its existing forms explicitly refer to commercial co-ventures or charitable sales promotions.
  • If you do have a commercial co-venture, refer to New York’s Five Best Practices for Transparent Cause Marketing in planning and publicizing the promotion; these best practices are a good starting point for compliance.

PATH Act Provides Certainty Regarding Gifts to 501(c)(4), 501(c)(5) and 501(c)(6) Tax-Exempt Organizations and Makes Permanent Certain Tax “Extenders”

Posted in Charitable Gift Planning, Unions, Associations, Clubs & Other Tax-Exempt Organizations

On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”).  The PATH Act contains several provisions of note for tax-exempt organizations.  This post focuses on two:  (1) gift tax consequences of contributions to 501(c)(4), (c)(5), and (c)(6) organizations, and (2) permanent enactment of certain tax “extenders” intended to incentivize charitable giving.

Contributions to 501(c)(4), (c)(5), and (c)(6) Organizations Exempt from Federal Gift Tax.

The PATH Act has finally cleared up the uncertainty that has lingered over the last few years regarding whether contributions to organizations exempt from income tax under IRC Sections 501(c)(4), (c)(5), and (c)(6) were subject to federal gift tax.  (We had previously written about this uncertainty and issued a client alert.)  The PATH Act provides that contributions (of cash or property) to these organizations are not subject to federal gift tax.  However, the newfound certainty is only available for gifts made after December 18, 2015.

Tax Extenders Made Permanent.

The PATH Act enacts a number of tax provisions intended to incentivize charitable giving, including:

  • The ability to make tax-free distributions from individual retirement plans (IRAs) directly to tax-exempt charities (the so-called “IRA Rollover”). These rollovers are subject to certain limitations, such as a $100,000 per year cap, a minimum participant age of 70-1/2, and the recipient may not be a private foundation, supporting organization, or a donor-advised fund.
  • Increased charitable deduction limits for contributions by individuals or corporations of real property interests for conservation purposes (the adjusted gross income limit for appreciated property gifts is increased to 50% – from 30% – and the carryforward limit is extended from five years to 15 years).

The PATH Act also includes several other charitable giving provisions, slightly modified from their previous versions.  Anyone intending to take advantage of the PATH Act’s permanent tax extenders should consult his or her tax advisor.

New Law Eases Dissolution of Inactive California Nonprofit Corporations.

Posted in AG, IRS, FTB, & Property Tax Proceedings, Formation & Tax Exempt Status, IRS, FTB & Attorney General Controversies, Nonprofit Governance & Ethics

California’s nonprofit sector is vibrant and lively.  Nonprofit entrepreneurs form new entities in California every day, with great hopes for garnering support and tackling society’s pressing problems or serving constituencies with specialized needs.

Nonetheless, despite good ideas and best intentions, sometimes things just don’t work out as planned.  When that happens, nonprofit founders are stuck with regulatory compliance obligations associated with maintaining a nonprofit corporation, or they must embark on a potentially cumbersome process of dissolution.

A new law in California, AB 557, makes it easier to get out from under the consequences of a failed nonprofit enterprise in two ways:  streamlined dissolution, and administrative dissolution/surrender.

Streamlined Dissolution

To be eligible for streamlined dissolution, which is available as of January 1, 2016, the dissolving corporation must file the new Domestic Nonprofit Corporation Short Form Certificate of Dissolution (Form DSF NP) within 24 months of the date of incorporation.  In addition, the filer must declare, under penalty of perjury, all of the following (using statutory language set forth on the Form):

  • The corporation has no debts or other liabilities (other than tax liability, or as provided in California Corporations Code section 6610.5(d), 8610.5(d) or 9680.5(d));
  • The corporation’s tax liability, if any, will be satisfied on a taxes-paid basis or assumed by a person, corporation, or other business entity;
  • The final tax return has been or will be filed with the Franchise Tax Board (“FTB”);
  • The corporation was created in error;
  • The corporation has not issued memberships, and if the corporation has received payments for memberships, those payments have been returned to those making payments;
  • The majority of the directors (or incorporators, if directors were not named and none have been elected) authorized the dissolution and elected to dissolve the corporation; and
  • The assets have been distributed to the persons entitled thereto or no assets have been acquired.

A nonprofit corporation that successfully dissolves using this process may also be entitled to abatement of taxes, interest, and penalties assessed for taxable years in which the nonprofit corporation certifies that it was not doing business.  See new Section 23156 of the California Revenue and Taxation Code for more information about abatement.

The streamlined dissolution procedures are set forth in new Sections 6610.5 (public benefit), 8610.5 (mutual benefit), and 9680.5 (religious) of the California Corporations Code.

Administrative Dissolution/Surrender

AB 557 also establishes procedures for the administrative dissolution (for domestic corporations) or surrender (for foreign corporations) of an abandoned nonprofit corporation that, as of January 1, 2016, or later, has been suspended from doing business in California for at least 48 consecutive months.

The new law requires the Franchise Tax Board (“FTB”) to mail written notice of the pending dissolution/surrender to the corporation’s last known address, and the California Secretary of State to post notice on the Secretary’s web site for 60 days.

If the corporation does not submit to the FTB a written objection to the proposed dissolution/surrender during the 60-day notice period, then it will be administratively dissolved or surrendered.

If the corporation objects in writing during the 60-day notice period, then it will have 90 days from the date of the written notice to pay any owed taxes, penalties, and interest and file a current Statement of Information (Form SI-100), or it will be administratively dissolved/surrendered at the end of the 90-day period.  (The FTB is authorized to grant one 90-day extension.)

Upon administrative dissolution/surrender, any taxes, penalties, and interest owed by the corporation shall be abated (although liability to creditors is not discharged by virtue of the administrative dissolution/surrender).

The procedures for administrative dissolution/surrender are set forth in new Section 5008.9 of the Corporations Code.

Correction:  The original post included an incorrect reference to a section of California law, which has now been corrected.  The new abatement provision is in Section 23156 of California Revenue and Taxation Code, not of the California Corporations Code.

New York College Cannot Change Its Name in Return for a Proposed Donation

Posted in Charitable Gift Planning, IRS, FTB & Attorney General Controversies, Public Charities

Paul Smith’s College, “the College of the Adirondacks,” was established in 1937 and remains the only baccalaureate-degree-granting institution in Adirondack Park, New York.  Paul’s son, Phelps Smith, bequeathed the bulk of his estate to create a college in his father’s name, and his bequest required that the college “be forever known” as Paul Smith’s College of Arts and Sciences.

Fast forward to the present.  Joan Weill, the spouse of the former chief executive and chairman of Citigroup, Sanford I. Weill, proposed a $20 million gift to the College, provided that the College change its name to Joan Weill-Paul Smith’s College in honor of Ms. Weill’s contributions and her commitment to the future of the school.  According to the New York Times, College officials characterized the proposed donation “as a lifeline that could allow them to recruit students nationally and draw more donations from the couple’s wealthy friends” and concluded that “in order to consummate the gift, it needed to undo the century-old naming restriction, which it said nearly fatally impedes the ability of Paul Smith’s to seek large gifts from a single donor in order to make the investments it needs to remain viable.”

The State Supreme Court in Franklin County, New York, disagreed.  Under the equitable doctrine of cy pres, a court may reform a written gift instrument to reflect the donor’s intention as closely as possible, if changed circumstances have rendered the administration of the gift according to its literal terms impracticable or impossible.  The Court determined that the College failed to show “that its name is holding the College back from being a shining success both in enrollment and in producing successful college graduates” or that the College could not operate effectively without the name change.  Therefore, the court concluded that the existing name requirement was not impracticable to a degree that it frustrated the charitable purpose of Phelps Smith’s gift.  As a result, Ms. Weill is not now making her gift.

There are other recent examples of a prominent charity changing its name, or attempting to do so, in order to generate revenue.  For instance, last year Lincoln Center agreed to change the name of Avery Fisher Hall to David Geffen Hall in connection with a $100 million donation. In that case, Lincoln Center negotiated with the Fisher family to relinquish the name and did not go to court.

For the full New York Times article reporting this court decision, see http://www.nytimes.com/2015/10/08/nyregion/judge-rejects-paul-smiths-colleges-request-to-change-its-name.html?_r=0.

Proposition C Impacts Nonprofit Organizations Lobbying in San Francisco

Posted in Nonprofit Governance & Ethics, Public Charities, Tax Treatment of Lobbying & Political Activities, Unions, Associations, Clubs & Other Tax-Exempt Organizations

The City and County of San Francisco’s lobbying ordinance (Campaign and Governmental Conduct Code §§2.100-155) currently requires any person influencing local legislative or administrative actions through contacts with city officials or their staff to register with the Ethics Commission, but the ordinance provides an exemption for certain nonprofits (all 501(c)(3)s and some smaller 501(c)(4)s). The Ethics Commission of San Francisco has placed Proposition C (“Prop. C”) on the November 2015 ballot, which would expand the definition of lobbyist and covered lobbying activities without similarly expanding the exemption for nonprofits.

If passed, Prop. C would create a new category of lobbyist, the “expenditure lobbyist.” An entity or individual would become an expenditure lobbyist if it directly or indirectly made payments totaling $2,500 or more in a calendar month to solicit, request, or urge other people to communicate with a city or county official in order to influence local legislative or administrative action. Unless an exception applies, each expenditure lobbyist would be required to pay a $500 registration fee and file monthly reports with the Commission. Failure to pay an annual fee terminates registration under the current ordinance. The proposed measure does not change the registration termination provisions or clarify whether these registration and reporting obligations continue even after the lobbying activities have ceased.

Because the definition of “expenditure lobbyist” has a low dollar threshold, and because there is no exemption for nonprofit organizations, Prop. C could affect many nonprofit organizations that are active in the City and County of San Francisco. The proposed ordinance expressly identifies as covered an expenditure for any of the following: public relations, media relations, advertising, public outreach, research, investigation, reports, analyses, and studies to the extent those activities are used to further efforts to solicit, request, or urge other persons to communicate directly with an officer of the City and County of San Francisco.

For public charities, Prop. C would cover grassroots lobbying efforts urging others to contact city and county officials. The measure’s inclusion of administrative lobbying could also cause private foundations to be characterized as expenditure lobbyists if they spend more than the threshold amount urging others to contact officials regarding administrative actions. Although prohibited from engaging in legislative lobbying, private foundations are generally permitted under federal tax law to influence administrative actions. However, under Prop. C such private foundations may nonetheless be deemed expenditure lobbyists, and their registration and public reports could generate audit flags for the IRS.

The Alliance For Justice has taken a stance against this measure. Organizations interested in taking a similar position on this measure may wish to seek counsel to determine if their activities qualify under the self-defense exception to the federal lobbying rules.

IRS Commissioner Hints at Timing for New Political Regulations, Summarizes Thousands of Public Comments

Posted in AG, IRS, FTB, & Property Tax Proceedings, Private Foundations, Public Charities, Tax Treatment of Lobbying & Political Activities, Unions, Associations, Clubs & Other Tax-Exempt Organizations

We looked at IRS Commissioner John Koskinen’s written statement to the Senate Finance Committee, with attached documents, submitted with his testimony on Tuesday, October 27, at http://www.finance.senate.gov/imo/media/doc/27OCT2015Koskinen.pdf.

Here’s what’s newsworthy:

First, from the Commissioner’s oral testimony and from his prepared statement, the IRS and Treasury have not been intimidated by Republican calls to discontinue the rulemaking process.  He emphasized that the IRS aims to “clarify” the political activity rules, not change them to deprive organizations of their free speech rights.  The Commissioner said there was no timetable for the release of the second version of the proposed regulations, but that there would be “ample, additional opportunity” for public commentary and public hearings.

He did say in his oral testimony that the next version might come out in early 2016, and be finalized “before the election,” but his previously-stated position has always been that the new rules would not be “effective” (legally binding) on organizations or activities until after the 2016 elections.

What’s new is the IRS effort to summarize public comments received (160,000) since the first version was released in November 2013, almost two years ago.  No precise prediction can be gleaned from its rendition of the comments on three key issues: how much political activity should be permitted under 501(c)(4), the scope of the definition of political campaign activity, and the potential use of a uniform definition for all 501(c) groups.  However, the summary does perhaps reveal a bit about the thought process of the lawyers drafting the new rules—what they take from the public comments and what legal arguments might be used to support certain outcomes.

From what we’ve seen, a common theme is apparent.  Social welfare 501(c)(4) organizations cannot be viewed in isolation; both the range of public comments and the fabric of the law itself require considering the interplay between section 501(c)(4) and section 527 (political organizations), as well as among the other main categories–501(c)(3) (charities), (c)(5) (labor unions), and (c)(6) (business and professional associations)—that may be active in election periods.

Highlights:

  • The IRS and Treasury appear to remain open to various arguments on “how much” political activity is too much for 501(c)(4) exempt status, considering the existing “primarily” standard, an “exclusively” standard, or a “no substantial part” standard, as well as a percentage-of-expenditures limit.  Over 3,000 commenters expressed opinions on this topic, and many “generally supported” retention of the “primarily” standard.  The IRS concludes by citing comments arguing that Congress, by adopting section 527 in 1975, recognized that 501(c) groups may engage in “some” political activity taxable under 527(f). In that view, Congress essentially ratified the IRS position rather than “amending the existing ‘primarily’ standard under the 1959 regulations.”
  • The IRS goes into some detail on the definition of “candidate” that it proposed in 2013, sweeping in appointees for public office as well as those running for election.  From the strong objections it received containing rather persuasive legal analysis, it appears the IRS may be convinced to drop that suggestion and focus only on electoral campaigns for public office.
  • On issue advocacy, the IRS notes the arbitrariness of timeframes, such as 30 or 60 days before an election, used to capture any public communication that mentions the name of a candidate.  As commentary (from the Bright Lines Project, actually) pointed out, the result could be under-inclusive, failing to capture “politically motivated” messages outside of the timeframe, yet be over-inclusive, limiting “legitimate policy advocacy inside it.”
  • 20,000 comments, the largest segment reported by the IRS, complained that classifying all forms of voter education and outreach as political campaign activity would have an adverse impact on nonpartisan social welfare activities that encourage civic participation and engage the public.
  • Finally, the IRS addresses comments related to the “potential application of a uniform definition of political campaign intervention across section 501(c).”  Seven thousand commenters saw the 2013 first draft of regulations as inequitable because it did not apply to other tax-exempt organizations.  Some argued that (c)(4), (5) and (6) entities “are often prominent and competing players in the same advocacy space,” so that singling out the (c)(4)s for regulation “would create an uneven political playing field.”  Further, commenters noted, if the same definitions did not apply to 501(c)(3) charitable organizations (for which political intervention is completely prohibited), the result could be a system of burdensome, multiple standards with a chilling effect on nonpartisan activities historically permitted under section 501(c)(3).  Again, the IRS recognizes the interaction of sections 501(c) and 527, noting comments suggesting a single definition of political intervention for all categories.

I chair the Drafting Committee of the Bright Lines Project, which has been pressing for clearer IRS definitions of political intervention for over five years.  We are heartened to see the IRS and Treasury continuing their work to pursue better political activity rules, building on the wealth of public input and the harmonization of existing tax code distinctions.  As I said in testimony to a Senate Judiciary subcommittee in July, “we don’t want bad political rules that apply only to (c)(4)s, but good rules for everybody.”

Good News on the Investment Front!! California Passes AB 792, Harmonizing Investment Standards for Nonprofits in California

Posted in Charitable Gift Planning, Private Foundations, Public Charities, Religious Institutions

The stock market may be in shambles, but California charities have reason to celebrate.  Historically, charities formed as California nonprofit public benefit corporations have had to satisfy two state law investment standards:  Corp. Code Section 5240 and UPMIFA (found at Probate Code section 18501 and following).  Corp. Code Section 5240(b) provides that in making investments, a board must “avoid speculation, looking instead to the permanent disposition of the funds, considering the probable income, as well as the probable safety of the corporation’s capital.” On the other hand, UPMIFA sets forth a modern prudent investor standard – it sets forth several factors which are to be considered when making investment decisions, states that investment decisions are to be applied to the fund as a whole, and provides that an individual investment must be analyzed in the context of the total portfolio and the overall risk-reward objectives. These two standards have been very difficult for charities and their advisors to reconcile, in great part because the Corp. Code: (a) appears to focus on individual investments (whereas UPMIFA focuses upon the portfolio as a whole); and (b) directs the charity to “avoid speculation,” a term which does not appear to have a precise legal definition.

Fortunately, AB 792 provides that effective January 1, 2016, compliance with UPMIFA will be deemed to be compliance with Corp. Code Section 5240(b).  There is a similar provision for religious corporations subject to Corp. Code Section 9250. Thus, beginning in 2016, California charities need to focus only on satisfying the UPMIFA standard (of course, charities which are private foundations also have to be concerned with IRC Section 4944, which prohibits jeopardizing investments).  Note that the other provisions of Corp. Code Section 5240 still apply – importantly, the ability of a donor to “authorize” or “require” a charity to retain a contributed asset, which can ease the directors’ standard of care as to the investment and re-investment of that asset.

Treasury Releases Final Regulations for Private Foundations Making International Grants Using Foreign Public Charity Equivalence Determinations

Posted in Grantmaking & Social Investing, International Charitable Transactions & Operations, Private Foundations

Treasury will release tomorrow final regulations regarding private foundations and their use of a process called “foreign public charity equivalence” or “equivalency determination.” Treasury’s hope in issuing these regulations is to facilitate international grantmaking while ensuring that foundation equivalency determinations are appropriately made.

Background and 2012 proposed regulations. As explained in a prior post, before the 2012 proposed regulations, private foundations wishing to make grants to non-U.S. charities generally had to exercise expenditure responsibility over their grants, or use equivalency determination. Under equivalency determination, a private foundation would make a good faith determination, based on a grantee-completed affidavit or opinion of counsel, that the foreign charity met the basic requirements of a Section 501(c)(3) public charity, but for the fact that the IRS had not recognized the foreign charity as such. Among other things, the 2012 proposed regulations expanded the class of tax practitioners on whose opinion the private foundation could rely, from counsel only to include CPAs and enrolled agents, collectively known as “qualified tax practitioners.”

Final regulations. The final regulations adopted the expansion of the class of “qualified tax practitioners” in the proposed regulations, but otherwise substantially revised them. Key changes include:

  • Relying solely on grantee affidavits. Previously, a private foundation grantor could “ordinarily” rely solely on a grantee affidavit to make its good faith determination, without an opinion of a qualified tax practitioner. Now, a grantor may only rely on an affidavit as the sole basis for making a good faith determination where “reasonable and appropriate under the facts and circumstances.” As examples, reliance only on an affidavit may still be appropriate where a foundation manager of the grantor understands U.S. tax law sufficiently to assess the reliability of grantee affidavits, or where the grantee understands U.S. tax law sufficiently to ensure that it has completed the affidavit appropriately.
  • DAFs. The final regulations clarify that sponsoring organizations of donor advised funds may use these regulations as guidance for grantmaking to foreign organizations.
  • Foreign counsel. The final regulations clarify that foreign counsel may assist in gathering information relevant to the equivalency determination and provide advice to a qualified tax practitioner providing an opinion to the grantor. Unless the foreign counsel is also a “qualified tax practitioner,” however, the grantor may not rely directly upon the foreign counsel’s opinion to make its good faith determination.

Other important items include:

  • Shared advice. While acknowledging that grantors’ sharing the advice of a qualified tax practitioner with one another may be economical, IRS and Treasury expressed concern that the foundation receiving shared advice may not be in a position to evaluate its reliability. Therefore, a grantor wishing to rely on written advice from a qualified tax practitioner must receive the advice directly from the qualified tax practitioner (which includes qualified equivalency determination repositories), and not from another grantor.
  • Reliance period. For grantees meeting a public support test, the final regulations clarify that the organization may be treated as publicly-supported for two years immediately following the end of the five-year support test period.
  • Update to Revenue Procedure 92-94. Treasury intends to update Rev. Proc. 92-94, the revenue procedure outlining the affidavit process that practitioners agree is largely outdated.
  • Conforming changes. The final regulations also make minor changes for consistency with prior changes in law, such as the 2006 Pension Protection Act changes that eliminated certain 509(a)(3) supporting organizations from the class of organizations that may receive distributions treated as qualifying distributions and that may receive grants for which expenditure responsibility is not required.
  • Transition period. The final regulations provide for a 90-day transition period (through December 24, 2015), during which foundations may distribute grants in accordance with former regulations. Also, a grantor that has made a written commitment on or before September 25, 2015, in accordance with prior procedures may rely on those prior procedures if the committed amount is distributed by September 25, 2020.

Practical aspects. Many private foundation grantors have been using qualified tax practitioners in any event. (This includes, for example, both in-house and outside counsel and CPAs, as well as repositories.) For these grantors, not much may change. Grantors who have been relying on gathering affidavits and making their own good faith determination without the involvement of a qualified tax practitioner, however, should promptly reassess this aspect of their international grantmaking processes.

IRS Clarifies Position on Private Foundation Mission-Related Investments Under Section 4944

Posted in Grantmaking & Social Investing, Private Foundations, Social Enterprise

In Notice 2015-62 issued on Tuesday, the IRS explained that a private foundation and its managers will not necessarily be penalized under Internal Revenue Code Section 4944 for a mission-related investment that does not qualify as a program-related investment (PRI) and that offers a lower return than more standard alternatives, since a foundation’s charitable purposes are relevant to determining whether its managers have exercised ordinary business care and prudence in making investment decisions.

Section 4944 of the Internal Revenue Code imposes an excise tax on a private foundation, and in some situations the foundation’s managers, for any investments that are deemed “to jeopardize the carrying out of any of [the foundation’s] exempt purposes.” PRIs are a statutory safe-harbor, but to qualify as a PRI an proposed investment must meet several criteria, namely:  (i) the primary purpose of the investment must be to further one or more exempt purposes of the foundation; (ii) the production of income or the appreciation of property may not be a significant purpose of the investment; and (iii) the PRI cannot be used to fund electioneering or lobbying activity.  Where the PRI recipient is not a U.S. public charity, the foundation is additionally required to exercise expenditure responsibility over the investment, in accordance with the very specific requirements of the Treasury regulations.

The regulations to Section 4944 define a “jeopardizing investment” in part as one where foundation managers “have failed to exercise ordinary business care and prudence, under the facts and circumstances prevailing at the time of making the investment, in providing for the long- and short-term financial needs of the foundation to carry out its exempt purposes.” (Treas. Reg. Section 53.4944-1(a)(2)(i)).

Notice 2015-62 clarifies that the relevant facts and circumstances foundation managers may consider in exercising “ordinary business care and prudence” can include the relationship between a particular investment and the foundation’s charitable purposes.  Consequently, even where an investment doesn’t qualify as a PRI because, for example, the production of income is a significant motivation behind it, the fact that the investment was made to further a charitable purpose of the foundation may help to avoid having it classified as a jeopardizing investment under Section 4944.

As Notice 2015-62 explains, this clarification helps to make IRS guidance consistent with the standard under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted by most states, which provides that managers may take into account any special relationship between a proposed investment and the organization’s charitable purposes.  (See UPMIFA Sections 3(a), 3(e)(1)(H) and accompanying comments, as well as, for example, California Probate Code Sections 18501-18510.

The following resources provide further background on private foundations, PRIs, and mission-related investing:

Proposed Regulations Would Bring Program-Related Investments into the 21st Century, by David A. Levitt and Robert A. Wexler, Journal of Taxation, August 2012

Investing In The Future: Mission-Related And Program-Related Investments For Private Foundations by David A. Levitt, The Practical Tax Lawyer, Spring 2011

Unscrambling ‘MRIs’ and ‘PRIs’ by David A. Levitt, Philanthropy Journal (on-line), April 5, 2011