4.76.4  Private Foundations

Manual Transmittal

October 02, 2014

Purpose

(1) This manual transmits revised IRM 4.76.4, Exempt Organizations Examinations Guidelines, Private Foundations.

Material Changes

(1) In addition to the changes listed below, this manual incorporates various editorial changes, including punctuation, grammar, and spelling. Where first introducing a reference to another IRM section outside of this manual, inserted the title of that IRM section. Likewise, when first referencing a business unit or computer program, inserted the full name of the unit or program and placed parentheses around the abbreviation.

(2) IRM 4.76.4.2 (2): Replaced "established" with "created or organized" and added "or U.S. territories" .

(3) IRM 4.76.4.2.1 (1): In the note replaced "do" with "may" .

(4) IRM 4.76.4.2.1 (5): Inserted new paragraph, resulting in the renumbering of the remainder of the section. Sentence reads, "IRC 4941, 4944, and 4945 impose taxes on foundation managers for knowingly participating in taxable transactions on behalf of the foundation, and for refusing to agree to correction."

(5) IRM 4.76.4.2.2 (1): Changed the "2%" for IRC 4940 to "up to 2%" .

(6) IRM 4.76.4.2.2 (2) through IRM 4.76.4.2.2 (4): Inserted new paragraphs, resulting in the renumbering of the remainder of the section.

(7) IRM 4.76.4.2.2 (5): Removed the note.

(8) IRM 4.76.4.2.2.1 (4): Replaced "net capital gain" with "capital gain net income" and "net capital gain of zero" with "no net capital losses" .

(9) IRM 4.76.4.2.2.1 (7): Replaced "is" with "meets the requirements" , and added "of" .

(10) IRM 4.76.4.2.2.2 (3): Added "but generally have a lesser "amount involved" than discrete acts" . Replaced "Can be continuing based on facts and circumstances" with "Unless leasing of property" and "Discrete (Can be continuing based on facts and circumstances)" with "Continuing" . Removed two instances of "(Can be continuing based on facts and circumstances)" . Changed "Certain" to "Agreement to make" . Eliminated plurals of payments and officials. In the Note, replaced "or categories" with "of acts" .

(11) IRM 4.76.4.2.2.2 (4): Replaced "their" with "his or her" , ", and no" with "or" and ", prior to" with "until" in the two examples.

(12) IRM 4.76.4.2.2.2 (6): Replaced ", while the" with "until correction is made Jan. 1, 2013. The" .

(13) IRM 4.76.4.2.2.3 (2): Removed "Unlike IRC 4941," . Added "like continuing acts of self-dealing, but a failure to distribute in a given year may give rise to tax in multiple years in the taxable period like discrete acts of self-dealing" . Replaced "However" with "Also" . Changed "This" to "IRC 4942" .

(14) IRM 4.76.4.2.2.3 (5): Inserted "generally" . Replaced "how you redo Part XIII" with "qualifying distributions" and "(You may find the election in another part of the form.)" .

(15) IRM 4.76.4.2.2.3 (7): Inserted "; in other words, a foundation has until the end of Year 2 to make qualifying distributions of its distributable amount for Year 1" .

(16) IRM 4.76.4.2.2.4 (2): Inserted ", like discrete acts of self-dealing and 4942" . Removed "only" . Added "and each subsequent year in the taxable period. The amount of tax may vary from year to year as the excess holdings vary."

(17) IRM 4.76.4.2.2.4 (3): Split off from IRM 4.76.4.2.2.4 (2), resulting in renumbering of rest of section. Removed "20%, if the enterprise is controlled by a disqualified person" . Inserted "(ownership of foundation and disqualified persons combined)" , removed "not" , inserted "effectively" , replaced "any disqualified" with "third" , added "(See Rev. Rul. 81-111)" . Added "20% (ownership of foundation and disqualified persons combined), in all other cases." Replaced "it's" with "a passive holding company is" . Changed "4945(d)(3)(B)" to "4943(d)(3)(B)" .

(18) IRM 4.76.4.2.2.4 (4): Inserted "in many instances" , replaced "different time limits for when they must" with "a grace period to" , inserted ", which varies depending on the circumstances" , removed "the" , "inserted acquired other than by purchase"

(19) IRM 4.76.4.2.2.4 (5): Added "es" to "summons" .

(20) IRM 4.76.4.2.2.4 (6): Inserted "grace" and "of" .

(21) IRM 4.76.4.2.2.5 (7): Replaced "investment" with "amount invested on" . Deleted "/correction" . Inserted ", like discrete acts of self-dealing and 4942 and 4943 taxes" .

(22) IRM 4.76.4.2.2.6 (2): Replaced "shelled out" with "paid or incurred" .

(23) IRM 4.76.4.2.2.6 (4): Inserted at the end of the note ", and the tax is imposed only once in the taxable period" . Removed "(d)(3)," .

(24) IRM 4.76.4.2.2.6 (5): Replaced "if" with "whether" . Inserted at the end of the note ", though it may be required as part of correction" .

(25) IRM 4.76.4.2.2.6 (8): Converted the alphabetical list to a step list.

(26) IRM 4.76.4.2.2.7 (2): In Example 2 replaced "increases" with "decreases" . In the table following the example, for Part XI Line 7, replaced "Increase" with "Decrease" . In Example 3, replaced "reduced" with "increased" and "decreasing" with "increasing" . Removed "Full or partial refunds may be possible on previously assessed IRC 4942 taxes, but be cautious in making such determinations." , "When qualifying distributions are insufficient to offset the undistributed income for two years in a row, tax occurs." and "Part V Line 1(b) or 1(c) Increase" .

(27) IRM 4.76.4.2.2.7 (3): In Example 2 inserted ", and is not otherwise a disqualified person with respect to the foundation" . Replaced "is not otherwise a disqualified person" with "the pastor and family are not otherwise disqualified persons" .

(28) IRM 4.76.4.2.2.7 (4): Changed "triggers" to "may trigger" .

(29) IRM 4.76.4.2.2.7 (5): Deleted "thus" in the third example. Changed "also triggers" to "may also trigger" .

(30) IRM 4.76.4.2.3 (2): Inserted "and IRC 4963(d)(2)" and "Reduce the amount of undistributed income to zero." Replaced "The proceeds of any sale or disposition can't in themselves be jeopardizing investments." with "(other than exchanging for another jeopardizing investment)" . Replaced "transaction" with "expenditure" at two spots. Inserted ", or obtain approval of grantmaking procedures" . Replaced "would be" with "would have been" , and inserted "it" .

(31) IRM 4.76.4.2.3 (3): Inserted "below-market" .

(32) IRM 4.76.4.2.3 (5): Changed "entity" to "party" .

(33) IRM 4.76.4.2.3 (8): Replaced "is reasonably" with "can't reasonably be" .

(34) IRM 4.76.4.2.3.1 (6): Replaced "Exhibit 4.76.4-19" with "Letter 5305, Private Foundation Correction Approval Letter."

(35) IRM 4.76.4.2.3.1 (7): Replaced "Exhibit 4.76.4-20" with "Letter 5306, Private Foundation Correction Rejection Letter."

(36) IRM 4.76.4.2.4 (2): Moved IRM 4.76.4.2.4(4) to IRM 4.76.4.2.4(2). Inserted ", are imposed at the same time that first tier taxes are imposed in the case of assessment or issuance of a notice of deficiency, and are abated if correction is made within the correction period." Removed "(indicate in your RAR" .

(37) IRM 4.76.4.2.4 (3): Replaced "all" with "six months" . Inserted "all of" , "all of" , and "also" in the second example.

(38) IRM 4.76.4.2.4 (4): Replaced "For an example of a Thorne letter, see" with "See" . "Inserted for sample language used in a Thorne letter for a theoretical IRC 4945 scenario" .

(39) IRM 4.76.4.2.5 (2): Replaced "an" with "the" . Inserted "(if any)" and "public" (third bullet).

(40) IRM 4.76.4.2.5 (3): Replaced "incurred" with "engaged in" . Removed "had" and "IRC 507(b)(1) terminations result in the foundation being treated as a new organization, effective the day after the termination date."

(41) IRM 4.76.4.2.5 (6): Removed Pub 950. The publication is obsolete.

(42) IRM 4.76.4.2.5 (7): Replaced "RCCMS" with "the Reporting Compliance and Case Management System (RCCMS)" .

(43) IRM 4.76.4.2.5 (12): Inserted "Termination of private foundation status under IRC 507 results in the foundation being treated as a new organization created on the day after termination. IRC 509(c)." Replaced "a new" with "an" .

(44) IRM 4.76.4.2.6 (1): Inserted "but the circumstances do not warrant involuntary termination of private foundation status under IRC 507(a)(2)" . Replaced "The" with An "IRC 501(c)(3)" .

(45) IRM 4.76.4.2.6 (5): Inserted "the foundation becomes a taxable foundation and must file an income tax return as well as Form 990-PF." Replaced "status codes 18 and 19 are used" with "Use status codes 18 (for trusts) and 19 (for corporations)" . Removed "A revoked foundation that is a trust becomes a non-exempt charitable trust." Replaced "18, changing the organization type to 6, and subsection code to 92. Status code 19 is used for foundations that are corporations. In both situations," with "change and" .

(46) IRM 4.76.4.2.7 (1): Inserted "initially" and "statutory limitations periods for assessment and collection of taxes (or" and ")" .

(47) IRM 4.76.4.2.7 (2): Inserted "that discloses the transaction" .

(48) IRM 4.76.4.2.7 (3): Replaced "statute" with "statutory period" . Inserted "assessing" . Replaced "reporting" with "disclosing" . Inserted "(must adequately identify existence and nature of transaction)" . Removed "*Deemed reported if disclosed on return, and adequately identifies existence and nature of transaction."

(49) IRM 4.76.4.2.7 (6): Replaced "The statute of the Form 990-PF on which a Chapter 42 act or failure to act is reportable controls the statute for the Forms 4720 for the year of the acts/failures to act." with "The statutory limitations period for chapter 42 taxes reportable on Form 4720 ordinarily begins with the filing of Form 990-PF, whether or not Form 4720 is filed." Replaced "acts" with "act" . In the table replaced "Date" with "Begins" .

(50) IRM 4.76.4.2.7 (11): Inserted "As a single act or failure to act may give rise to chapter 42 tax for a number of years in the taxable period, the fact that the statute has closed assessment/collection for the year of the original act or failure to act does not preclude assessment/collection of the tax imposed in subsequent years in the taxable period that are still open."

(51) IRM 4.76.4.2.8 (5): Replaced "who" with "that" . (Foundations aren't persons.)

(52) IRM 4.76.4.2.8 (6): Inserted "and" as well as "on the responsible party" .

(53) IRM 4.76.4.2.8 (7): At the end of the second example inserted "These penalties would be adjusted if the second tier tax is abated."

(54) IRM 4.76.4.3 (4): Replaced "For purposes of computing the IRC 4940 net investment income tax, the foundation must compute the unrelated business income tax (UBIT) as if it were still tax-exempt." with "A taxable foundation owes IRC 4940 tax to the extent that such tax (plus unrelated business income tax, computed as if it were still exempt), exceeds its income tax liability."

(55) IRM 4.76.4.3 (6): Removed "nondeductible contributions disclosure" . Inserted "for not making required disclosures under IRC 6113 of nondeductibility of contributions for the first five years after revocation" .

(56) IRM 4.76.4.4 (1): Inserted "or under the laws of" . Replaced ", one of its possessions, or under either U.S. laws or those of its possessions. The list of U.S. possessions includes" with "or U.S. territories, which include" .

(57) IRM 4.76.4.4 (3): Inserted "and does not include capital gains and losses"

(58) IRM 4.76.4.4 (5): Replaced "don't complete Parts IV or V" with "are not required to complete some parts" .

(59) IRM 4.76.4.4.1 (1): Inserted ", per IRC 4948(b)" , "(IRC 4948(c))" , ", IRC 4948(a)" , "More than" , and "4948(a)" . Removed "or more" .

(60) IRM 4.76.4.4.1 (2): Replaced "Chapter" with "Except for willful and flagrant violations, chapter" . Removed "(e)" . Inserted "(other than IRC 4942)" and "generally" .

(61) IRM 4.76.4.4.1 (3): Inserted "for purposes of IRC 4940" and ", though it may matter for purposes of IRC 4945(d)(4)" .

(62) IRM 4.76.4.4.2 (2): Inserted "withholding" .

(63) IRM 4.76.4.5 (2): Inserted "To qualify for abatement of second tier tax, the taxable event must be corrected within the correction period." and "of first tier tax" .

(64) IRM 4.76.4.5 (8): Inserted "EPR" .

(65) IRM 4.76.4.6 (1): Deleted "of" and "which" in the last bullet.

(66) IRM 4.76.4.6 (2): Replaced "32" and "33" with "30 " and "31" , replaced "2011" with "2013" , "many" with "most" . Inserted "See Rev. Rul. 75-38" . In the note replaced "individual" with "founders" .

(67) IRM 4.76.4.6 (4): At the end of the reminder inserted "An unrelated business directly conducted by a foundation, however, may constitute an excess business holding as a "sole proprietorship" business enterprise."

(68) IRM 4.76.4.6 (6): Inserted "(timely mailing treated as timely filing)" . Changed "report" to "reported" (Part XIII).

(69) IRM 4.76.4.6 (9): Inserted "and Part XIII" and "(For private operating foundations, Part XIV permits you to obtain records for the three prior years.)" . Replaced "Part V" with "Parts V and XIII" .

(70) IRM 4.76.4.6 (10): Inserted "Review of the general ledger and bank statements for transactions with disqualified persons."

(71) IRM 4.76.4.7 (2): Inserted "for an advance ruling" .

(72) IRM 4.76.4.7 (3): Changed "month" to "monthly" . Inserted ", and determine whether they qualify as such" , "as a loan with a disqualified person." , and "as a sale with a disqualified person" .

(73) IRM 4.76.4.7 (8): Inserted "taxes" .

(74) IRM 4.76.4.7 (11): Removed "a" . Inserted "language used in a" and "for a theoretical IRC 4945 scenario" .

(75) IRM 4.76.4.8 (4): Inserted "for sample language used in a Thorne letter for a theoretical IRC 4945 scenario" . Replaced "paragraph (7)" with "IRM 4.76.4.8 (7)"

(76) IRM 4.76.4.8 (5): Replace "Exhibit 4.76.4-19" with "Letter 5305" and "Exhibit 4.76.4-20" with "Letter 5306" .

(77) IRM 4.76.4.8 (6): Eliminated "-A" and "-Non-Declaratory Judgment" .

(78) IRM 4.76.4.8 (7): Inserted "Obtain a full copy of the tax form under protest showing the date received, if not already present in the file or on RCCMS. Use Online SEIN if obtaining a Form 990-PF or a filed Form 4720." Replaced "a sample" with "sample language used in a" . Inserted "for a theoretical IRC 4945 scenario" . Replaced "270" with "425" . Inserted "Note: Effective September 2, 2014, all cases received in Appeals require 365 days remaining on the assessment statute of limitations." Replaced "paragraph (8)" with "IRM 4.76.4.8 (8)" .

(79) Exhibit 4.76.4-2: Replaced "(Treas. Reg. 53.4941(e)-1(c)(6))" with "plus any income derived from the use of the $25,000" . Inserted "if the return provided adequate notice of the transaction" , "in 2011" , and "Note that while there is a single, discrete act of self-dealing, the tax is imposed in each year or partial year in the taxable period."

(80) Exhibit 4.76.4-3: Replaced "1995" with "2005" and "2013" with "2012" . Inserted "The loans are all non-recourse with the properties as collateral, and DP Victor obtained them within 10 years of transferring the properties to PF Foxtrot." , "or properties" , and "The taxes for the first three years in the taxable period are determined as follows."

(81) Exhibit 4.76.4-4: Moved "in the building" . Inserted "per month" , "($0.10 per square foot per month)" , ", and $1.85 in 2012 and 2013, excess of the" , "(at the time of the act of self-dealing or time of correction, whichever is higher)" , "(and that would have been paid if the lease ran for the full term)" , "(and that would have been paid if the lease ran for the full term)" , "For 2013, the amount involved is $32,375 ($1.85 sq.ft./month x 3500 sq.ft. x 5 months)." , "12/31/2013" , "4941(a)(1)" , "76,650.00" , "77,700.00" , "Lease of office space 1/1/2013" , "32,375.00" , "186,725.00" , "0" , "186,725.00" , "10%" , "18,672.50" , "0" , "18,672.50" , "12/31/2013" , and "4941(a)(1) 12/31/2013 18,672.50" . Replaced "18.25" with "1.825" , "18.25" with "1.85" , "766,500.00" with "77,700.00" , "762,300.00" with "73,500.00" , "777,000.00" with "77,700.00" (4 instances), "772,200.00" with "72,900.00" , "771,600.00" with "72,300.00" , "771,000.00" with "71,700.00" , "770,400.00" with "71,100.00" , "3,847,500.00" with "361,500.00" , "shall be" with "is" , "$766,500.00, as computed above" with "$76,650.00, ($1.825/sq. ft./month x 3500 sq. ft. x 12 months)" , "777,000.00, also shown in the table above" with "$77,700.00 ($1.85/sq. ft./month x 3500 sq. ft. x 12 months)" , "766,500.00" with "76,650.00" (4 instances), "777,000.00" with "77,700.00" , "1,543,500.00" with "154,350.00" (2 instances), "76,650.00" with "7,665.00" (2 instances) and "154,350.00" with "15,435.00" (2 instances). Removed "12/31/2011" .

(82) Exhibit 4.76.4-5: Inserted "equal to or" , "10/1/2012 130,500 x .0269 x 4/12 = 1,170.15 1,000.00 1,170.15" , and a new Form 4883 with "9/30/2013" , "1,010.00" , "5,464.80" , "4,673.25" , "Continuing loan on 10/1/2012" , "1,170.15" , "12,318.20" , "0" , "12,318.20" , "10%" , "1,231.82" , "0" , "1,231.82" , "9/30/2013" , "9/30/2013" and "4941(a)(1) 9/30/2013 1,231.82" . Deleted "As the 201309 Form 4720 is not due until February 15, 2014, the report of examination will only propose taxes for the periods ended September 30, 2010, September 30, 2011, and September 30, 2012. If desired, Partnership Hotel could file the Form 4720 early and pay the tax in 2013."

(83) Exhibit 4.76.4-6: Inserted "and that you make your report on Dec. 1, 2012" .

(84) Exhibit 4.76.4-7: Removed "All of the amounts that were disqualified were found to be self-dealing transactions that are also not qualifying distributions." Inserted "(taxable as of 1/1/2011)" , "(taxable as of 1/1/2012)" , and "(taxable as of 1/1/2013)" .

(85) Exhibit 4.76.4-9: Replaced "50" with "55" and "10" with "5" . Inserted "In 2012 Oscar breaks the engagement." , "(75%)" and "You issue your report Dec. 1, 2012. Note that IRC 4943(a) taxes are not imposed until the end of each year in the taxable period, unlike excise taxes under IRC 4941(a), 4942(a), and 4944(a)."

(86) Exhibit 4.76.4-10: Replaced "Exhibit 4.76.4-8" with "Exhibit 4.76.4-9" , "New" with "Penalty arising from 2nd tier tax" and "Old" with "Penalty arising from 1st tier tax" .

(87) Exhibit 4.76.4-11: Replaced "into" with "in" (two places). Removed "their" , "their" , and "that" . Inserted "201209 16,500,000.00 10% 1,650,000.00 10% 0.00" , "You issue your reports May 1, 2012." , "9/30/2012" , "4944(a)(1)" , "16,500,000.00" , "16,500,000.00" , "0" , "16,500,000.00" , "10%" , "1,650,000.00" , "0" , "1,650,000.00" , "9/30/2012" and "4944(a)(1) 9/30/2012 1,650,000.00" . Replaced "appearance and success" with "appearing and succeeding" .

(88) Exhibit 4.76.4-12: Replaced "were November 15, 2009, and November 15, 2010" with "for the years ending 201009 and 201109 were February 15, 2011 and February 15, 2012. (The due date for the 201209 return is February 15, 2013, thus no failure to file or failure to pay penalties apply to the proposed assessment for the 201209 return.)" , "a sample letter" with "sample language used in a Thorne letter for a theoretical IRC 4945 scenario" and "You determine that FM Papa's actions are willful and flagrant, and" with "Because FM Papa was previously liable for a chapter 42 tax," . Inserted "The second tier tax on management is 20% of the investment, not to exceed $20,000." , "on him" , "9/30/2012" , "4944(a)" , "16,500,000.00" , "16,500,000.00" , "0" , "16,500,000.00" , "10%" , "1,650,000.00" , "0" , "1,650,000.00" , "9/30/2012" , and "4944(a)(1) 9/30/2012 1,650,000.00 " . Moved "4,125,000.00" at two locations (Form 4883 and Form 4621).

(89) Exhibit 4.76.4-14: Replaced "they are" with "he is" and "letter" with "language used in a Thorne letter for a theoretical IRC 4945 scenario" . Inserted "for a willful and flagrant violation and for fraud on the Form 4720" and "2nd Tier" .

(90) Exhibit 4.76.4-15: Replaced "transferred to" with "received from" . Inserted "in IRC 507(b)(2) transfers" .

(91) Exhibit 4.76.4-16: Inserted "This exhibit contains sample language for a theoretical situation involving IRC 4945. Consult Counsel when needing to draft a Thorne letter. Counsel approves the issuance of all Thorne letters, and assists in individually designing each letter specific to the fact pattern presented." Removed the heading, salutation, and signature portions of the letter. Removed the quotations around "no correction" .

(92) Removed Exhibits 4.76.4-19 and 4.76.4-20. The material in the exhibits is now contained in Letters 5305 and 5306.

Effect on Other Documents

This manual supersedes IRM 4.76.4, dated May 15, 2013.

Audience

Tax Exempt and Government Entities
Exempt Organization
Examinations

Effective Date

(10-02-2014)

Tamera L. Ripperda
Director, Exempt Organizations
Tax Exempt and Government Entities (EO)

4.76.4.1  (10-02-2014)
Introduction

  1. This manual covers the procedures for conducting audits of private foundations. For the comprehensive technical guidance on these entities, see IRM 7.26, Private Foundations Manual, and IRM 7.27, Exempt Organizations Tax Manual. Where appropriate, this manual provides direct hyperlinks to the manual section on that topic. With respect to the current tax rates and limits on excise taxes, refer to this manual.

  2. This manual discusses both taxable and tax-exempt domestic and foreign private foundations, as the tax treatment for each is different.

  3. If using IRM Online, right click on the highlighted links below and select Open in New Tab. Toggle between the manuals by clicking on the tabs at the top of the web browser.

4.76.4.2  (10-02-2014)
Domestic Tax-Exempt Private Foundations

  1. A private foundation (PF) may be either domestic or foreign in origin. Tax exempt domestic private foundations are described in IRC 501(c)(3) and don't meet the requirements for classification under IRC 509(a)(1), (2), (3), or (4). Private foundations typically have a single major source of funding (usually gifts from one family or corporation rather than funding from many sources). Many foundations primarily make grants to charitable organizations and to individuals, rather than directly conducting charitable programs.

  2. A tax-exempt domestic private foundation is either a corporation, association, or trust created or organized in the United States or U.S. territories. For a discussion of required elements in the organizational document, see IRM 7.26.1.2.2, 508 (e) Governing Instrument Requirements, and IRC 508(e).

4.76.4.2.1  (10-02-2014)
Code Provisions

  1. Domestic private foundations and their disqualified persons are subject to a number of excise taxes. The table below lists the applicable code sections.

    Code Section Tax on IRM Section
    IRC 507(c) Terminations IRM 7.26.7, Termination of Private Foundation Status
    IRC 4940 Net investment income IRM 7.27.14, Tax on Net Investment Income of Private Foundations
    IRC 4941 Self dealing transactions IRM 7.27.15, Taxes on Self-Dealing
    IRC 4942 Failure to distribute income IRM 7.27.16, Taxes on Foundation Failure to Distribute Income
    IRC 4943 Excess business holdings IRM 7.27.17, Taxes on Excess Business Holdings
    IRC 4944 Jeopardizing investments IRM 7.27.18, Taxes on Investments Which Jeopardize Charitable Purposes
    IRC 4945 Taxable expenditures IRM 7.27.19, Taxable Expenditures of Private Foundations
    Note: IRM 7.27.14 through IRM 7.27.19 may not reflect changes in the Pension Protection Act of 2006.
  2. IRC 4941 through IRC 4945 require that in addition to paying an excise tax, the foundation and/or other taxpayer must correct the act or failure to act that gave rise to the excise tax liability in order to avoid second tier taxes and any additional penalties. See IRM 4.76.4.2.3 for a discussion of correction.

  3. IRC 4946 lists definitions for purposes of foundation status computations and for Chapter 42 excise taxes. The table below lists those deemed "disqualified persons" .

    IRC 4946 definitions IRM Section
    Substantial contributor (SC) IRM 7.27.20.2, Substantial Contributor General
    Foundation manager (FM) IRM 7.27.20.3, Foundation Manager
    Owner of >20% of entity that is a SC IRM 7.27.20.4, Owner of More Than 20 Percent Interest of an Organization that is a Substantial Contributor to a Foundation
    Family member of the above individuals IRM 7.27.20.5, Family Member Within the Meaning of IRC 4946(d)
    Entity >35% owned by one of the above IRM 7.27.20.6, Organizations in Which Certain Disqualified Persons Hold More Than a 35 Percent Interest
    PF with in-common controlling individual(s)
    (For IRC 4943 only)
    IRM 7.27.20.7, Certain Private Foundations
    Government official
    (For IRC 4941 only)
    IRM 7.27.20.8, Government Officials
  4. By default, all private foundations are deemed non-operating foundations under IRC 4942. A private non-operating foundation is subject to the full range of excise taxes listed above in IRM 4.76.4.2.1 (1). The table below lists the exceptions to classification as a private non-operating foundation. These entities are exempted from certain excise taxes.

    IRC Section Type of entity IRM Section
    IRC 4942(j)(3) Private operating foundation (IRM 7.26.6, Private Operating Foundations—IRC 4942(j)(3))
    IRC 4940(d)(2) Exempt operating foundation (IRM 7.27.14.2.2, Exempt Operating Foundation)
  5. IRC 4941, 4944, and 4945 impose taxes on foundation managers for knowingly participating in taxable transactions on behalf of the foundation, and for refusing to agree to correction.

  6. Pension Protection Act of 2006, P. L. 109–280, (PPA 2006) modified the Code with respect to Chapter 42 excise taxes. Most of the first tier excise taxes were doubled, as were the limits on the foundation manager taxes. The law also substantially modified IRC 4940, with the changes taking effect as of the first full tax year that began after August 17, 2006. See IRM 4.76.4.2.2.1.

4.76.4.2.2  (10-02-2014)
First Tier Excise Taxes

  1. IRM 4.76.4.2.1 provides a list of Chapter 42 excise taxes applicable to tax-exempt domestic private foundations. The table below identifies the parties subject to the taxes, the applicable tax rates before and after the implementation of PPA 2006, and what limit, if any, applies to the tax, and if so, how much.

    Code Section Liable party Tax Rate (PPA 2006*) Limit? (PPA 2006*)
    Before After Before After
    IRC 4940(a) PF up to 2% up to 2% None None
    IRC 4941(a)(1) Self dealer 5% 10% None None
    IRC 4941(a)(2) FM 2.5% 5% $10,000 per act $20,000 per act
    IRC 4942(a) PF 15% 30% None None
    IRC 4943(a)(1) PF 5% 10% None None
    IRC 4944(a)(1) PF 5% 10% None None
    IRC 4944(a)(2) FM 5% 10% $5,000 per act $10,000 per act
    IRC 4945(a)(1) PF 10% 20% None None
    IRC 4945(a)(2) FM 2.5% 5% $5,000 per act $10,000 per act
    *The tax rate changes are effective for full tax years that begin after August 17, 2006.
  2. If an organization or individual incurs an excise tax under 4941, 4942, 4943, or 4944 in a given year, then the first-tier tax is imposed that year and each subsequent tax year or partial year in the taxable period (under 4943, only for tax years that end within the taxable period). The taxable period does not end until the earliest of full correction, assessment, or issuance of a notice of deficiency. The notice of deficiency should reflect taxes owed for all years and partial years up to the date of notice, as a second notice of deficiency might not be allowed for taxes relating to the same act or failure to act (IRC 6212(c)).

  3. Under IRC 4945, there is only one first-tier tax in the taxable period (unlike IRC 4941-IRC 4944).

  4. The tax year of the disqualified person is used for purposes of IRC 4941 (Rev. Rul. 75-391).

  5. With the exception of IRC 4940, excise taxes are reported on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code. For taxes on individuals, convert the Form 4720 to a Form 4720-A by writing "-A" after the 4720 on the top of the form.

  6. To compute IRC 4940 and IRC 4942 taxes, complete the Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation. Reclassify expenditures as necessary to determine the qualifying distributions. (IRM 7.27.14.2.3.4, Qualifying Distribution and IRM 7.27.16.3.2, Qualifying Distributions Defined.)

  7. The applicable report forms are:

    • Form 4621, Exempt Organizations - Report of Examination

    • Form 4883, Exempt Organizations Excise Tax Audit Changes

    • Form 886-A, Explanation of Items

    • Form 870-E, Waiver of Restrictions on Assessment and Collection of Deficiency and Acceptance of Overassessment

4.76.4.2.2.1  (10-02-2014)
IRC 4940: Net Investment Income

  1. For the comprehensive technical discussion of IRC 4940, see IRM 7.27.14. This subsection focuses on:

    • tax law updates

    • tax calculations

    • tax assessments

    Note:

    There is no second tier tax for IRC 4940.

  2. For IRC 4940, PPA 2006 makes clear that for taxable years beginning after enactment, gross investment income includes income (other than unrelated business taxable income (UBTI)) from and from sources similar to:

    • interest

    • dividends

    • rents

    • payments with respect to securities loans (IRC 512(a)(5))

    • royalties (including overriding royalties)

  3. The law also changes the treatment of capital gains and losses so that all capital gains and losses (other than UBTI, if applicable) are included in gross income, with a specific exception for like-kind exchanges of related-use property. The law now also provides that no carrybacks or carryovers of capital losses are permitted in computing gross investment income. Finally, the law redefines capital gain net income to include property used for the production of gross investment income.

  4. Net investment income is composed of a series of simple calculations. The tables below provide the basic formulas for computing the tax.

    Term Equation
    Net investment income = Gross investment income
    Plus capital gain net income
    Less allowable deductions
    Capital gain net income* = Capital gains
    Less capital losses**
    * Capital losses can't exceed capital gains (i.e. no net capital losses.)
    **Capital losses can't be carried forward or back.
  5. Complete the Form 990-PF, Part I to ensure that you include all of the appropriate income and deductions.

  6. There are several possible tax rates applicable under IRC 4940:

    • 0%

    • 1%

    • 2%

  7. To obtain a 0% tax rate, a foundation must be a private operating foundation under IRC 4942(j)(3) that meets the requirements, for the tax year in question, of an exempt operating foundation under IRC 4940(d). See IRM 7.27.14.2.2.

  8. To achieve a 1% reduced tax rate, a foundation needs to meet the requirements of IRC 4940(e). Complete the Form 990-PF, Parts X, XI, XII, and V to determine eligibility for the reduced rate. This typically requires redoing the Form 990-PF for the prior five years. If you determine that Part V Line 8 is less than Part V Line 7, due to reclassifying expenses or disqualifying distributions, the foundation is subject to the 2% rate.

  9. The tax is reported on Form 990-PF. Any adjustments to the tax will be made to the Form 990-PF. Use Forms 4621 and 4883 to propose any changes in the IRC 4940 tax. Use Form 870-E to secure agreement. See Exhibit 4.76.4-1 for an example of how to compute the tax and complete the Forms 4883 and 4621.

4.76.4.2.2.2  (10-02-2014)
IRC 4941: Self-Dealing

  1. For the comprehensive technical discussion of IRC 4941, see IRM 7.27.15. This subsection focuses on how to calculate and assess the tax once you've determined that a self-dealing transaction has occurred.

  2. IRC 4941 taxes are imposed for every year or partial year within a taxable period. The taxable period starts with the self-dealing act and ends with the earlier of:

    • correction (IRM 4.76.4.2.3)

    • issuance of a statutory notice of deficiency

    • assessment of the excise tax

  3. IRC 4941 self-dealing transactions are classified as discrete or continuing. Taxes for discrete transactions are imposed for each year/partial year in the taxable period. Taxes for continuing transactions are imposed for each year/partial year in the taxable period, and are deemed to create new transactions on the first day of each subsequent taxable year in the taxable period. (See Treas. Reg. 53.4941(e)-1(e)(1).) Continuing transactions "pyramid" the tax liabilities but generally have a lesser "amount involved" than discrete acts. The table below lists the transactions that are generally considered to be discrete or continuing, respectively.

    Type of transaction Discrete or continuing transaction
    Sale of property to/from a DP Discrete
    Exchange of property with a DP Discrete
    Leasing of property to/from a DP Continuing
    Lending of money to/from a DP Continuing
    Other extension of credit to/from a DP Continuing
    Furnishing of goods Discrete
    Furnishing of services Discrete
    Furnishing of facilities Discrete (Unless leasing of property)
    Payment of compensation Continuing
    Transfer of a PF asset to a DP Discrete
    Use of a PF asset by a DP Continuing
    Use of a PF asset for the benefit of a DP Continuing
    Agreement to make payment to government official Discrete

    Note:

    See Treas. Reg. 53.4941(e)-1(e)(1)(i) for the list of acts that will generally be treated as "continuing" .

  4. The following examples illustrate the concept of discrete and continuing transactions.

    Example:

    Discrete: A substantial contributor to a foundation buys back a piece of artwork originally donated to the foundation. The payment is made on December 30, 2010. The foundation and contributor are calendar year taxpayers. No correction was made or tax assessed or notice of deficiency mailed until January 1, 2012. The contributor will owe tax on the transaction in 2010, again in 2011, and again in 2012. The table below illustrates the discrete concept:

    Date 2010 2011 2012
    12/30/2010 X X X

    Example:

    Continuing: A substantial contributor donates a painting to the foundation on January 17, 2010. The contributor then hangs the painting in his or her study in their home on the same day. No correction was made or tax assessed or notice of deficiency mailed until January 1, 2012. The foundation and contributor are calendar year taxpayers. The contributor will owe tax on the use of the painting in 2010, 2011, and 2012. In addition, the contributor is deemed to have a new transaction on January 1, 2011, and again on January 1, 2012. The table below illustrates the continuing ("pyramiding" ) concept:

    Date 2010 2011 2012
    1/17/2010 X X X
    1/1/2011   X X
    1/1/2012     X
  5. There are exceptions to the rules for self-dealing. See IRM 7.27.15.4.2, Exceptions to Self-Dealing.

  6. Due to the nature of a transaction, the amount involved in a transaction is determined differently based on the type of transaction. The general rule is that the amount involved is the greater of:

    • the fair market value of the property given

    • the fair market value of the property received

    This rule is modified for the use of money or property, where the amount involved is the greater of:

    • the amount paid for such use

    • the fair market value of such use

    for the period for which the property is used. Other modifications may also apply. See IRM 7.27.15.7.1, Amount Involved Reg. 53.4941(e)–1(b), and Treas. Reg. 53.4941(e)-1(b).

    Example:

    A private foundation sells a condominium to its founder. The condo's fair market value is $250,000. The founder pays $25,000. The amount involved under the general rule is the greater of $250,000 or $25,000. In this case, the amount involved is $250,000. This amount is subject to the self-dealing tax.

    Example:

    On July 1, 2010, a child of a substantial contributor moves into a foundation owned apartment complex to attend a nearby college. The child lives rent free in their apartment for all of 2010, 2011, and 2012 until correction is made Jan. 1, 2013. The next door neighbors in an identical apartment pay $700 per month in rent in 2010, $750 in rent in 2011, and $800 in rent in 2012. The foundation and the child are calendar year taxpayers. The act triggers separate deemed acts on January 1, 2011, and January 1, 2012. The amount involved in each year is as follows:

    Date Rent Amount Time in months Amount involved
    7/1/2010 700.00 x 6 = 4,200.00
    1/1/2011 750.00 x 12 = 9,000.00
    1/1/2012 800.00 x 12 = 9,600.00
  7. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  8. See Exhibit 4.76.4-2 through Exhibit 4.76.4-6 for examples of how to compute the tax and complete the Forms 4883 and 4621. Prepare Form 870-E.

  9. The tax is reported on Form 4720-A, assessed against the self-dealer(s), and if applicable, the foundation manager(s). Open the Audit Information Management System (AIMS) control(s) on Business Master File (BMF) using Master File Tax (MFT) 50. Establish the module as a substitute for return using source code 44 and push code 036. Ensure that you create a substitute for return package per IRM 4.75.22.7.1, Substitute For Return Package.

    Note:

    Delinquent returns are acceptable in lieu of substitutes for return, however they take six to eight weeks to post to BMF. The returns can take longer if errors are present or information is missing, such as signatures or required schedules. To process a delinquent return, see IRM 4.75.22, EO Delinquent, Amended and Substitute for Return Procedures .

4.76.4.2.2.3  (10-02-2014)
IRC 4942: Failure to Distribute

  1. For the comprehensive technical discussion of IRC 4942, see IRM 7.27.16. This subsection focuses on how to calculate and assess the tax once you've determined that the foundation has failed to meet its distribution requirements.

  2. IRC 4942 taxes don't pyramid like continuing acts of self-dealing, but a failure to distribute in a given year may give rise to tax in multiple years in the taxable period like discrete acts of self-dealing. Also, if there is a failure to distribute in one year, there may be a failure to distribute in subsequent years. IRC 4942 may be triggered when you disqualify an otherwise "qualifying distribution" .

  3. Qualifying distributions are made to achieve IRC 170(c)(2)(B) purposes. IRM 7.27.16.5 outlines the ways in which distributions are deemed to qualify.

  4. If you determine that a distribution doesn't serve an IRC 170(c)(2)(B) purpose, and doesn't meet an exception outlined in IRC 4942 or in Treas. Reg. 53.4942(a)-3, then redo the Form 990-PF Parts X, XI, XII, and XIII for the year(s) under audit. If operating under a six year statute memo from Area Counsel, redo the form for each year under audit.

    Note:

    Some transactions that constitute self-dealing transactions and/or taxable expenditures aren't qualifying distributions. Look at each transaction/expenditure on a case by case basis.

  5. A taxpayer generally can't make any elections with respect to qualifying distributions during your audit. Elections must be made prior to the filing of the Form 990-PF. If the taxpayer properly made a pre-filing election, verify the election. If there is a valid election, account for that in your revised Part XIII. (You may find the election in another part of the form.)

  6. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  7. Complete Forms 4883, 4621, 886-A and 870-E. See Exhibit 4.76.4-7 and Exhibit 4.76.4-8 for examples of computing and proposing the tax. Note that to incur the tax requires two years of failing to distribute; in other words, a foundation has until the end of Year 2 to make qualifying distributions of its distributable amount for Year 1. Consider opening all periods with open statutes when dealing with possible disqualified distributions.

  8. The tax is reported on Form 4720 and assessed against the private foundation. Open the AIMS control(s) on BMF using MFT 50. Establish the module as a substitute for return using source code 44 and push code 036. Ensure that you create a substitute for return package per IRM 4.75.22.7.1.

    Note:

    Delinquent returns are acceptable in lieu of substitutes for return, however they take six to eight weeks to post to BMF. The returns can take longer if errors are present or information is missing, such as signatures or required schedules. To process a delinquent return, see IRM 4.75.22.4, Delinquent Return Received.

4.76.4.2.2.4  (10-02-2014)
IRC 4943: Excess Business Holdings

  1. For the comprehensive technical discussion of IRC 4943, see IRM 7.27.17. This subsection focuses on how to calculate and assess the tax once you've determined that the foundation has exceeded its permitted business holdings.

  2. IRC 4943, like discrete acts of self-dealing and 4942 taxes, are imposed for the year in which the foundation has excess business holdings and each subsequent year in the taxable period. The amount of tax may vary from year to year as the excess holdings vary.

  3. The foundation may hold an ownership interest in a business enterprise. The foundation is permitted to hold up to:

    • 2%, regardless of disqualified person ownership percentages (de minimis rule)

    • 35% (ownership of foundation and disqualified persons combined), if the enterprise is effectively controlled by third persons. (See Rev. Rul. 81-111 .)

    • 20% (ownership of foundation and disqualified persons combined), in all other cases.

    Caution:

    Pay particular attention to the source of the income in the business enterprise. If 95% or more of the gross income is from passive sources, then the above rules don't apply, as a passive holding company is not considered a business enterprise. Passive sources include but are not limited to interest, dividends, payments with respect to securities loans, royalties, and rent from real property. (IRC 4943(d)(3)(B), IRC 512(b)(1), IRC 512(b)(2), and IRC 512(b)(3))

  4. Foundations in many instances have a grace period to get rid of the excess ownership interest, which varies depending on the circumstances. In general, the foundation has five years in which to dispose of excess holdings acquired other than by purchase without incurring any tax. There are exceptions to the rule, such as a 90 day time limit in certain situations. See IRM 7.27.17.5, Five-Year Disposition Period.

  5. When examining a private foundation, verify the amount of ownership in any business enterprises. Perform third party contacts with the disqualified persons as needed to determine their ownership percentages. Issue summonses as needed if the disqualified persons are uncooperative.

    Note:

    Be aware that some business enterprise holdings may also constitute jeopardizing investments. See IRM 4.76.4.2.2.5.

  6. If there are excess business holdings, determine for how long the foundation has had the excess holdings. Review IRM 7.27.17.5 to determine the applicable grace period for disposing of the holdings. If the foundation has exceeded the applicable period, proceed to calculate and propose the tax on the foundation.

  7. For purposes of the tax calculation, determine the highest value of the holdings within the tax year. If the ownership interest is in a privately held company or partnership, determine whether a Specialist Referral System referral needs to be made for a Large Business and International (LB&I) economist or engineer. The tax is on the fair market value of the excess portion of the business holdings for the tax year. Assess the tax for each year for which the foundation has/had excess holdings.

  8. Consider expanding your audit to additional years for which the statute is open, and for which the foundation still had excess holdings as of the start of the tax year. The tax amount may vary per year, depending on the increase/decrease in excess holdings that occurred in the years under audit.

  9. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  10. Complete Forms 4883, 4621, 886-A and 870-E. See Exhibit 4.76.4-9 and Exhibit 4.76.4-10 for examples of how to determine and compute the tax.

  11. The tax is reported on Form 4720 and assessed against the private foundation. Open the AIMS control(s) on BMF using MFT 50. Establish the module as a substitute for return using source code 44 and push code 036. Ensure that you create a substitute for return package per IRM 4.75.22.7.1.

    Note:

    Delinquent returns are acceptable in lieu of substitutes for return, however they take six to eight weeks to post to BMF. The returns can take longer if errors are present or information is missing, such as signatures or required schedules. To process a delinquent return, see IRM 4.75.22.4.

4.76.4.2.2.5  (10-02-2014)
IRC 4944: Jeopardizing Investments

  1. For the comprehensive technical discussion of IRC 4944, see IRM 7.27.18. This subsection focuses on how to identify liability for, calculate, and assess the tax once you've determined that the foundation possesses jeopardizing investments.

  2. Investment in a Ponzi scheme may potentially trigger IRC 4944, depending on the facts and circumstances. If you find that the foundation invested in a Ponzi scheme, consult with Area Counsel.

  3. Look for investments that show a lack of reasonable business care and prudence in providing for the long and short term financial needs of the foundation for it to carry out its exempt function. No single factor determines a jeopardizing investment.

  4. No category of investments is treated as an intrinsic violation. Apply careful scrutiny to:

    1. Trading in securities on margin

    2. Trading in commodity futures

    3. Investing in working interests in oil and gas wells

    4. Buying puts, calls, and straddles

    5. Buying warrants

    6. Selling short

  5. As long as the investment decision was sound at the time the investment was made, it's not a jeopardizing expense, even if it later results in a loss.

  6. Keep in mind that the tax doesn't apply to investments:

    • Originally made by a donor who gifted them to the foundation*

    • Acquired by the foundation as a result of a corporate reorganization

    • Made before 1970**

    Exception:

    * If the person receives any consideration from the foundation on the transfer, the foundation will be treated as having made an investment equal to the consideration.

    Exception:

    ** If the form or terms of the investments are later changed, or they are exchanged for other investments, then the investments can be subject to the tax.

  7. Compute the tax using the value of the amount invested on the day the investment was made. Assess the tax for each year or partial year in the taxable period. The tax amount is the same for each year, like discrete acts of self-dealing and 4942 and 4943 taxes.

  8. In addition to the IRC 4944(a)(1) tax imposed on foundations, IRC 4944(a)(2) provides for a tax on the foundation manager who knowingly and willfully participates in the investment. See IRM 7.27.18.6.2, First-Tier Tax on Foundation Managers, for the criteria to be met in order to propose the tax.

  9. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  10. Complete Forms 4883, 4621, 886-A and 870-E. See Exhibit 4.76.4-11 and Exhibit 4.76.4-12 for examples of how to determine and compute the tax.

  11. The IRC 4944(a)(1) tax is reported on Form 4720 and assessed against the private foundation. Open the AIMS control(s) on BMF using MFT 50. Establish the module as a substitute for return using source code 44 and push code 036. Ensure that you create a substitute for return package per IRM 4.75.22.7.1.

    Note:

    Delinquent returns are acceptable in lieu of substitutes for return, however they take six to eight weeks to post to BMF. The returns can take longer if errors are present or information is missing, such as signatures or required schedules. To process a delinquent return, see IRM 4.75.22.4.

  12. The foundation manager tax is reported on Form 4720-A and assessed against the responsible individual(s). Follow the same procedures as in IRM 4.76.4.2.2.5 (11).

4.76.4.2.2.6  (10-02-2014)
IRC 4945: Taxable Expenditures

  1. For the comprehensive technical discussion of IRC 4945, see IRM 7.27.19. This subsection focuses on how to identify liability for, calculate, and assess the tax once you've determined that the foundation made taxable expenditures.

  2. IRC 4945(d) provides for five categories of taxable expenditures. These include amounts:

    1. Spent to carry on propaganda or attempt to influence legislation. IRC 4945(d)(1)

    2. Expended to influence the outcome of any specific public election, or to carry on a partisan voter registration drive (directly or indirectly). IRC 4945(d)(2)

    3. Paid as a grant to an individual for travel, study, or other similar purposes. IRC 4945(d)(3)

    4. Disbursed as a grant to an organization, unless the organization is a public charity (other than certain supporting organizations - see IRC 4945(d)(4)(A)(ii)) or exempt operating foundation. IRC 4945(d)(4)

    5. Paid or incurred for any purpose other than one specified in IRC 170(c)(2)(B). IRC 4945(d)(5)

  3. For the required elements of and exceptions for each category, see the following IRM sections:

    • For IRC 4945(d)(1), see IRM 7.27.19.3, Attempting to Influence Legislation (Lobbying).

    • For IRC 4945(d)(2), see IRM 7.27.19.4, Public Elections and Voter Registration Drives.

    • For IRC 4945(d)(3), see IRM 7.27.19.5, IRC 4945(d)(3) Grants to Individuals.

    • For IRC 4945(d)(4), see IRM 7.27.19.6, .Grants to Organizations IRC 4945(d)(4)

    • For IRC 4945(d)(5), see IRM 7.27.19.7, Expenditures for Noncharitable Purposes IRC 4945(d)(5).

  4. An expenditure may fall into several categories of taxable expenditure. Regardless of the number of categories violated, the tax is assessed only once.

    Example:

    A foundation manager issues a series of payments to two individuals to travel throughout several counties in a state during an election year. The recipients act as paid signature gatherers for a number of ballot initiatives to modify current laws. They also go door to door to sign up eligible voters, based on a list of potential voters provided by a state political party. They provide pamphlets to the voters promoting specific party candidates. The individuals submit travel vouchers for reimbursement to the foundation, along with the signature pages, lists of voter registrations, and paid invoices for the printing of the pamphlets.

    Note:

    In the above example, the foundation has violated IRC 4945(d)(1), (d)(2), and (d)(5). The foundation is liable only once for the tax on the reimbursements to the individuals, and the tax is imposed only once in the taxable period.

  5. When examining the foundation, review all of the expenditures. Determine which expenditures constitute grants. For grants to individuals for travel, studies, or similar purposes, verify that the organization has obtained an IRC 4945(g) advance ruling letter. The letter may be requested during the initial application process or in a subsequent ruling request. If the foundation doesn't have a ruling letter, determine whether it meets an exception under IRC 4945(d)(3) (IRM 7.27.19.5) or IRC 4945(g) (IRM 7.27.19.5.7, Advance Approval Under IRC 4945(g)). Assess the tax if the foundation fails to meet the exceptions.

    Note:

    The foundation may submit Form 8940, Request for Miscellaneous Determination, and pay a user fee to request an IRC 4945(g) advance ruling letter. The subsequent ruling is prospective from the date of the letter and is not retroactive, though it may be required as part of correction.

  6. Unless a grant was made to a public charity (other than certain supporting organizations - see IRC 4945(d)(4)(A)(ii)) or an exempt operating foundation, determine whether the foundation exercised expenditure responsibility. See IRM 7.27.19.6.5, Expenditure Responsibility. Review the:

    • pre-grant inquiries (IRM 7.27.19.6.6, Pre-grant Inquiry Requirement IRC 4945(h)(1))

    • grant agreements (IRM 7.27.19.6.7, Terms of Grant Agreements)

    • the grantee reports (IRM 7.27.19.6.10, Reporting Requirements of the Grantee Organization)

    • the grantor reports (IRM 7.27.19.6.11, Reporting Requirements of the Grantor)

    For those grants that failed the expenditure responsibility requirement, propose the first tier tax and request correction. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  7. Be mindful that there are permitted expenditures. Examples of permitted expenditures include:

    • Expenditures to acquire investments that generate income to be used to further the purposes of the organization

    • Reasonable expenses related to acquiring these investments

    • Payment of taxes

    • Expenses that qualify as allowable deductions in figuring unrelated business income tax (UBIT)

    • Any payment that is an IRC 4942 qualifying distribution

    • Any deduction allowed in arriving at taxable net investment income (IRC 4940)

    • Reasonable expenditures to evaluate, acquire, modify, and dispose of program-related investments

    • Business expenses of the recipient of a program related investment

  8. Payment of unreasonable administrative expenses, including wages, consultant fees, and other fees for services performed, are taxable expenditures unless:

    1. Made in the good faith belief that the amounts were reasonable.

    2. Consistent with ordinary business care and prudence.

  9. Request documentation that supports the reasonableness determination for any expenditure that appears unreasonable. Expenditures may be taxable if the trustees, officers, or foundation managers made no effort to determine whether the expenditures were reasonable. If needed, submit a Specialist Referral System request for an LB&I engineer to evaluate the expenditure. Determine the excess expenditure and propose the tax for the excess amount.

  10. Compute the tax using the expenditure amount, or excess amount if deemed unreasonable. Propose the tax for the year in which the expenditure was made.

  11. In addition to the IRC 4945(a)(1) tax imposed on foundations, IRC 4945(a)(2) provides for a tax on a foundation manager who knowingly and willfully agrees to the expenditure. See IRM 7.27.19.8 for the criteria to be met in order to propose the tax.

  12. See IRM 4.76.4.2.3 for a discussion of acceptable correction.

  13. Complete Forms 4883, 4621, 886-A and 870-E. See Exhibit 4.76.4-13 and Exhibit 4.76.4-14 for examples of how to determine and compute the tax.

  14. The IRC 4945(a)(1) tax is reported on Form 4720 and assessed against the private foundation. Open the AIMS control(s) on BMF using MFT 50. Establish the module as a substitute for return using source code 44 and push code 036. Ensure that you create a substitute for return package per IRM 4.75.22.7.1.

    Note:

    Delinquent returns are acceptable in lieu of substitutes for return, however they take six to eight weeks to post to BMF. The returns can take longer if errors are present or information is missing, such as signatures or required schedules. To process a delinquent return, see IRM 4.75.22.4.

  15. The foundation manager tax is reported on Form 4720-A and assessed against the responsible individual(s). Follow the same procedures as in IRM 4.76.4.2.2.6 (14).

4.76.4.2.2.7  (10-02-2014)
One Act/Failure to Act, Multiple Violations

  1. The structure of Chapter 42 permits the assessment of excise taxes under different statutes for the same violation. For instance, a self-dealing transaction (IRC 4941) is frequently also a taxable expenditure IRC 4945, that may also affect the net investment income (IRC 4940) and the qualifying distributions (IRC 4942).

  2. IRC 4940 and IRC 4942 are inseparable. Adjustments to the net value of non-charitable use assets impact the computation of the distribution ratio (IRC 4940) and the minimum investment return (IRC 4942). Both taxes rely upon the determination of qualifying distributions, with IRC 4940 using the distribution ratio to determine eligibility for the 1% tax rate, and IRC 4942 applying them against undistributed income to arrive at the tax liability. The following examples illustrate several outcomes when changes are made to the first page of the Form 990-PF.

    Example:

    1. The organization engages in self-dealing expenditures. These amounts were reported in Part I Column d as charitable disbursements. These amounts are subsequently disallowed. The amount reported on Part XII Line 1a is reduced. This in turn reduces the qualifying distributions. When the qualifying distributions for the year are less than the sum of 1% of the net investment income and the product of 1) the 5 year average distribution ratio and 2) the net value of the non-charitable use assets, the foundation can't use the IRC 4940(e) 1% tax rate. For IRC 4942 purposes, undistributed income is offset by qualifying distributions. When the qualifying distributions are reduced or disallowed, the potential for tax on undistributed income arises. (The flow of actions is demonstrated as follows:

    Form 990-PF line adjustment Increase or decrease
    Part I Line 26 Column (d) Decrease
    Part XII Line 1(a) Decrease
    Part XII Line 4 Decrease
    Part V Line 8 Decrease
    Part XIII Line 4 Decrease

    If Part V Line 8 is less than Part V Line 7, use the 2% tax rate for 4940. If Part XIII Line 2 Column (c) is greater than Part XIII Line 4 Column C, the amount in Part XIII Line 6(e) is subject to 4942.)

    Example:

    2. The organization understates the net investment income (either understating investment revenues or over-allocating/overstating investment expenses or both). This directly increases the IRC 4940 tax. In addition, this decreases the distributable amount (Part XI). This decreases the amount of undistributed income to be offset by qualifying distributions in Part XIII. The flow of actions is demonstrated as follows:

    Form 990-PF line adjustment Increase or decrease
    Part I Line 27(b) Increase
    Part VI Line 5 Increase
    Part XI Line 2(a) Increase
    Part XI Line 7 Decrease
    Part XIII Line 1 Decrease

    If the amount on Part XIII Line 1 is greater than the sum of Part XIII Lines 4(d) and 5, there will be an amount in Part XIII Line 6f. This amount in turn is reported on the subsequent year's Form 990-PF Part XIII Line 2a.

    Example:

    3. The organization overstates the net investment income. The IRC 4940 tax is reduced, and the distributable amount in turn is increased, increasing any possible IRC 4942 tax.

    Example:

    4. The organization understates the non-charitable use assets. (This frequently occurs when the return preparer averages the beginning and end of year bank/brokerage balances in lieu of the month end balances.) The non-charitable use assets net value increases, as does the minimum investment return (Part X Lines 5 and 6). In addition to affecting the subsequent year's distribution ratio, the threshold for meeting the IRC 4940(e) reduced tax rate is raised. For IRC 4942 purposes, the distributable amount increases, thus increasing the chance for tax two years down the road.

    Example:

    5. The organization overstates the non-charitable use assets. The net value of non-charitable use assets decreases, as do the minimum investment return and distributable amount. The IRC 4940(e) threshold is lowered, and the chance for a possible IRC 4942 tax is reduced.

  3. IRC 4941 and IRC 4945 can commonly occur for the same transaction. Many self-dealing transactions aren't considered to be for IRC 170(c)(2)(B) purposes, thus becoming taxable expenditures. On the other hand, a taxable expenditure isn't necessarily a self-dealing transaction. Remember when analyzing each transaction to apply the appropriate code and regulations.

    Example:

    1. A foundation manager uses foundation funds to go on a vacation in the Bahamas. The foundation does not have advance approval under IRC 4945(g) to make grants to individuals. This transaction is both a self-dealing transaction and a taxable expenditure.

    Example:

    2. The same foundation manager is a member of Church X congregation. The manager uses the funds to pay for a "recuperation retreat" for the church's pastor and the pastor's family in the Bahamas. The manager is not related to the pastor by blood or marriage, and the pastor and family are not otherwise disqualified persons with respect to the foundation. Due to lack of advance approval of the grant procedures under IRC 4945(g), the transaction constitutes a taxable expenditure but not a self-dealing expenditure.

  4. An act subject to IRC 4943 may also trigger other taxes in certain situations.

    Example:

    A foundation purchases stock of a disqualified person's wholly owned corporation directly from the disqualified person (see IRM 7.27.15.4.2.6, Securities Transactions). The purchase of the stock constitutes a self-dealing transaction. If the foundation becomes the owner of more than 2% of the total stock of the corporation, the purchase may trigger IRC 4943. (A donation of the stock won't constitute a self-dealing transaction, but may trigger IRC 4943.)

  5. As with IRC 4943, an act subject to IRC 4944 may also trigger other taxes in certain situations.

    Example:

    The foundation bought stock of a disqualified person's wholly owned corporation from the disqualified person. The corporation is a corporate sole entity used to shelter the disqualified person's income and assets. The disqualified person isn't a minister of a church and thus the entity constitutes a sham corporation. The purchase constitutes a jeopardizing investment and a self-dealing transaction. As with the previous example, if the foundation owns more than 2% of the total stock of the corporation, the transaction may also trigger IRC 4943.

4.76.4.2.3  (10-02-2014)
Correction

  1. Each Chapter 42 excise tax provides for correction of the act or failure to act that triggers the excise tax. Failure to make correction can result in the imposition of second tier taxes. When one transaction triggers multiple excise taxes, the correction for one tax may possibly also satisfy correction for the other taxes.

  2. The following table below identifies the code subsection requiring correction and the actions required for making correction. There is no correction for IRC 4940, as it has no second tier excise tax. (IRC 4940 is an excise tax that is computed like an income tax, except that certain deductions are not allowed, such as the net operating loss deduction under IRC 172. See Treas. Reg. 53.4940-1(e).

    Code Section Correction
    IRC 4941(e)(3) Undo the transaction to the extent possible. Restore the foundation to the same or better financial position than it would have been had the transaction not occurred. IRM 7.27.15.7.2, Correction, Treas. Reg. 53.4941(e)-1(c)
    IRC 4942(h)(2) and IRC 4963(d)(2) Reduce the amount of undistributed income to zero. Can elect to treat qualifying distributions as made from a prior year's undistributed income. (Treas. Reg. 53.4942(a)–3(b)(6) requires distribution of cash if failure to distribute was willful and not due to reasonable cause.) IRM 7.27.16.6.8.7, Failure to Distribute Minimum Amounts.
    IRC 4943(c) Depending on when and how the business holding was received, the organization may have a transition period in which to get rid of the excess holding. Correction is obtained when no excess holdings remain. IRM 7.27.17.11, Correction, Treas. Reg. 53.4943-9(c)
    IRC 4944(e)(2) Remove the investment from jeopardy by either selling it or otherwise disposing of it (other than exchanging it for another jeopardizing investment). IRM 7.27.18.5, Removal from Jeopardy, Treas. Reg. 53.4944-5(b)
    IRC 4945(i)(1) Recover as much of the expenditure as possible, and any other correction we prescribe if unable to recover the whole expenditure. In certain situations, obtain or make a report concerning the use of a grant, or obtain approval of grantmaking procedures. IRM 7.27.19.9.3, Correction of Taxable Expenditures and Second-Tier Taxes, Treas. Reg. 53.4945-1(d)
  3. The correction amount is not necessarily the same as the amount involved in a particular transaction. Compute the correction amount and the taxable amount involved separately. Refer to the specific manual sections and regulations for directions on the appropriate correction methods.

    Note:

    When two or more taxes are involved, verify that correction has been made for each tax code section. What may constitute correction for one section may not be sufficient correction under another section.

    Example:

    A foundation issues a below-market "loan" to a disqualified person, who in turn uses the money to purchase a vacation property for their personal use. The transaction is both self-dealing and a taxable expenditure. To correct the taxable expenditure, the disqualified person needs to repay the loan. To correct the self-dealing transaction, the disqualified person needs to not only repay the loan, but also pay interest.

  4. When correction is made, obtain verification of the correction. The following is a list of acceptable proof. This list isn't exclusive. Discuss with your manager and Area Counsel, if desired, as to appropriate methods of correction and proof of that correction.

    • Copies of cancelled check(s) to the foundation and bank statement(s) showing the deposit(s)

    • New title documents for returned real property

    • Copies of cancelled check(s) and bank statement(s) showing appropriate distributions

    • Brokerage/financial institution statement(s) showing that a foundation no longer owns an asset or stock

    • Copies of reports secured concerning the uses of grants made

  5. Be alert for attempts to circumvent the correction requirement. At a minimum, ensure that the parties don't take the following actions:

    • Deposit the correction amount and then issue a new check back to the party making correction.

    • Obtain new title documents for returned property and then change title back to the party that returned the property.

    • Redeposit amounts distributed to satisfy IRC 4942 (e.g. voided checks, circular transactions).

    • Transfer assets or stocks to other financial institutions or to disqualified parties for which statements aren't provided.

  6. In the event that you're revoking or involuntarily terminating the foundation, request and verify that correction is made to a governmental agency or other IRC 501(c)(3) organization that isn't itself at risk of revocation.

  7. You may receive requests for extending the correction period (IRC 4963(e)(1)(B)). Under Delegation Order 7-4 (IRM 1.2.46.5, Delegation Order 7-4 (formerly DO-139, Rev. 7)), Area Managers may authorize extensions of the correction period, or delegate the authority to the group manager. Consult your group manager if considering granting an extension of time to make correction.

  8. Extensions of the correction period are not ordinarily granted unless the following factors are present:

    1. The taxpayer is actively seeking in good faith to correct the taxable event.

    2. Adequate correction is unavailable or can't reasonably be expected to occur during the original correction period.

    3. The taxable event appears to be an isolated occurrence, and it appears unlikely that similar taxable events will occur in the future.

    See Treas. Reg. 53.4963–1(e)(3).

    Note:

    An extension of the correction period also extends the period in which the taxpayer may petition the Tax Court with respect to the deficiency. Treas. Reg. 301.6213-1(e).

  9. A taxpayer paying the full amount of the first tier tax during the original correction period extends the correction period to the later of:

    • Ninety days after payment of the first tier tax

    • The last day of the original correction period.

    Note:

    If the taxpayer pays the first tier tax after a statutory notice of deficiency has been mailed and before the 90 day period of the notice has expired, the taxpayer will have 90 days from the date of payment to make correction. Treas. Reg. 53.4963-1(e)(4). If the taxpayer petitions the Tax Court with respect to liability for second tier taxes, prior to the expiration of the correction period (including extensions), the correction period runs until the decision is final. Treas. Reg. 53.4963-1(e)(2).

4.76.4.2.3.1  (10-02-2014)
Advance Approval of Proposed Correction

  1. Taxpayers may request advance approval of a proposed correction. If granted, the advance approval provides assurance to taxpayers and organizations that an intended remedial action will be favorably viewed as correction.

  2. Advance approval is only available where:

    1. The only barrier is the reluctance to correct because of the uncertainty of final IRS approval.

    2. The other aspects of the issue are not in dispute.

    For all other cases, treat the case as unagreed if the taxpayer is unwilling to make correction.

  3. In order to grant advance approval, all of the following conditions must be met:

    • The taxpayer indicates acceptance of initial tax liability (IRC 4941 through 4945).

    • Correction will be very difficult or costly, requiring the exercise of sound judgment on a broad scale.

    • The proposed correction should be able to be completed within 90 days from the date of approval.

    • The taxpayer submits a written request for advance approval, attention of the Area Manager.

  4. The written request must:

    1. Describe fully the surrounding circumstances giving rise to the initial tax liability.

    2. Outline in detail the nature and method of the proposed correction.

    3. Accept an initial tax liability for the act or failure to act in question.

    4. Include the date by which the correction will actually be completed.

  5. Upon receipt, suspend further action with respect to the issue. Continue all other aspects of the examination. Send a copy of the request to the Area Manager (scanned and secured e-mail if possible). Schedule and hold a conference call with your Group and Area Managers.

  6. If the Area Manager approves the request, prepare and issue a draft correction approval letter. See Letter 5305, Private Foundation Correction Approval Letter. The letter must:

    1. Set forth in detail the corrective action to be taken.

    2. Specify the due date for correction completion.

    3. Require notification of the Area Manager upon completion.

    4. Clarify that reliance on the letter is conditioned upon meeting the conditions specified for correction.

    Reminder:

    Keep in mind the time remaining on the statute of limitations. Consider requesting a statute extension as needed.

  7. If the Area Manager denies the request, prepare and issue a draft correction rejection letter. See Letter 5306, Private Foundation Correction Rejection Letter. In the letter:

    1. Outline the taxpayer's proposal.

    2. Explain why it does not constitute correction.

    3. Clarify that other methods of correction are still available.

    4. Suggest a particular correction action (or actions) that would be acceptable.

  8. If the request is accepted, keep the case in the group, and continue to work other issues on the case. Upon notification of the Area Manager of completed correction, secure proof of correction. Secure the taxpayer's agreement to the first tier tax on Form 870-E. Collect the first tier tax or secure an installment agreement request (Form 9465, Installment Agreement Request).

  9. If no notification or proof is received by the due date for correction, make a final contact to the taxpayer to confirm correction. Request that proof be promptly submitted (e.g. mailed via express mail, faxed, or scanned and sent via e-mail.) Upon receipt, follow the procedures outlined in IRM 4.76.4.2.3.1 (8) above.

  10. If no proof of correction is received, close the case as unagreed. See IRM 4.75.16, Case Closing Procedures , for closing procedures.

4.76.4.2.4  (10-02-2014)
Second Tier Excise Taxes

  1. The following table identifies the second tier taxes applicable to each code section.

    Code Section Liable party Tax Rate Limit? (PPA 2006*)
      Before After
    IRC 4941(b)(1) Self dealer 200% None None
    IRC 4941(b)(2) FM 50% $10,000 per act $20,000 per act
    IRC 4942(b) PF 100% None None
    IRC 4943(b) PF 200% None None
    IRC 4944(b)(1) PF 25% None None
    IRC 4944(b)(2) FM 5% $10,000 per act $20,000 per act
    IRC 4945(b)(1) PF 100% None None
    IRC 4945(b)(2) FM 50% $10,000 per act $20,000 per act
    *The limit changes are effective for the first full tax years that begin after August 17, 2006.
  2. Second tier taxes are triggered by the failure to make correction, are imposed at the same time that first tier taxes are imposed in the case of assessment or issuance of a notice of deficiency, and are abated if correction is made within the correction period. Indicate in your report of examination (Forms 4883, 4621, 886-A) the amount of potential second tier taxes if the taxpayer doesn't make correction. With Area Manager approval, you may delay the closure of an agreed first tier tax case for a reasonable period to permit correction, depending on the facts and circumstances. Before granting such an extension, ensure that:

    1. The taxpayer has signed the Form 870-E.

    2. The taxpayer has paid the first tier tax.

    3. The taxpayer has granted a statute extension, if necessary.

    Note:

    Area Manager approval is required due to the substantial additional cycle time that is incurred.

  3. All second tier taxes are imposed once per act/failure to act. For assessment purposes, report the second tier tax on the last year of the audit. In situations where partial correction is performed, the second tier tax will be on the uncorrected remaining amount.

    Note:

    For purposes of IRC 4941(b), where an act of self-dealing involves a loan or lease in which a new act of self-dealing arises under the pyramiding rule, the amount involved is separately determined for each act, including deemed acts. In determining the amount involved for the second tier tax, the fair market value used is the highest fair market value during the taxable period.

    Example:

    1. IRC 4941(b)(1) discrete act: in 2012, a substantial contributor purchases back a piece of artwork previously donated to the foundation. The contributor pays $2,000 for the artwork that has a fair market value of $250,000. The amount involved is $250,000 (Treas. Reg. 53.4941(e)-1(b)). For the 2012 tax year, the second tier tax is $250,000 x 200% = $500,000.

    Example:

    2. IRC 4941(b)(1) continuing act: on July 1, 2010, a child of a substantial contributor moves into a foundation owned apartment complex to attend a nearby college. The child lives rent free in their apartment for six months of 2010, all of 2011, and all of 2012, while the next door neighbors in an identical apartment pay $700 per month in rent in 2010, $750 in rent in 2011, and $800 in rent in 2012. The foundation and the child are calendar year taxpayers. The act also triggers separate deemed acts on January 1, 2011, and January 1, 2012. The amount involved in each year is as follows:

    Date Rent Amount Time in months Amount involved
    7/1/2010 800.00 x 6 = 4,800.00
    1/1/2011 800.00 x 12 = 9,600.00
    1/1/2012 800.00 x 12 = 9,600.00
    Total 24,000.00
      x 200%
    Tax 48,000.00
  4. Before asserting the second tier tax on a foundation manager, issue a Thorne letter requesting that they take specific actions. See Thorne v. Commissioner, 99 T.C. 67 (1992). For assistance in drafting a Thorne letter, contact Area Counsel. See Exhibit 4.76.4-16 for sample language used in a Thorne letter for a theoretical IRC 4945 scenario. See also IRM 7.27.15.3.2, Tax on Foundation Manager.

  5. If the taxpayer doesn't agree to the tax or fails to make correction, close the case to Mandatory Review as unagreed. If the case isn't subject to a protest to Appeals, Mandatory Review issues the statutory notice of deficiency assessing the first and second tier taxes. See IRM 4.75.16 for case closing procedures.

    Reminder:

    If the case has fewer than 270 days on the statute remaining, the group is responsible for preparing the statutory notice of deficiency. See IRM 4.75.16 and IRM 4.75.20, Final Case Processing for further guidance.

4.76.4.2.5  (10-02-2014)
Termination Tax

  1. See IRM 7.26.7 for the comprehensive technical discussion of private foundation terminations. This section focuses on those situations when tax is due. The termination tax functions like a third tier excise tax.

  2. The phrase termination has several different meanings in the context of private foundations. When a public charity terminates, the entity dissolves or goes out of business. In the case of a private foundation, termination does not necessarily mean a dissolution has occurred. Termination for IRC 507 purposes means:

    1. The foundation notifies the Service and pays the IRC 507(c) tax (if any). (IRC 507(a)(1))

    2. The Service involuntarily terminates the foundation and imposes IRC 507(c) tax. (IRC 507(a)(2))

    3. The foundation transfers all of its net assets to certain public charities. (IRC 507(b)(1)(A))

    4. The foundation becomes a public charity. (IRC 507(b)(1)(B))

    Note:

    Transfer under IRC 507(b)(2) of all of a foundation's net assets to one or more other foundations does not, by itself, terminate private foundation status. The foundation must separately terminate, whether voluntarily (507(a)(1)) or involuntarily (507(a)(2)).

  3. Provided that the foundation hasn't engaged in repeated willful acts or one flagrant, willful act triggering Chapter 42 taxes, the foundation may opt for termination under IRC 507(b). If terminated under IRC 507(b), the foundation pays $0 in termination taxes.

  4. If the foundation voluntarily terminates under IRC 507(a)(1), they submit their final Form 990-PF and pay a termination tax. The foundation follows the instructions to the Form 990-PF as to the method of notification.

  5. Consider imposing an IRC 507(a)(2) involuntary termination when the foundation has committed multiple willful repeated acts under Chapter 42. You can also consider IRC 507(a)(2) if the foundation committed one willful flagrant act triggering Chapter 42 treatment. If proposing involuntary termination, you can propose revocation at the same time. See IRM 7.26.7.3.2, Involuntary IRC 507(a) (2) Terminations.

    Note:

    As a practical matter, termination tax assessments are more likely to occur during a subsequent audit. Once Chapter 42 taxes have been assessed, any new violations identified in a later audit will provide proof of willfulness.

  6. Computing the termination tax requires multiple smaller computations normally provided by the foundation: .

    The termination tax is the smaller of:
    A) The aggregate tax benefit - the sum of: B) The value of the net assets as of the date the foundation first committed a Chapter 42 violation, or the effective termination date, whichever amount is higher. See IRC 507(e)(1). Default to this amount unless the "aggregate tax benefit" is calculated.
    1. The increase in income, estate, and gift taxes** on substantial contributors that would result from the disallowance of their contributions. The taxes are computed from the later of the foundation inception date or March 1, 1913. (IRC 507(d)(1)(A))
    2. The income taxes of the foundation, had the foundation filed Forms 1120, U.S. Corporation Income Tax Return, or Forms 1041, U.S. Income Tax Return for Estates and Trusts, in lieu of Forms 990-PF. The taxes are computed from the later of the foundation inception date or January 1, 1913.* (IRC 507(d)(1)(B))
    3. Amounts received from private foundations to which IRC 507(b)(2) transferee liability applies. (Treas. Reg. 1.507-3)
    4. The accumulated interest on the above amounts as computed via RGS NT or IDRS command code INTST. (IRC 507(d)(1)(C))
    *For purposes of this calculation, the charitable contribution deduction allowed a trust is deemed to have been limited to 20% of taxable income. IRC 507(d)(1)(B)(ii).

    ** For any year in which a gift tax would be due if a charitable deduction were not available, refer to the Instructions to Form 709, United States Gift (and Generation - Skipping Transfer) Tax Return, for that particular year for assistance in calculating the appropriate amount of deemed gift tax.
  7. As we retain records for a limited period, you may not necessarily be able to compute the tax from the date of inception. Obtain what information you can via IDRS, return requests, and Online SEIN. Establish AIMS controls via the Reporting Compliance and Case Management System (RCCMS) using source code 45 to retrieve the returns of the substantial contributors.

  8. See IRM 4.75.31 for guidance on converting the Forms 990-PF to Forms 1120 or 1041. Use the Report Generation System NT (RGS NT) to determine the increase in income tax from the disallowance of charitable contributions deductions..

  9. Propose the tax using Forms 4883 and 4621. Use Form 990-PF to assess the tax in lieu of Form 4720. See Exhibit 4.76.4-15 for an example.

  10. Imposition of the termination tax doesn't eliminate liability for the underlying Chapter 42 taxes that initiated the termination process.

  11. When closing the case as a termination prepare Form 2363-A, Request for IDRS Input for BMF/EO Entity Change, to update the status code, indicating the effective date in YYYYMM format:

    • Status 23: 507(a)

    • Status 24: 507(b)(1)(A) (No termination tax applies)

    • Status 25: 507(b)(1)(B) (No termination tax applies)

    All terminations are subject to Mandatory Review. Leave the Form 2363-A in the case file.

  12. Termination of private foundation status under IRC 507 results in the foundation being treated as an organization created on the day after termination. IRC 509(c).

4.76.4.2.6  (10-02-2014)
Revocation

  1. Propose to revoke exemption if the foundation ceases to be operated exclusively for exempt purposes but the circumstances do not warrant involuntary termination of private foundation status under IRC 507(a)(2). An IRC 501(c)(3) foundation must engage primarily in activities that accomplish IRC 501(c)(3) purposes. If more than an insubstantial part of its activities doesn't further an exempt purpose, propose revocation. A private foundation is subject to the auto revocation process of IRC 6033(i) and IRC 6033(j). (See IRM 4.75.16.)

  2. Foundations are subject to similar restrictions as other IRC 501(c)(3) organizations:

    • Absolute prohibition for political campaigning

    • Limitation on lobbying (subject to IRC 4945(d))

    • Prohibition on inurement

    • Prohibition on operating for benefit of private interests

    • Limitation on UBI activities (less than primary purpose)

    • Limitation on commercial-type insurance (IRC 501(m))

    • Prohibition on illegal activities/purposes that violate public policy

  3. If the foundation violates any of the prohibitions and/or restrictions listed above, propose revocation. When proposing revocation, follow the procedures in IRM 4.75.31, Conversion of Returns Upon Revocation of Exemption. Upon revocation, the foundation becomes a taxable private foundation. See IRM 4.76.4.3.

  4. In many revocations, the foundation, disqualified persons, and foundation managers may also be subject to Chapter 42 excise taxes. If there are multiple repeated acts or a single flagrant act triggering Chapter 42 taxes, propose the termination tax in addition to revocation. The basic report forms in Exhibit 4.76.4-15 may be included with Letter 3614, 30-day letter package for Chapter 42 excise taxes. Form 870-E will reflect all tax deficiencies of the foundation.

  5. In revocations of private foundations, the foundation becomes a taxable foundation and must file an income tax return as well as Form 990-PF. Use status codes 18 (for trusts) and 19 (for corporations) in lieu of status code 22. Status codes 18 and 19 set the Form 990-PF and Form 1041 or Form 1120 filing requirements. In such situations, prepare Form 2363-A with status code change and indicate the effective date of revocation in YYYYMM format.

  6. All revocations are subject to Mandatory Review. Leave the Form 2363-A in the case file.

4.76.4.2.7  (10-02-2014)
Statute of Limitations

  1. The Form 990-PF initially controls all statutory limitations periods for assessment and collection of taxes (or "statutes" ) with respect to the excise taxes. (IRC 6501(l)(1), Treas. Reg. 301.6501(n)-1(a)) The following table identifies the code section, the taxable party, the return used to impose the tax, and the year on which the tax is imposed.

    Code Section Liable party Tax form Tax year
    IRC 4940(a) PF 990-PF On the same form, same year.
    IRC 4941(a)(1) Self dealer 4720-A If individual: Year of Form 1040, U.S. Individual Income Tax Return, in which transaction occurs.
    All others: Year of Form 1041, 1065, U.S. Return of Partnership Income, or 1120 in which transaction falls. If a partnership, flows through to the respective partners.*
    IRC 4941(a)(2) FM 4720-A Form 1040 year in which transaction occurs.
    IRC 4942(a) PF 4720 Same year of Form 990-PF
    IRC 4943(a)(1) PF 4720 Same year of Form 990-PF
    IRC 4944(a)(1) PF 4720 Same year of Form 990-PF
    IRC 4944(a)(2) FM 4720-A Form 1040 year in which transaction occurs.
    IRC 4945(a)(1) PF 4720 Same year of Form 990-PF
    IRC 4945(a)(2) FM 4720-A Form 1040 year in which transaction occurs.
    * If assessing a Chapter 42 tax on a partnership, also assess tax on the partners. Pro-rate the amount of tax per partner based on their percentage of control of the partnership.
  2. If no Form 990/990-EZ/990-PF has been filed, the Form 4720/4720-A that discloses the transaction can start its own statute.

  3. The rules for the length of statutory period for assessing Chapter 42 taxes are:

    Length of statute Requirements Code Section
    3 years Form 990/990-EZ/990-PF filed disclosing the transaction (must adequately identify existence and nature of transaction). IRC 6501(a)
    6 years IRC 4940, 4948: Exceeds 25% of amount reported on return.
    IRC 4941 - IRC 4945: Transaction not disclosed on the return.
    Requires Area Counsel memo.
    IRC 6501(e)(3)
    Open ended False or fraudulent return with intent to evade tax.
    Form 990, Return of Organization Exempt From Income Tax/990-EZ, Short Form Return of Organization Exempt From Income Tax/990-PF not filed (SFR).
    Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or Form 990EZ, filed (doesn't start the statute).
    Requires Area Counsel memo for false or fraudulent returns.
    IRC 6501(c)(1), IRC 6020(b)
  4. IRC 4942 has some statute modifications:

    IRC 4942 Subsection Additional Time Code Section Reference
    IRC 4942(g)(3)
    Failure to distribute deficiency
    +1 year to statute date IRC 6501(l)(2)
    IRC 4942(g)(2)(B)(ii)
    Failure to set aside deficiency
    +2 years to statute date IRC 6501(l)(3)
  5. Prepare and obtain statute extensions for all parties to an excise tax. This entails extensions on the foundation, disqualified persons, and foundation managers, if applicable. Use Form 872, Consent to Extend the Time to Assess Tax, to secure the extension.

    Caution:

    Form 872-A, Special Consent to Extend the Time to Assess Tax, is available as an alternative, that provides for an open ended extension, until terminated by the submission of Form 872-T, Notice of Termination of Special Consent to Extend the Time to Assess Tax. Use of Form 872-A should be limited only to cases with valid formal protests to Appeals.

  6. The statutory limitations period for chapter 42 taxes reportable on Form 4720 ordinarily begins with the filing of Form 990-PF, whether or not Form 4720 is filed. If there are multiple acts/failures to act over a period of years, the Forms 4720/4720-A will have separate statutes for each transaction. When extending the statute for the Form 4720/4720-A, extend the statute for all of the transactions.

    Example:

    A private foundation with a fiscal year ending in August makes a series of continuing self-dealing transactions in 2008, 2009, 2010, and 2011. Transactions occurred on November 1, 2008, June 1, 2009, October 1, 2009, March 15, 2010, September 15, 2010, and May 20, 2011. The self-dealer's fiscal year ends in December. The Forms 990-PF for 200908 through 201108 were filed February 20, 2010, March 10, 2011, and February 15, 2012. The table below illustrates how the statutes work for the Forms 990-PF and 4720, as of an extension request date of September 1, 2012:

    Transaction Form 990-PF Statute Begins Form 4720 Statute Begins
    11/1/2008 200908 2/20/2010 200812 2/20/2010
    6/1/2009 200908 2/20/2010 200912 2/20/2010
    9/1/2009 (continuing acts) 201008 3/10/2011 200912 3/10/2011
    10/1/2009 201008 3/10/2011 200912 3/10/2011
    3/15/2010 201008 3/10/2011 201012 3/10/2011
    9/1/2010 (continuing acts) 201108 2/15/2012 201012 2/15/2012
    9/15/2010 201108 2/15/2012 201012 2/15/2012
    5/20/2011 201108 2/15/2012 201112 2/15/2012
    9/1/2011 (continuing acts) 201208 TBD 201112 TBD
  7. When preparing the extensions, reference the specific code section in the type of tax. Use "excise (§494X)" or "excise (section 494X)" . If extending both income and excise taxes, state "income and/or excise (§494X)" . If extending multiple excise tax code sections, state "excise (§§ 494X and 494Y)" .

  8. Extensions for IRC 4941 through IRC 4945 taxes require a modification of the Form 872. Replace the phrase "on any returns made by or for the above taxpayer(s) for the period(s) ended" with "from the above taxpayer(s) for the years that are fully or partially within the taxable period(s) that began" . Use the date of the first act or failure to act for the start of the taxable period. See Exhibit 4.76.4-17 for an example.

  9. If there are multiple acts in a single tax year that trigger Chapter 42 taxes, you may list them on the modified Form 872. See Exhibit 4.76.4-18 for an example.

  10. As the IRC 4940 tax is assessed on the Form 990-PF, prepare any statute extensions for IRC 4940 taxes using the regular Form 872. Associate the statute extension with the appropriate Form 990-PF.

  11. As a single act or failure to act may give rise to chapter 42 tax for a number of years in the taxable period, the fact that the statute has closed assessment/collection for the year of the original act or failure to act does not preclude assessment/collection of the tax imposed in subsequent years in the taxable period that are still open.

4.76.4.2.8  (10-02-2014)
Applicable Penalties

  1. For a comprehensive discussion of the penalties applicable to private foundations, see IRM 20.1.8, Employee Plans and Exempt Organizations Miscellaneous Civil Penalties.

  2. As the Form 990-PF is both an information return and an excise tax return, foundations are subject to several sets of penalties. Foundations may be liable for penalties under IRC 6652(c), concerning daily delinquencies, public inspections, and prohibited tax shelters. Foundations are also subject to the standard failure to file, failure to pay, estimated tax, and negligence penalties. (IRC 6651(a), IRC 6655, and IRC 6662(c)) (IRM 20.1.2, Failure To File/Failure To Pay Penalties, IRM 20.1.3, Estimated Tax Penalties and IRM 20.1.5.7, IRC 6662(c), Negligence or Disregard of Rules or Regulations.)

    Note:

    The daily delinquency penalty of IRC 6652(c)(1)(A) is computed on the number of days late. The failure to file penalty is computed as a percentage of the IRC 4940 tax due. A late filed Form 990-PF can be subject to both penalties. Both are normally automatically computed and assessed when the return is posted to BMF.

  3. Foundations can also be subject to the criminal penalties of IRC 7203, IRC 7206, and IRC 7207, as well as the civil fraud penalty of IRC 6663. (See IRM 9.1.3, Criminal Statutory Provisions and Common Law and IRM 20.1.5.14, IRC 6663, Civil Fraud Penalty.)

  4. Foundations, individuals, and taxable entities who file Form 4720 may be subject to failure to file, failure to pay, estimated tax, negligence, and civil fraud penalties. Any entity that has previously owed a Chapter 42 tax reported on Form 4720 may be subject to the 100% penalty. (IRC 6684, IRM 20.1.8.2.2, Failure to Act Due to Reasonable Cause for Private Foundations and Certain Other Tax-exempt Organizations.)

  5. Foundations that file Form 990-T may be subject to failure to file, failure to pay, estimated tax, accuracy and civil fraud penalties.

  6. The officers, directors, trustees, and employees of a foundation may be subject to the public inspection compliance penalty of IRC 6685 on the responsible party. (IRM 20.1.8.2.3, .IRC 6685 - Failure to Comply with the Public Inspection Requirements for Certain Tax Exempt Organizations)

  7. When computing penalties on Chapter 42 tax liabilities that are based on a percentage of the tax, prepare two computations. The first computation uses the first tier tax. The second computation uses the second tier taxes.

    Example:

    In an initial report of examination issued to a disqualified person for self-dealing transactions, the agent proposes $15,000 in tax on a $150,000 payment. The agent has prepared a substitute for return package (IRM 4.75.22.7.1), as the taxpayer has not filed the late Form 4720. The agent proposes the failure to file and pay penalties. The 200912 return was due on May 15, 2010. The report was issued October 15, 2012. The failure to file penalty is at the maximum 22.5% rate (4.5% x 5 months), for $3,375. The failure to pay penalty rate is at 14.5% (.5% x 29 months late), for $2,175.

    Example:

    The taxpayer disagrees with the initial report. In the formal report of examination, the agent proposes the second tier tax in the Form 886-A, Explanation of Items. The agent then recomputes the failure to file and failure to pay penalties. The report is issued on November 15, 2012. The failure to pay penalty is now $70,875 ($15,000 first tier tax + $300,000 second tier tax multiplied by 22.5%). The failure to pay penalty is $47,250 ($315,000 in taxes multiplied by 15%). The failure to pay penalty rate increased by an additional .5% as another month had passed without full payment. These penalties would be adjusted if the second tier tax is abated.

  8. For examples of penalty computations, see Exhibit 4.76.4-9, Exhibit 4.76.4-10, Exhibit 4.76.4-12, Exhibit 4.76.4-13, and Exhibit 4.76.4-14.

4.76.4.3  (10-02-2014)
Domestic Taxable Private Foundations

  1. Taxable private foundations are former tax-exempt private foundations whose exemptions were revoked. Unless terminated under IRC 507, they remain private foundations, and under TE/GE jurisdiction.

  2. Taxable private foundations are required to file Form 990-PF in addition to either the Form 1120 or Form 1041.

  3. Taxable foundations remain subject to Chapter 42 taxes.

  4. A taxable foundation owes IRC 4940 tax to the extent that such tax (plus unrelated business income tax, computed as if it were still exempt), exceeds its income tax liability. The foundation isn't subject to the Form 990-T filing requirement, but may attach the Form 990-T, Exempt Organization Business Income Tax Return, to the Form 990-PF to show the computations.

  5. When computing the IRC 4940 tax:

    1. Compute the 1% or 2% tax via Form 990-PF Part V.

    2. Add the tax computed via Form 990-T.

    3. Subtract the tax determined via Form 1120 or Form 1041.

    Note:

    Taxable private foundations can't qualify as IRC 4940(d)(2) exempt operating foundations.

  6. Taxable foundations are subject to the penalty of IRC 6710 for not making required disclosures under IRC 6113 of nondeductibility of contributions for the first five years after revocation. (IRM 20.1.8.2.4, IRC 6710 - Failure to Disclose that Contributions are Nondeductible.)

  7. If acts/failures to act that give rise to Chapter 42 taxes are found, consider proposing involuntary termination. See IRM 4.76.4.2.5.

4.76.4.4  (10-02-2014)
Foreign Private Foundations

  1. Foreign organizations are those not created in or under the laws of the U.S. or U.S. territories, which include:

    1. American Samoa

    2. Guam

    3. Northern Mariana Islands

    4. Puerto Rico

    5. U.S. Virgin Islands

  2. The inception of a corporation or trust in a foreign country doesn't preclude exemption under IRC 501(c)(3). Generally (subject to applicable treaties), charitable contributions to such entities aren't deductible under IRC 170(c)(1), (2), (3), or (4).

  3. The primary benefit of IRC 501(c)(3) exemption is to reduce the income tax liability on U.S. sourced investment income. Foreign private foundations are taxed at a 4% rate on their U.S. sourced gross investment income (instead of a statutory 30% rate for foreign entities). Some foundations are exempted out of the tax due to tax treaties that change the tax treatment of the income. For purposes of IRC 4948, gross investment income is defined per IRC 4940(c)(2) and does not include capital gains and losses.

    Note:

    Amounts reported as income on Form 990-T are excepted from the IRC 4948(a) tax computation.

  4. When examining foreign foundations, verify that the foundation is foreign. Some entities initially incorporate in a foreign country and then file for domestic incorporation before filing an application for exemption. Consult Area Counsel if you encounter such entities.

  5. Be mindful of the filing requirements for foreign foundations. They are not required to complete some parts of the Form 990-PF. They aren't required to submit a copy to a state official. They aren't required to comply with the public inspection requirements.

    Note:

    Foreign foundations aren't required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Foreign foundations aren't considered United States persons, as they aren't created or organized in the U.S. or under U.S. laws.

4.76.4.4.1  (10-02-2014)
Foreign Tax Exempt Foundations

  1. Tax exempt foreign private foundations are treated differently depending on the source of their income, per IRC 4948(b).

    Type of income source Subject to Exempt from
    Category 1)
    85% or more foreign
    Prohibited transactions (IRC 4948(c)),
    IRC 511 through IRC 514, IRC 4948(a)
    Tax under IRC 4940 through IRC 4945, IRC 507, IRC 508
    Category 2)
    More than 15% domestic
    IRC 507, IRC 508,
    IRC 511 through IRC 514,
    IRC 4941 through IRC 4945, 4948(a)
    IRC 4940
    For purposes of the income test above, disregard gross investment income.
  2. For a discussion of prohibited transactions, see IRM 7.27.27.4.1, Meaning of Prohibited Transaction. Engaging in prohibited transactions will result in revocation.

    Note:

    Except for willful and flagrant violations, chapter 42 transactions (excluding IRC 4942) constitute prohibited transactions only after the IRS issues notice to the foundation that subsequent transactions are deemed prohibited transactions. In effect, if you find a Chapter 42 transaction (other than IRC 4942), you generally can't propose revocation based on prohibited transactions unless the foundation has already been placed on notice. If you find an initial act/failure to act, place the foundation on notice. Contact Area Counsel for assistance in preparing and issuing the notice.

  3. Be aware that foreign foundations can qualify as both IRC 4942(j)(3) private operating foundations and IRC 4940(d) exempt operating foundations. Classification as an exempt operating foundation is a moot issue for purposes of IRC 4940 as foreign foundations aren't subject to IRC 4940, though it may matter for purposes of IRC 4945(d)(4). Foreign foundations can apply for reclassification as a public charity by filing Form 8940. If they are claiming to be an operating foundation, they are required to complete Part X of the Form 990-PF.

  4. Foundations in Category 1 (IRM 4.76.4.4.1 (1)) aren't required to complete Parts X, XI, XIII, and XIV of the Form 990-PF. They are required to attach a computation of the 85% test to the Form 990-PF.

  5. When examining such entities, verify that the foundation properly computed the IRC 4948 tax. Look at all of the sources of the income and determine the percentage of non-investment income from domestic sources. Identify the foundation category (IRM 4.76.4.4.1 (1)). Then look at the transactions to determine liability under Chapter 42.

4.76.4.4.2  (10-02-2014)
Foreign Taxable Foundations

  1. A taxable foreign private foundation is one that has been revoked. Such foundations can reapply for exemption. See IRM 7.27.27.6, Reestablishment of Exempt Status.

  2. Unless a termination tax is imposed, the foundation retains its assets upon revocation. Foundations in Category 1 (IRM 4.76.4.4.1 (1)), aren't subject to the termination tax, but are subject to the 30% withholding rate of IRC 1441, IRC 1442, and IRC 1443 on U.S. sourced income.

  3. Foundations in Category 2 (IRM 4.76.4.4.1 (1)) may be subject to the termination tax. The entity that remains after an IRC 507(a)(2) termination is either a corporation or a trust. Regardless of the type of entity, the 30% tax rate applies, as the entity is considered a foreign person.

  4. IRC 511 through IRC 514 no longer apply to a foreign taxable foundation. Regular corporate or trust tax rules apply instead.

  5. Foreign taxable foundations file either Form 1040-NR, U.S. Nonresident Alien Income Tax Return, or Form 1120-F, U.S. Income Tax Return of a Foreign Corporation in addition to Form 990-PF.

4.76.4.5  (10-02-2014)
Abatement of Excise Taxes

  1. Under IRC 4961 and 4962, abatement is available for the following taxes:

    Code Section First Tier Second Tier
    4941 No Yes
    4942 Yes Yes
    4943 Yes Yes
    4944 Yes Yes
    4945 Yes Yes
  2. To qualify for abatement of second tier tax, the taxable event must be corrected within the correction period. To qualify for abatement of first tier tax, the following must be true:

    1. The taxable event was due to reasonable cause.

    2. The taxable event wasn't due to willful neglect.

    3. The taxable event has been corrected within the correction period.

  3. The correction period begins on the date the event occurs and ends 90 days after the mailing date of a notice of deficiency in connection with the second tier tax imposed on that taxable event (IRC 4963, IRC 6212). That time is extended by:

    • Any period in which a petition to the Tax Court for redetermination of the deficiency is pending. (IRC 6213(a))

    • Any other period we determine is reasonable and necessary to correct the taxable event.

  4. If correction hasn't occurred or doesn't occur, abatement is unavailable. If correction is made, consider whether abatement is applicable for the first tier tax. Correction within the correction period requires abatement of the second tier tax.

    Note:

    In practice, assessment of the tax is on hold until after the 90 day period (plus any court time) has elapsed. If correction is made, Mandatory Review and Examination Special Support (ESS) adjust the assessment amount to reflect only the first tier tax.

  5. If correction is made prior to the issuance of a statutory notice of deficiency, don't propose the second tier tax. Any subsequent statutory notice will exclude consideration of the second tier tax.

  6. If correction is made after the correction period has expired, abatement isn't available under IRC 4962.

    Note:

    If a request for abatement or claim for refund is received, verify whether the second tier tax was assessed via an examination. If needed, request a copy of a previous examination report via RCCMS using source code 45.

  7. If the request for abatement occurs during your audit, verify correction first. If you determine that the facts don't warrant abatement, document the willful neglect and failure to establish reasonable cause. If the facts warrant abatement, don't propose the tax. Address the issue in an advisory closing letter. See IRM 4.75.15, Closing Letters and Reports of Examination.

  8. Under Delegation Order 7-11 (IRM 1.2.46.12, Delegation Order 7-11 (formerly DO-237, Rev. 2)), the Director, Exempt Organizations must approve all abatements of first tier taxes in excess of $200,000. The Manager, EO Examinations, Programs and Review (EPR) must approve all abatements of first tier taxes for all amounts less than $200,000. If deciding that the taxpayer qualifies for abatement, indicate on Form 3198-A, TE/GE Special Handling Notice, that the case is subject to Mandatory Review, and requires the approval of the appropriate individual (Director, EO or Manager, EPR).

    Note:

    Abatement requests for Chapter 42 first tier taxes in excess of $200,000 are subject to mandatory technical advice. See IRM 4.75.36, Procedures For Processing Technical Advice Cases.

  9. The lists below provide examples of abatement/non-abatement scenarios.

    Possible abatement:
    The foundation incurred an IRC 4943(a) liability when an unrelated third party exercised its property rights on an ownership interest in a jointly owned business enterprise. This was done at a time, and in a manner that made it difficult for the foundation to identify its risk in a timely manner in spite of prudent precautions.
    The foundation incurred an IRC 4945(a) liability when it gave scholarships for the first time without obtaining advance approval of its scholarship procedures. Upon review of its procedures, an EO specialist determined that the procedures met the criteria for advance approval at the time the scholarships were originally given.
    The foundation relied, in good faith, on the written, reasoned advice of an attorney or accountant (dated before the transaction) that the transaction wasn't subject to Chapter 42.
    Likely non-abatement:
    The foundation's officers, directors, and representatives state they were ignorant of the provisions of the law.
    The Form 990-PF return for the tax period was prepared by a compensated attorney, accountant, or enrolled agent. The return gave no notice that a specifically identified questionable transaction had occurred.
    The foundation, a related foundation, or a predecessor foundation had a previous Chapter 42 tax amount abated under IRC 4962 for the same type of taxable event.
    The taxable transaction wasn't identified as a potential violation of Chapter 42 by any party until an audit began.

4.76.4.6  (10-02-2014)
Pre-Examination Procedures

  1. If a copy of the determination file isn't already in the file, request a copy from Cincinnati via Form 8057, EP/EO Microfiche Request. A copy may be provided either on disk, via secure e-mail, or via Office Communicator (OCS). See IRM 4.75.10, Exempt Organizations Pre-Audit Procedures for the general discussion concerning determination file reviews. With respect to private foundations, focus additional attention on:

    • Who are the founders, initial substantial contributors, and foundation managers?

    • What is the purpose of the foundation (actively operating, grant making, etc.)?

    • Did the organization request advance approval of individual grant making under IRC 4945(g)?

    • If grant making, what criteria were provided, and what constitutes the applicant pool?

    • What assets were donated to form the corpus of the foundation?

    • Who contributed the assets?

  2. Make note of whether the articles of incorporation, association, or trust document contains the IRC 508 language. See IRM 7.26.1.2.2 (or Pub 557 pages 30, 31 (Rev. 10-2013)). Note that most states now incorporate the language into state law, thus eliminating the requirement to have the language in the document. See Rev. Rul. 75-38. If the language is present, note all who signed the document.

    Note:

    If you encounter a Chapter 42 violation, be sure to incorporate this information into your report of examination, if relevant to the party committing the transaction (self-dealers, foundation managers.) This helps establish that at a minimum the founders acknowledged such restrictions at the time of the formation of the foundation.

  3. If the application and/or tax return provide a website address for the foundation, visit the website. Determine whether the information matches what was provided in the application. Note any changes from the application materials. Verify any contact information provided against that of the tax return and the application.

  4. Obtain copies of prior and subsequent Forms 990-PF and 990-T via Online SEIN.

    1. Review the Forms 990-T to determine the sources of income reported.

    2. Using the Forms 990-T as a guide, add to your initial Information Document Request (IDR) any items on the Form 990-T that merit review.

    3. Match the income and expenses reported on the Form 990-PF to the Form 990-T. Note any differences. Note whether there may be allocation issues.

    4. Perform the standard risk analysis, identifying the large, unusual, and questionable items for inclusion on the IDR.

    Reminder:

    Private foundations can be subject to the Form 990-T filing requirement for the same reasons as a public charity. The foundation is permitted to generate income within the limitations set by Chapter 42. An unrelated business directly conducted by a foundation, however, may constitute an excess business holding as a "sole proprietorship" business enterprise.

  5. Obtain IDRS transcripts for the foundation and the disqualified persons. Perform Accurint research on the disqualified persons. Review the completed research for possible compliance issues (such as missing returns, prior Chapter 42 liabilities, same disqualified person and foundation addresses, foundation vehicles registered under disqualified persons, payments to disqualified person businesses listed on the Form 990-PF.)

  6. Review the Form 990-PF for the period(s) under audit. Perform the review in the following sequence:

    Review of the Form 990-PF:
    Verify the statute of limitations
    1 Find the date stamped received.
    2 Determine the date mailed, if possible.
    3 Apply the rules of IRC 7502 (timely mailing treated as timely filing).
    Analyze the first page, Letters A through J (in the top third of the page)
    1 Note the accounting method
    2 Note whether this is an initial, amended, or final return.
    3 Determine whether there has been a name or address change.
    4 Check whether a foreign foundation and percentage of foreign support.
    5 Check for unusual events: prospective exemption, 507(b)(1)(A) termination, 507(b)(1)(B) conversion.
    6 Note the type of entity.
    Review Parts VII-A and VII-B, Statements Regarding Activities
    1 Verify the presence of all required schedules. Note any missing documents.
    2 Check for an FBAR, if indicated.
    3 Determine the liability for Form 4720.
    4 Note any private benefit disclosures.
    Review Part VIII, Information About Officers, Directors, Trustees, Foundation Managers, Highly Paid Employees, and Contractors
    1 Match the amounts reported to the Forms W-2. (Use command code IRPTRR to retrieve the Forms W-2.)
    2 Note the top paid individuals and contractors. Match to the list of founders, substantial contributors, and foundation managers reported in the determination application and in Part XV. (May be subject to IRC 4941.)
    Review XVII, Information Regarding Transfers To and Transactions and Relationships With Noncharitable Exempt Organizations
    1 Identify any large, unusual, or questionable items.
    2 Verify the non-charitable entities exemptions on IDRS.
    3 Print the INOLES/BMFOLO information for each non-charitable entity.
    4 Use Online SEIN to obtain copies of the Forms 990 or 990-EZ for each entity.
    5 Check EO Select Check for electronic postcard information.
    6 See if there are any related parties on the board of each entity.
    Review Part XV, Supplementary Information
    1 Identify any large, unusual, or questionable items.
    2 Compare any entries to information from the determination application.
    Review Part IV, Capital Gains and Losses for Tax on Investment Income
    1 Verify the math. Note any errors.
    2 Identify any large, unusual, or questionable items.
    3 Note the type of asset(s) for future reference in the interview and IDR.
    Review Part I, Analysis of Revenue and Expenses
    1 Verify the math. Note any errors.
    2 Identify any large, unusual, or questionable items.
    Review Part XVI-A, Analysis of Income-Producing Activities and Part XVI-B, Relationship of Activities to the Accomplishment of Exempt Purposes
    1 Verify the math. Note any errors.
    2 Identify any large, unusual, or questionable items.
    3 Compare to Part I. Note any differences.
    4 Compare to any filed Forms 990-T. Note any differences.
    Review Part II, Balance Sheets
    1 Verify the math. Note any errors.
    2 Identify any large, unusual, or questionable items.
    3 Check for any attached schedules. Note any missing schedules.
    4 Compare any amounts on the attached schedules to Part II. Note any differences.
    Review Part III, Analysis of Changes in Net Assets or Fund Balances
    1 Verify the math. Note any errors.
    2 Note any increases or decreases not included in Part I, Line 27a. Determine whether such amounts should be included in Part I.
    Review Part IX, Summary of Direct Charitable Activities, Summary of Program-Related Investments
    1 Identify any large, unusual, or questionable items.
    2 Compare the expenses reported to the amounts listed in Part I.
    3 If applicable, compare the investment amounts to the amounts listed in Part II.
    Review Part X, Minimum Investment Return
    1 Verify the math. Note any errors.
    2 Note the existence of any acquisition indebtedness for IRC 514 purposes.
    Review Part XI, Distributable Amount
    1 Verify the math. Note any errors.
    2 Note whether there was any income tax. Check the amount against Form 990-T (or Form 1120/Form 1041 if a taxable foundation.)
    3 Note any recoveries of qualifying distributions for inclusion in the IDR.
    Review Part XII, Qualifying Distributions
    1 Verify the math. Note any errors.
    2 For set asides, note whether claiming prior IRS approval or look for an attached schedule. If prior approval, or schedule is missing, note for inclusion in IDR.
    Review Part XIII, Undistributed Income
    1 Verify the math. Note any errors.
    2 Note any excess distributions. Compare the amounts reported to the prior years Forms 990-PF.
    3 For entries indicating election required, check for the attached statement. If none present, include in the IDR a request of the election.
    Review Part V, Qualification Under Section 4940(e) for Reduced Tax on Net Investment Income
    1 Verify the math. Note any errors.
    2 Compare the entries in Line 1 to the prior years Forms 990-PF Parts X through XII. Note any differences.
    Review Part VI, Excise Tax Based on Investment Income
    1 Verify the math. Note any errors.
    2 Note the tax rate used. Verify whether the correct rate was used.
    3 Note any additional taxes reported. Verify whether properly entered. (If tax-exempt, UBIT is not included. If taxable, UBIT and regular income tax are included.)
    Review Part XIV, Private Operating Foundations
    1 Verify the math.
    2 Note which operating foundation status was claimed. (IRC 4942(j)(3) vs. IRC 4942(j)(5)). If IRC 4942(j)(5), compare the charitable activities to the code and regulation requirements. See IRM 7.27.16.4.2 and the Instructions to the Form 990-PF.
    3 Note the letter date. Request a copy via the initial IDR.

    Note:

    The above method of reviewing the Form 990-PF is based on the sequencing chart for completing the Form 990-PF (Instructions for Form 990-PF).

  7. Review any information provided with the case file when received from Classification. If there are indicators of potential Chapter 42 transactions or exemption issues, be prepared to start an administrative record. See IRM 4.75.32, Declaratory Judgment Cases And The Administrative Record.

  8. Modify your initial interview/questionnaire to incorporate any items identified during the review of the application and tax returns. Additional questions to ask:

    • Please describe the relationship, if any, between the foundation manager(s), founders, and any substantial contributors. (If all the same person, don't ask.)

    • Please explain your understanding of the Chapter 42 provisions/prohibitions.

  9. Incorporate the items noted in your analysis of the application and the tax returns. When asking for financial information, you can ask for the supporting source documents for up to five years back, due to Part V and Part XIII. This means that with respect to the qualifying distributions and minimum investment income, you can ask for the bank statements and cancelled checks for the five prior years. (For private operating foundations, Part XIV permits you to obtain records for the three prior years.)

    Note:

    When asking for the records, make sure that you indicate the basis for your request, (i.e., "Please provide the bank statements and cancelled checks for the years XXXX through YYYY to support the amounts reported on Parts V and XIII of the Form 990-PF" ).

    Caution:

    If you identify any self-dealing transactions or taxable expenditures in prior years, ensure that the statute is still open prior to pursuing the issue. Request a Counsel memo concerning a six-year statute, if applicable.

  10. Additional items that can be requested in the IDR:

    • A list of all business enterprises and percentage of ownership for the foundation and disqualified persons. See Part XV of the Form 990-PF.

    • The list of all scholarship and grant recipients.

    • Relationship information of the scholarship/grant recipients to the founder(s), substantial contributor(s), and foundation manager(s).

    • Copies of the scholarship/grant criteria and any applications.

    • Copies of any applications received for the year(s) under exam.

    • Title documents to any foundation owned real property.

    • Compensation contracts for the foundation manager(s).

    • Notes and other loan documents involving disqualified persons.

    • Review of the general ledger and bank statements for transactions with disqualified persons

4.76.4.7  (10-02-2014)
Field/Office Correspondence Exam Procedures

  1. Review any revised organizing documents. Verify that any IRC 508 language is included, if not covered by state law. (IRM 7.26.1.2.2) Determine whether any changes have modified the exempt purpose or jeopardize the exemption.

  2. Perform the foundation status test. Verify whether the entity continues to fail to qualify under IRC 509(a)(1) and IRC 509(a)(2).

    Note:

    If the foundation satisfies the test for either 509(a)(1) or 509(a)(2), inform the organization of the possibility of an IRC 507(b)(1)(B) termination. To apply for an advance ruling the organization must file Form 8940 with EO Determinations.

  3. Examine the financial statements and financial records. At a minimum, perform the following actions:

    Financial statement and financial record analysis:
    1 Compute the average fair market value of the securities using the twelve monthly ending values.
    2 Do the same for the bank statements.
    3 Compare the amounts to Form 990-PF Part X Line 1.
    4 Identify the program related investments, if reported on Form 990-PF Part IX-B, and determine whether they qualify as such.
    5 Determine if there is any overlap between program related investments and non-charitable use investments.
    6 Identify any assets purchased in the year(s) under audit.
    7 Compare the asset purchase amounts to the amount reported in Part XII Line 2.
    8 Determine any differences, verify whether any amounts are for non-charitable use.
    9 Identify any amounts listed as set aside.
    10 Verify the set aside. See IRM 7.27.16.6.8, Set-Asides. If the set aside fails to meet the criteria, see IRM 4.76.4.7 (5).
    11 Identify any acquisition indebtedness.
    12 Determine whether IRC 514 applies. If so, verify that a Form 990-T was filed and that it included the debt financed income.
    13 Determine whether the acquisition indebtedness triggers IRC 4941 as a loan with a disqualified person..
    14 Determine whether any of the asset purchases trigger IRC 4941 as a sale with a disqualified person.
    15 Review the other assets of the organization.
    16 Look at the title documents. Review for any questionable elements involving disqualified persons.
    17 Inquire and verify whether the assets are being used by any disqualified persons.
    18 Review the cancelled checks and check registers. Request explanations for questionable expenditures.
    19 Inspect any receipts provided for the questionable expenditures.
    20 Identify all payments that are grants, scholarships, and/or to disqualified persons.
    21 Determine whether the payments meet the exceptions to IRC 4941 and IRC 4945.
    22 Compare the Forms W-2/1099 to the amounts reported on Form 990-PF Part VIII and to the amounts reported in the register.
    23 Determine whether there are any missing or incorrectly reported Forms W-2/1099.
  4. With respect to the assets, determine how they were used. Verify the relationship of the asset to the exempt purposes of the foundation.

  5. Using a blank Form 990-PF, revise the amounts reported according to your findings. Changes to the return impact the IRC 4940 tax, and may trigger the IRC 4942 tax. If you have reviewed the financial records from prior years, revise the prior year Forms 990-PF as needed. Use the modified information from the prior years to revise Parts V and XIII of the exam year Form 990-PF.

  6. If you determine that amounts reported in Part I Column d are not charitable expenditures, remove the amounts in your revised Form 990-PF. Self-dealing transactions and taxable expenditures should be removed from Part I Column d if previously reported as such. This in turn modifies Part XII, directly impacting the computations in Part XIII.

  7. Determine whether the foundation has:

    1. Engaged in any self-dealing transactions.

    2. Failed to make qualifying distributions.

    3. Held or acquired excess business holdings.

    4. Made jeopardizing investments.

    5. Made taxable expenditures.

  8. If there are any acts/failures to act giving rise to Chapter 42 taxes, ensure that the statute of limitations is protected. Request extensions from the foundation and from each disqualified person party to an act/failure to act. Open AIMS controls on BMF for the foundation and any business entities. Open AIMS controls on NMF for any individuals. See IRM 4.76.4.2.2 (5).

  9. For any Chapter 42 taxes, prepare a report of examination for each liable party. Ensure that there are no disclosure violations. See IRM 4.75.15 for the appropriate report letter and attachments to issue. All excise tax reports include Forms 4621, 4883, 886-A, and 870-E.

  10. If an act requires correction, verify that correction is made prior to closing an agreed case. See IRM 4.75.15 for the initial report, formal report, protest to Appeals, and rebuttal procedures.

  11. Use the initial report to propose the first tier tax and request correction. If the taxpayer is unwilling to agree, propose the second tier tax in the formal report. Prepare and issue a Thorne letter with Counsel assistance. See IRM 4.76.4.2.4. (See Exhibit 4.76.4-16 for sample language used in a Thorne letter for a theoretical IRC 4945 scenario.)

  12. For egregious cases, consider involuntary termination and revocation. Discuss these possibilities with your group manager and Area Counsel prior to pursuing these actions. Prepare an administrative record if the case is to be unagreed. See IRM 4.75.32.

4.76.4.8  (10-02-2014)
Exam Case Closing Procedures

  1. In audits of Forms 990-PF, there may be several related issues to resolve:

    • Employment tax cases such as worker reclassification, fringe benefit treatment, and unreported amounts.

    • Income tax cases (Forms 990-T for tax-exempt foundations, Forms 1120 or 1041 for taxable foundations).

    • Excise tax cases (gaming and/or Chapter 42 taxes).

    Discuss with your group manager whether to close the related cases separately at the earliest opportunity, or to close them together.

  2. A Form 990-PF can be closed as a no change/no change with advisory if there is no modification to the IRC 4940 tax, foundation status, or exempt status. See IRM 4.75.16 for case file assembly and other common closing procedures.

  3. For agreed cases involving employment, income, or gaming excise taxes:

    1. Issue report of examination.

    2. Secure the agreement.

    3. Collect payment or complete a request for an installment agreement. See IRM 4.75.16.

    4. Prepare the appropriate closing letter. See IRM 4.75.15.

    5. Close the case to your manager, who in turn closes it to ESS.

  4. For agreed cases involving Chapter 42 taxes:

    1. Request correction.

    2. Obtain verification of correction.

    3. Correction made: Issue report of examination..

    4. Correction not made: Treat as unagreed. Go to IRM 4.76.4.8 (7).

    5. Secure the agreement on Form 870-E.

    6. Collect payment and/or complete the installment agreement request.

    7. Prepare the appropriate closing letter.

    8. Close the case to your manager, who in turn closes it to ESS.

    Note:

    If planning to impose excise taxes on the foundation manager(s), issue a Thorne letter. See Exhibit 4.76.4-16 for sample language used in a Thorne letter for a theoretical IRC 4945 scenario. Consult with Area Counsel for pre-issuance review of the Thorne letter.

  5. For cases requiring correction, follow the procedures below:

    1. If correction is acceptable, issue the acceptance letter. See Letter 5305.

    2. If correction is inadequate or unacceptable, issue the rejection letter. See Letter 5306.

    3. If uncorrected, determine whether additional time is needed for correction.

    4. Grant an extension of time with managerial approval for the correction to be made.

    5. If uncorrected as of the end of the extension date, close as unagreed, even if the taxpayer previously signed an agreement to the 1st tier tax on Form 870-E.

  6. For agreed cases involving revocation, termination, or foundation status modification:

    1. Secure Form 6018, Consent to Proposed Action.

    2. Obtain a statute extension, if less than 270 days remaining on the statute of limitations.

    3. Prepare a Form 3198-A, completing the Mandatory Review/Operations, Planning & Review section.

    4. Close the case to your manager, who closes the case to Mandatory Review.

  7. For unagreed cases, regardless of the type of tax or action (revocation, termination, foundation status modification):

    • Obtain a full copy of the tax form under protest showing the date received, if not already present in the file or on RCCMS. Use Online SEIN if obtaining a Form 990-PF or a filed Form 4720.

    • Issue a formal report of examination with the appropriate waiver/agreement form(s).

    • Issue a Thorne letter if proposing excise taxes on the foundation manager(s). (See Exhibit 4.76.4-16 for sample language used in a Thorne letter for a theoretical IRC 4945 scenario.)

    • Ensure that there are 425 days remaining on the statute of limitations when closed from the group.

      Note:

      Effective September 2, 2014, all cases received in Appeals require 365 days remaining on the assessment statute of limitations.

    • Prepare a Form 3198-A, completing the Mandatory Review/Operations, Planning & Review section.

    • Verify that a formal protest to Appeals is valid. See IRM 4.76.4.8 (8). If invalid, secure a valid protest.

    • Prepare and issue a full rebuttal to any protests.

    • Close the case to your manager as unagreed (with or without protest.)

    Note:

    If applicable, consider offering to enter into a Fast Track Settlement prior to issuing the formal report of examination. Acceptance of a request to enter into fast track negotiations requires both agent and manager approval. See IRM 4.75.15 for Fast Track Settlement procedures.

  8. A valid protest contains the following elements:

    • The taxpayer’s name, address, Employer Identification Number (EIN) and a daytime phone number

    • A statement that they (the taxpayer) want to protest the proposed determination

    • A copy of the 30-day letter showing the findings that they disagree with (or the date and IRS office symbols from the letter)

    • An explanation of their reasons for disagreeing, including any supporting documents

    • The law or authority, if any, on which they are relying

    The protest must also contain a valid jurat statement: "Under penalties of perjury, I declare that I have examined this protest statement, including accompanying documents, and to the best of my knowledge and belief, the statement contains all relevant facts, and such facts are true, correct and complete." Representatives submitting the protest must also include a substitute declaration stating that the representative prepared the protest and any accompanying documents, and personally knows (or does not know) that the statement of facts in the protest and any accompanying documents are true and correct. Organization officers or representatives may sign the protest. (Pub 892, How to Appeal an IRS Decision on Tax Exempt Status.)

  9. For unagreed cases subject to IRC 7428 declaratory judgment procedures, prepare an administrative record. See IRM 4.75.32.

Exhibit 4.76.4-1 
IRC 4940 Example

In the course of examining Private Foundation Alpha, you review Part I of the Form 990-PF for the year under audit and the prior years. You obtain the books and records for the four previous years.

Note:

The amounts reported on Part V of the return under audit come from the prior years' Forms 990-PF. Because prior year amounts are reported on the return for the year under audit, you may request books and records from those years in order to verify the reported amounts

.

On Form 990-PF, the taxpayer paid an IRC 4940 tax of $13,192, claiming to be entitled to the IRC 4940(e) 1% tax rate. (The net investment income reported on Part I Line 27(b) was $1,319,200.)

Private Foundation Alpha reported the following amounts for 201112 in Part V of the Form 990-PF:

Base period years Adjusted qualifying distributions Net value of non-charitable use assets Distribution ratio
2010 207,577 22,902,232 0.009063614
2009 1,708,660 30,524,083 0.055977439
2008 1,586,932 20,563,743 0.077171359
2007 1,854,083 20,386,458 0.090946794
2006 840,244 39,168,308 0.021452139
The sum of the distribution ratios 0.254611346
Average distribution ratio for the 5-year base period 0.050922269
The net value of non-charitable use assets for 2011 24,303,581
The average distribution ratio multiplied by the assets net value 1,237,593
1% of net investment income 13,192
The sum of the two above amounts 1,250,786
Qualifying distributions from Part XII 1,261,332

In reviewing the records, you find that in lieu of taking the average of 12 end of month balances for each year as required by IRC 4940(e)(5) and IRC 4942(e)(1), the foundation used the January and December ending values divided by two to arrive at the net value of non-charitable use assets each year. You compile the following table of ending balances (cash and securities combined).

Month 2011 2010 2009 2008 2007 2006
Jan. 31,467,378 22,909,633 7,790,548 24,772,425 22,498,813 2,600,472
Feb. 36,106,867 38,109,497 7,812,389 28,594,378 21,152,025 20,145,814
Mar. 47,136,598 26,182,305 10,788,337 28,817,860 16,681,252 2,370,000
Apr. 32,926,971 29,863,039 19,031,437 21,156,140 20,279,695 25,270,619
May 31,875,373 27,058,917 33,118,231 39,092,678 39,887,291 26,965,403
Jun. 31,583,880 38,884,273 39,294,219 36,296,967 30,376,780 27,435,181
Jul. 30,528,076 36,832,683 53,680,220 10,716,462 29,931,354 29,136,744
Aug. 21,076,814 36,796,071 29,049,515 14,748,143 27,100,917 44,368,653
Sep. 19,892,556 42,501,813 57,976,763 15,576,231 19,211,371 50,075,854
Oct. 16,916,854 44,633,691 48,008,689 14,969,542 31,419,935 61,041,198
Nov. 16,298,983 19,057,261 33,245,104 14,814,622 23,810,364 74,151,584
Dec. 17,139,784 22,894,831 53,257,618 16,355,061 18,274,103 75,736,144
12 month avg. 27,745,845 32,143,668 32,754,423 22,159,209 25,051,992 36,608,139

Using the 12 month averages, you redo Part V. The schedule now reads:

Base period years Adjusted qualifying distributions Net value of non-charitable use assets Distribution ratio
2010 207,577 32,143,668 0.006457788
2009 1,708,660 32,754,423 0.052165779
2008 1,586,932 22,159,209 0.071615011
2007 1,854,083 25,051,992 0.074009405
2006 840,244 36,608,139 0.022952382
The sum of the distribution ratios 0.227200367
Average distribution ratio for the 5-year base period 0.045440073
The net value of non-charitable use assets for 2011 27,745,845
The average distribution ratio multiplied by the 2011 assets value 1,260,773
1% of net investment income 13,192
The sum of the two above amounts 1,273,965
Qualifying distributions from Part XII 1,261,332

For PF Alpha to qualify for the 1% IRC 4940 rate, the last line in the table has to be greater than the second to last line. As the foundation failed the computational test, you prepare Forms 4883 and 4621 to assess the additional $13,192 in tax.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Alpha [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
12/31/2011    
Internal Revenue Code Section for Proposed Adjustment 4940(a)    
1. Adjustments        
       
       
       
       
       
2. Total adjustments 0    
3. Amount reported on return or as previously adjusted 1,319,200.00    
4. Total amount as corrected 1,319,200.00    
5. Applicable tax rate % 2%    
6. Initial tax liability as corrected (line 4 x line 5) 26,384.00    
7. Initial tax liability reported 13,192.00    
8. Increase (or decrease) in tax 13,192.00    
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
990-PF [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Alpha  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2011      
         
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4940(a) 12/31/2011 13,192      
           
           
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-2 
IRC 4941: First Tier Tax Example - PF Payment to DP (No Services Rendered)

Disqualified Person Charlie establishes Private Foundation Bravo on June 1, 2005, depositing $500,000 into PF Bravo's savings account. PF Bravo's fiscal year ends June 30th. DP Charlie is the sole foundation manager of PF Bravo. DP Charlie applies for and receives exemption for PF Bravo under IRC 501(c)(3) as a private foundation. The determination letter is dated August 22, 2007. PF Bravo's Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, states that the foundation will make grants only to public charities. The determination letter (Letter 1076) states "We have not considered whether grants made under your procedures are excludable from the gross income of recipients under section 117(a) of the Code" (Selective Paragraph 3241) (IRM 7.21.5-21, Letter 1076 (DO/CG)EO Favorable Determination Letter to a Non-Operating Private Foundation). DP Charlie is a CPA, and partner of a small accounting firm. DP Charlie has 20 years of experience, with 10 years spent as the controller of a large public charity.

On October 10, 2009, PF Bravo issues a check to Mike, DP Charlie's child. DP Mike is 10 years old. The check is for $25,000. The memo field on the check states "Happy Birthday" . DP Mike has not rendered any services to the foundation.

During an audit of the Form 990-PF for 201006, you notify PF Bravo that the transaction constitutes a self-dealing transaction. Based on DP Charlie's work history, you recommend assessment of the foundation manager excise tax under IRC 4941(a)(2). For the report of examination, you propose the taxes on DP Charlie. The amount involved is the greater of the amount of money and the fair market value of the other property given or the amount of money and the fair market value of the other property received. (Treas. Reg. 53.4941(e)-1(b)(1)), or $25,000. The amount of correction is also $25,000 plus any income derived from the use of the $25,000.

DP Charlie filed the 201006 Form 990-PF on November 15, 2010. The statute of limitations on the self-dealing transaction is November 15, 2013 if the return provided adequate notice of the transaction. Because DP Charlie made correction in 2011, no second tier taxes are proposed. Note that while there is a single, discrete act of self-dealing, the tax is imposed in each year or partial year in the taxable period.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Charlie [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Bravo
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1) 4941(a)(1) 4941(a)(1)
1. Adjustments Check to Charlie's child 10/10/2009 25,000.00 25,000.00 25,000.00
       
       
       
       
       
2. Total adjustments 25,000.00 25,000.00 25,000.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 25,000.00 25,000.00 25,000.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 2,500.00 2,500.00 2,500.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 2,500.00 2,500.00 2,500.00
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Charlie [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Bravo
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4941(a)(2) 4941(a)(2) 4941(a)(2)
1. Adjustments Check to Charlie's child 10/10/2009 25,000.00 25,000.00 25,000.00
       
       
       
       
       
2. Total adjustments 25,000.00 25,000.00 25,000.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 25,000.00 25,000.00 25,000.00
5. Applicable tax rate % 5% 5% 5%
6. Initial tax liability as corrected (line 4 x line 5) 1,250.00 1,250.00 1,250.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 1,250.00 1,250.00 1,250.00
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Charlie Private Foundation Bravo
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2009 12/31/2010 6/30/2010  
  12/31/2011      
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4941(a)(1) 12/31/2009 2,500.00      
4941(a)(2) 12/31/2009 1,250.00      
4941(a)(1) 12/31/2010 2,500.00      
4941(a)(2) 12/31/2010 1,250.00      
4941(a)(1) 12/31/2011 2,500.00      
4941(a)(2) 12/31/2011 1,250.00      
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-3 
IRC 4941: First Tier Tax Example - DP Sale of Property to PF

Disqualified Person Victor creates Foundation Foxtrot on August 15, 2007. DP Victor initially deposits $50,000 into PF Foxtrot in order to fund the foundation, and to obtain a favorable determination letter. DP Victor files the application for exemption on November 10, 2009, and receives a Letter 1076, dated August 21, 2010. Upon receipt of the determination letter on August 30, 2010, DP Victor donates three business properties to the foundation. These properties consist of a seven story apartment complex, a four story retail complex/mall, and a 54 story office tower. PF Foxtrot is a calendar year taxpayer.

DP Victor's basis in the apartment complex consists of the $135,000 spent to purchase the land, and $1,473,000 spent to build the complex in 2005. As of the date of donation, DP Victor has a $365,000 construction loan outstanding on the property. The property tax valuation for the property for 2010 is $1,825,000.

DP Victor spent $3,486,000 to purchase the retail mall in July 2003. DP Victor obtained a loan for $2,760,000 to purchase the mall. As of the date of donation, DP Victor still has $1,504,000 remaining on the loan. The property tax valuation for the property for 2010 is $3,254,800.

DP Victor's office tower cost $65,375,000 to build (including the cost of the land.) DP Victor obtained a construction loan for $58,500,000 in July 2001. As of the date of donation, DP Victor still owed $48,716,700 on the loan. The property tax valuation for the property for 2010 is $84,325,000. The loans are all non-recourse with the properties as collateral, and DP Victor obtained them within 10 years of transferring the properties to PF Foxtrot.

The following table briefly summarizes the values of the properties

Building Basis Tax Valuation
Apartment complex 135,000
+ 1,473,000
1,608,000
1,825,000
Retail mall 3,486,000 3,254,800
Office tower 65,375,000 84,325,000

In accepting the three donated properties, PF Foxtrot has entered into three self-dealing transactions. (Treas. Reg. 53.4941(d)-2(a)(2)) The amount involved is the greater of the amount of money and the fair market value of the other property given or the amount of money and the fair market value of the other property received. (Treas. Reg. 53.4941(e)-1(b)(1)) In this case, the amounts involved are $1,825,000, $3,486,000, and $84,325,000. To achieve correction, the donation must be rescinded, and the foundation must be reimbursed for any amounts expended on the loans or properties in excess of the income received from the properties. (Treas. Reg. 53.4941(e)-1(c)(1))

During the audit of the 201012 Form 990-PF, you inform DP Victor that the donations constitute self-dealing transactions. You issue the initial report on July 10, 2012. (The statute of limitations on the timely filed Form 990-PF is May 15, 2014.) The taxes for the first three years in the taxable period are determined as follows:

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Victor [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Foxtrot
  Taxable Years Ended
12/31/2010 12/31/2011 12/31/2012
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1) 4941(a)(1) 4941(a)(1)
1. Adjustments Mortgaged property donation (8/30/2010) - apartment complex 1,825,000.00 1,825,000.00 1,825,000.00
Mortgaged property donation (8/30/2010) - retail mall 3,486,000.00 3,486,000.00 3,486,000.00
Mortgaged property donation (8/30/2010) - office tower 84,325,000.00 84,325,000.00 84,325,000.00
       
       
       
2. Total adjustments 89,636,000.00 89,636,000.00 89,636,000.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 89,636,000.00 89,636,000.00 89,636,000.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 8,963,600.00 8,963,600.00 8,963,600.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 8,963,600.00 8,963,600.00 8,963,600.00
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Victor Private Foundation Foxtrot
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2010 12/31/2011 12/31/2010  
  12/31/2012      
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4941(a)(1) 12/31/2010 8,963,600.00      
4941(a)(1) 12/31/2011 8,963,600.00      
4941(a)(1) 12/31/2012 8,963,600.00      
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-4 
IRC 4941: First Tier Tax Example - DP Use of PF Property

On January 1, 2011, Disqualified Person Victor (the same individual in Exhibit 4.76.4-3) leased space in the office tower donated to Private Foundation Foxtrot. DP Victor entered into the lease with PF Foxtrot, paying $350 a month in rent for a 3,500 square foot office ($0.10 per square foot per month,) located on the 54th floor. DP Victor's lease requires incremental increases in rent of $50 per month on January 1st of each succeeding year, with the lease renewable after 5 years. PF Foxtrot currently charges other tenants in the building $1.85 per square foot per month, with offices ranging from 2,000 square feet to entire floors at 14,000 square feet. In 2011, PF Foxtrot charged $1.825 per square foot, and $1.85 in 2012 and 2013.

In the expansion of the audit into the 201112 Form 990-PF, you inform DP Victor on May 10, 2013, during the initial interview, that the lease constitutes a self-dealing transaction. DP Victor then terminates the lease on May 31, 2013.

The leasing of property from the foundation constitutes a continuing self-dealing transaction. (Treas. Regs. 53.4941(d)-2(b)(1), 53.4941(e)-1(e)(1)) The amount of correction is equal to the excess of the fair market value of the leased property (at the time of the act of self-dealing or time of correction, whichever is higher) for the entire length of the lease, without regard to unexercised extensions or renewals, over the amount paid (and that would have been paid if the lease ran for the full term). (Treas. Reg. 53.4941(e)-1(c)(4). The correction amount is computed below.

Calendar Year FMV Amount Lease Payments Difference
2011 $1.85 x 3500 x 12 =
$77,700.00
$350.00 x 12 =
$4,200.00
$73,500.00
2012 $1.85 x 3500 x 12 =
$77,700.00
$400.00 x 12=
$4,800.00
$72,900.00
2013 $1.85 x 3500 x 12 =
$77,700.00
$450.00 x 12 =
$5,400.00
$72,300.00
2014 $1.85 x 3500 x 12 =
$77,700.00
$500.00 x 12 =
$6,000.00
$71,700.00
2015 $1.85 x 3500 x 12 =
$77,700.00
$550.00 x 12 =
$6,600.00
$71,100.00
Total Correction Amount $361,500.00

The amount involved is the greater of the amount paid for such use or the fair market value of such use for the period for which the money or other property is used. (Treas. Reg. 53.4941(e)-1(b)(2)(ii)) For 2011, the amount involved is $76,650.00, ($1.825/sq. ft./month x 3500 sq. ft. x 12 months). For 2012, the amount involved is $77,700.00 ($1.85/sq. ft./month x 3500 sq. ft. x 12 months). For 2013, the amount involved is $32,375 ($1.85/sq.ft./month x 3500 sq.ft. x 5 months).

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Victor [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Foxtrot
  Taxable Years Ended
12/31/2011 12/31/2012 12/31/2013
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1) 4941(a)(1) 4941(a)(1)
1. Adjustments Lease of office space 1/1/2011 76,650.00 76,650.00 76,650.00
Lease of office space 1/1/2012   77,700.00 77,700.00
Lease of office space 1/1/2013     32,375.00
       
       
       
2. Total adjustments 76,650.00 154,350.00 186,725.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 76,650.00 154,350.00 186,725.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 7,665.00 15,435.00 18,672.50
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 7,665.00 15,435.00 18,672.50
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Victor Private Foundation Foxtrot
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2011 12/31/2012 12/31/2011  
  12/31/2013      
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4941(a)(1) 12/31/2011 7,665.00      
4941(a)(1) 12/31/2012 15,435.00      
4941(a)(1) 12/31/2013 18,672.50      
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-5 
IRC 4941: First Tier Tax Example - PF Loan of Money to DP

On July 1, 2010, Private Foundation Golf lends Partnership Hotel $150,000. Under the terms of the note, Hotel will pay PF Golf $1,000 a month ($750 in principal, $250 in interest) on the first of each month for 15 years, with a final balloon payment of $15,000 (all principal, no interest). Hotel makes the first payment on August 1, 2010. PF Golf and Hotel are fiscal year taxpayers whose tax year ends September 30th.

Hotel has three partners, Romeo, Juliet, and India. Romeo and Juliet are trustees of PF Golf. India is the child of Romeo and Juliet. As Romeo and Juliet are disqualified persons under IRC 4946(a)(1)(B), India is also a disqualified person under IRC 4946(a)(1)(D). The loan constitutes a self-dealing transaction. As this transaction constitutes a continuing transaction, you need to separately compute the amount involved for each new act deemed to occur on the first day of each succeeding tax year of the foundation, as well as a separate correction amount. The two amounts are not necessarily identical.

The correction amount is the amount that would place the foundation in a position no worse than it would have been if PF Golf had been dealing with Hotel under the highest fiduciary standards. For purposes of correction, the Partnership Hotel must pay increased interest if the interest actually paid is below market, and return the principal to the foundation. If the interest paid was equal to or greater than fair market value (FMV) of interest for the deemed loans, no additional interest would have to be paid for correction.

Freddie Mac provides historical information on the national average mortgages rates for 1 year adjustable rate mortgages, 5/1 hybrid adjustable rate mortgages, 15 year fixed rate mortgages, and 30 year fixed rate mortgages. For July 2010, the 15 year rate was 4.04%. For October 2010, the 15 year rate was 3.68%. For October 2011, the 15 year rate was 3.35%, and for October 2012, the 15 year rate was 2.69%. The amount of correction is the principal and additional interest owed. The table below computes the interest owed on correction as of the date of your examination on December 10, 2012:.

Date Principal Amount Annual
Interest Rate
Number of Payments FMV Interest Interest Payments Received Interest Amounts Owed
7/1/2010 150,000 x .0404 x 2/12 = 1,010.00 - 500.00 = 510.00
10/1/2010 148,500 x .0368 x 12/12 = 5,464.80 - 3,000.00 = 2,464.80
10/1/2011 139,500 x .0335 x 12/12 = 4,673.25 - 3,000.00 = 1,673.25
10/1/2012 130,500 x .0269 x 4/12 = 1,170.15 - 1,000.00 = 170.15
Total additional interest owed: $4,818.20

The report of examination accounts for the January 1, 2013 payment, because it falls within the 30-day period for the report. A correction of $154,818.20 ($150,000 + $4,818.20) is immediately made on December 10, 2012. Because DP Hotel made correction, no second tier taxes will be proposed on the report of examination. The report of examination is dated December 15, 2012.

Where the use of money or other property is involved, the amount involved shall be the greater of the amount paid for such use or the fair market value of such use for the period for which the money or other property is used. (Treas. Reg. 53.4941(e)-1(b)(2)(ii)) (See IRM 4.72.11-5, Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction with Repayments for more information. (IRC 4975 mirrors IRC 4941.))

Date of Act Principal Amount Annual
Interest Rate
Number of Payments FMV Interest Interest Payments Received Amount Involved
7/1/2010 150,000 x .0404 x 2/12 = 1,010.00 500.00 1,010.00
10/1/2010 148,500 x .0368 x 12/12 = 5,464.80 3,000.00 5,464.80
10/1/2011 139,500 x .0335 x 12/12 = 4,673.25 3,000.00 4,673.25
10/1/2012 130,500 x .0269 x 4/12 = 1,170.15 1,000.00 1,170.15

As the 201309 Form 4720 is not due until February 15, 2014, the report of examination will only propose taxes for the periods ended September 30, 2010, September 30, 2011, and September 30, 2012. If desired, Partnership Hotel could file the Form 4720 early and pay the tax in 2013.

Reminder:

The amount involved is often less if there is proof of a loan transaction under IRC 4941(d)(1)(B) versus a mere transfer of assets under IRC 4941(d)(1)(A), such as a straightforward payment to a disqualified person. For loans, the amount involved is the greater of the amount paid for such use or the fair market value of such use for the period for which the money or other property is used. For straightforward payments, the amount involved is the greater of the amount of money and the fair market value of the other property given or the amount of money and the fair market value of the other property received.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Partnership Hotel [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Golf
  Taxable Years Ended
9/30/2010 9/30/2011 9/30/2012
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1) 4941(a)(1) 4941(a)(1)
1. Adjustments Loan from Golf to Hotel on 7/1/2010 1,010.00 1,010.00 1,010.00
Continuing loan on 10/1/2010   5,464.80 5,464.80
Continuing loan on 10/1/2011     4,673.25
       
       
       
2. Total adjustments 1,010.00 6,474.80 11,148.05
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 1,010.00 6,474.80 11,148.05
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 101.00 647.48 1,114.81
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 101.00 647.48 1,114.81
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Partnership Hotel [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Golf
  Taxable Years Ended
9/30/2013    
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1)    
1. Adjustments Loan from Golf to Hotel on 7/1/2010 1,010.00    
Continuing loan on 10/1/2010 5,464.80    
Continuing loan on 10/1/2011 4,673.25    
Continuing loan on 10/1/2012 1,170.15    
       
       
2. Total adjustments 12,318.20    
3. Amount reported on return or as previously adjusted 0    
4. Total amount as corrected 12,318.20    
5. Applicable tax rate % 10%    
6. Initial tax liability as corrected (line 4 x line 5) 1,231.82    
7. Initial tax liability reported 0    
8. Increase (or decrease) in tax 1,231.82    
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Partnership Hotel Private Foundation Golf
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
9/30/2010 9/30/2011 9/30/2010 9/30/2011
  9/30/2012 9/30/2013 9/30/2012 9/30/2013
[Insert EIN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4941(a)(1) 9/30/2010 101.00      
4941(a)(1) 9/30/2011 647.48      
4941(a)(1) 9/30/2012 1,114.81      
4941(a)(1) 9/30/2013 1,231.82      
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-6 
IRC 4941: Second Tier Tax Example

Assume the same facts presented in Exhibit 4.76.4-3 and Exhibit 4.76.4-4, except that no correction was made before issuing your report of examination and that you make your report on Dec. 1, 2012. Additional property values are provided in the table below for 2011 and 2012.

In order to determine the amount involved for the second tier tax, use the highest fair market value of the subject property during the taxable period. See IRC 4941(e)(2)(B). Note that the second tier tax is assessed for any uncorrected act of self-dealing. Where an act of self-dealing involves a loan or a lease in which a new act of self-dealing arises under the pyramiding rule, the same principles apply with respect to the new act, but the amount involved is separately determined for each new act, including deemed acts.

Transaction Date* Fair Market Value 4941(b) Tax at 200%
Apartment complex 08/30/2010 1,825,000.00  
04/01/2011 1,834,226.00  
04/01/2012 1,891,430.00 3,782,860.00
Retail mall 08/30/2010 3,486,000.00 6,972,000.00
04/01/2011 3,204,269.00  
04/01/2012 3,388,821.00  
Office tower 08/30/2010 84,325,000.00  
04/01/2011 88,432,648.00 176,865,296.00
04/01/2012 87,773,023.00  
Building lease
1/1/2011 act
01/01/2011 766,500.00  
01/01/2012 777,000.00 1,554,000.00
Building lease
1/1/2012 act
     
01/01/2012 777,000.00 1,554,000.00
Total second tier taxes 190,728,156.00
* The county in which the buildings are located issues the property tax bill annually on April 1st of each year.

Report the second tier tax on the final tax year of the taxable period. The following Form 4883 illustrates how the second tier tax is proposed after combining the examples in Exhibits 4.76.4-3 and 4.76.4-4.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Victor [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Foxtrot
  Taxable Years Ended
12/31/2010 12/31/2011 12/31/2012
Internal Revenue Code Section for Proposed Adjustment 4941(a)(1) 4941(a)(1) 4941(a)(1)
1. Adjustments Mortgaged property donation (8/30/2010) - apartment complex 1,825,000.00 1,825,000.00 1,825,000.00
Mortgaged property donation (8/30/2010) - retail mall 3,486,000.00 3,486,000.00 3,486,000.00
Mortgaged property donation (8/30/2010) - office tower 84,325,000.00 84,325,000.00 84,325,000.00
Lease of office space 1/1/2011   766,500.00 766,500.00
Lease of office space 1/1/2012     777,000.00
       
2. Total adjustments 89,636,000.00 90,402,500.00 91,179,500.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 89,636,000.00 90,402,500.00 91,179,500.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 8,963,600.00 9,040,250.00 9,117,950.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 8,963,600.00 9,040,250.00 9,117,050.00
9. Additional tax (minimum) at 200% (4941(b)(1))     190,728,156.00
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Victor Private Foundation Foxtrot
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2010 12/31/2011 12/31/2010 12/31/2011
  12/31/2012   12/31/2012  
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4941(a)(1) 12/31/2010 8,963,600.00      
4941(a)(1) 12/31/2011 9,040,250.00      
4941(a)(1) 12/31/2012 9,117,050.00 190,728,156.00    
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-7 
IRC 4942: First Tier Tax Example

Private Foundation Lima is under audit for three years: 200912, 201012, 201112. You are conducting the audit in March of 2013. PF Lima reports on Form 990-PF Part XIII the following information:

Description Amount reported
2009 Distributable amount 85,071
2010 Distributable amount 77,553
2011 Distributable amount 72,260
2009 Qualifying distributions 320,000
2010 Qualifying distributions 270,000
2011 Qualifying distributions 70,000
2004 Excess distributions 0
2005 Excess distributions 0
2006 Excess distributions 0
2007 Excess distributions 10,469
2008 Excess distributions 0
2009 Excess distributions 234,929
2010 Excess distributions 192,467

You determine that for 2009, PF Lima made only $4,525 in qualifying distributions, for 2010 only $2,425 in qualifying distributions, and for 201112 only $3,750 in qualifying distributions. No qualifying distributions were made in 2012. You find no issues with Parts X or XI of the Form 990-PF. The following tables illustrate how Part XIII is redone. (When completing Part XIII, use the PDF version of the Form 990-PF to see the fields that are to be completed. Much of the page is grayed out, limiting the possible entries.)

2009 Form 990-PF Part XIII
Line
#
Title
(abbreviated/paraphrased)
Amount as
Reported
Amount as
Corrected
1 Distributable amount for 2009 85,071 85,071
2a 2008 undistributed income 0 0
2b Prior years undistributed income 0 0
3a Excess distributions carryover from 2004 0 0
3b Excess distributions carryover from 2005 0 0
3c Excess distributions carryover from 2006 0 0
3d Excess distributions carryover from 2007 10,469 10,469
3e Excess distributions carryover from 2008 0 0
3f Total excess distributions carryover to 2009 10,469 10,469
4 2009 qualifying distributions 320,000 4,525
4a Applied to 2008 0 0
4b Applied to prior years 0 0
4c Treated as distributions out of corpus (election) 0 0
4d Applied to 2009 distributable amount 85,071 4,525
4e Remaining amount out of corpus 234,929 0
5 Excess distributions carryover applied to 2009 0 10,469
6a Corpus 245,398 0
6b Prior years undistributed income 0 0
6c Stat notice/previously taxed undistributed income 0 0
6d Taxable amount 0 0
6e Undistributed income for 2008 (taxable) 0 0
6f Undistributed income for 2009 (must be distributed in 2010) 0 70,077
7 170(b)(1)(E)/4942(g)(3) corpus distributions 0 0
8 2004 excess distributions carryover not applied 0 0
9 Excess distributions carryover to 2010 245,398 0
10a Excess distributions from 2005 0 0
10b Excess distributions from 2006 0 0
10c Excess distributions from 2007 10,469 0
10d Excess distributions from 2008 0 0
10e Excess distributions from 2009 234,929 0
2010 Form 990-PF Part XIII
Line
#
Title
(abbreviated/paraphrased)
Amount as
Reported
Amount as
Corrected
1 Distributable amount for 2010 77,553 77,553
2a 2009 undistributed income 0 70,077
2b Prior years undistributed income 0 0
3a Excess distributions carryover from 2005 0 0
3b Excess distributions carryover from 2006 0 0
3c Excess distributions carryover from 2007 10,469 0
3d Excess distributions carryover from 2008 0 0
3e Excess distributions carryover from 2009 234,929 0
3f Total excess distributions carryover to 2010 245,398 0
4 2010 qualifying distributions 270,000 2,425
4a Applied to 2009 0 2,425
4b Applied to prior years 0 0
4c Treated as distributions out of corpus (election) 0 0
4d Applied to 2010 distributable amount 77,553 0
4e Remaining amount out of corpus 192,447 0
5 Excess distributions carryover applied to 2010 0 0
6a Corpus 437,845 0
6b Prior years undistributed income 0 0
6c Stat notice/previously taxed undistributed income 0 0
6d Taxable amount 0 0
6e Undistributed income for 2009 (taxable) 0 67,652
6f Undistributed income for 2010 (must be distributed in 2011) 0 77,553
7 170(b)(1)(E)/4942(g)(3) corpus distributions 0 0
8 2004 excess distributions carryover not applied 0 0
9 Excess distributions carryover to 2011 437,845 0
10a Excess distributions from 2006 0 0
10b Excess distributions from 2007 10,469 0
10c Excess distributions from 2008 0 0
10d Excess distributions from 2009 234,929 0
10e Excess distributions from 2010 192,447 0
2011 Form 990-PF Part XIII
Line
#
Title
(abbreviated/paraphrased)
Amount as
Reported
Amount as
Corrected
1 Distributable amount for 2011 72,260 72,260
2a 2010 undistributed income 0 77,553
2b Prior years undistributed income 0 67,652
3a Excess distributions carryover from 2006 0 0
3b Excess distributions carryover from 2007 10,469 0
3c Excess distributions carryover from 2008 0 0
3d Excess distributions carryover from 2009 234,929 0
3e Excess distributions carryover from 2010 192,447 0
3f Total excess distributions carryover to 2011 437,845 0
4 2011 qualifying distributions 70,000 3,750
4a Applied to 2010 0 3,750
4b Applied to prior years 0 0
4c Treated as distributions out of corpus (election) 0 0
4d Applied to 2009 distributable amount 70,000 0
4e Remaining amount out of corpus 0 0
5 Excess distributions carryover applied to 2011 2,260 0
6a Corpus 435,585 0
6b Prior years undistributed income 0 67,652
6c Stat notice/previously taxed undistributed income 0 0
6d Taxable amount 0 67,652
6e Undistributed income for 2010 (taxable) 0 73,803
6f Undistributed income for 2011 (must be distributed in 2012) 0 72,260
7 170(b)(1)(E)/4942(g)(3) corpus distributions 0 0
8 2006 excess distributions carryover not applied 0 0
9 Excess distributions carryover to 2012 435,585 0
10a Excess distributions from 2007 8,209 0
10b Excess distributions from 2008 0 0
10c Excess distributions from 2009 234,929 0
10d Excess distributions from 2010 192,447 0
10e Excess distributions from 2011 0 0

Before preparing your report, PF Lima makes full correction by making qualifying distributions of $213,715 ($67,652 + $73,803 + $72,260) to an independent public charity described under IRC 170(b)(1)(A)(vi). You determine that abatement under IRC 4962 does not apply in this case. You would issue the following initial report where you solicit correction, or as part of your formal report after there is full correction.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Lima [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4942(a) 4942(a) 4942(a)
1. Adjustments Failure to distribute 2009 income (taxable as of 1/1/2011) 67,652.00 67,652.00 67,652.00
Failure to distribute 2010 income (taxable as of 1/1/2012)   73,803.00 73,803.00
Failure to distribute 2011 income (taxable as of 1/1/2013)     72,260.00
       
       
       
2. Total adjustments 67,652.00 141,455.00 213,715.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 67,652.00 141,455.00 213,715.00
5. Applicable tax rate % 30% 30% 30%
6. Initial tax liability as corrected (line 4 x line 5) 20,295.60 42,436.50 64,114.50
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 20,295.60 42,436.50 64,114.50
9. Additional tax (minimum)      
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Lima  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2011      
         
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4942(a) 12/31/2009 20,295.60      
4942(a) 12/31/2010 42,436.50      
4942(a) 12/31/2011 64,114.50      
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-8 
IRC 4942: Second Tier Tax Example

Take the example presented in Exhibit 4.76.4-7. Assume no correction was made. The following Form 4883 reflects how the second tier tax is proposed. Note that under IRC 4942(b), the second tier tax is on the remaining undistributed amount at the end of the taxable period. This tax is assessed once for the undistributed amount. Report the second tier tax on the last year for which there is a tax assessment.

Without correction, you would issue the following formal report of examination that includes the second tier tax with a 30-day letter (Letter 3614).

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Lima [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Lima
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4942(a) 4942(a) 4942(a)
1. Adjustments Failure to distribute 2009 income 67,652.00 67,652.00 67,652.00
Failure to distribute 2010 income   73,803.00 73,803.00
Failure to distribute 2011 income     72,260.00
       
       
       
2. Total adjustments 67,652.00 141,455.00 213,715.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 67,652.00 141,455.00 213,715.00
5. Applicable tax rate % 30% 30% 30%
6. Initial tax liability as corrected (line 4 x line 5) 20,295.60 42,436.50 64,114.50
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 20,295.60 42,436.50 64,114.50
9. Additional tax (minimum) at 100% (4942(b))     213,715.00
10. Penalties (Code section ________)      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Lima  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2011      
         
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4942(a) 12/31/2009 20,295.60      
4942(a) 12/31/2010 42,436.50      
4942(a) 12/31/2011 64,114.50 213,715.00    
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-9 
IRC 4943: First Tier Tax Example

Private Foundation Kilo owns 15% of the common stock in a privately held corporation. Disqualified person Delta owns 25% of the stock in the same corporation. Oscar, DP Delta's fiancé, owns 55% of the stock in the corporation. Oscar's parents jointly own the remaining 5% of the stock. DP Delta donated the stock to the foundation in 2003, when DP Delta formed the foundation and became the foundation manager. DP Delta is still the foundation manager.

You are examining the 200912 Form 990-PF for the foundation. The highest value of the stock for the year is listed as $3,000, per the foundation's records. You obtain an LB&I engineer via a SRS referral to perform a valuation. The engineer appraises the stock's highest value for 2009 at $2,895,000, using the information reported on the Form 1120 and other valuation sources. After conferring with the Fraud Technical Specialist and presenting the information in a conference with CI, you're informed that CI will pass on the case.

You expand the audit to the 201012 and 201112 tax years. In 2010, Oscar gifts DP Delta with 2% of the stock, and in 2011, Oscar further gifts DP Delta with another 2% of the stock. In 2012 Oscar breaks the engagement. The Form 990-PF lists the value of its stock at $5,000 for 2010, and $4,000 for 2011. The engineer subsequently determines the highest value for the stock in 2010 to be $4,256,000, and in 2011 to be $3,748,000. Based on the fact pattern, you decide to assert the civil fraud penalty under IRC 6663 (75%).

A fiancé is not a disqualified person under IRC 4946(d), as a fiancé is not a spouse. As Oscar holds the controlling interest in the corporation, the excess amount held by the foundation and the disqualified person is 5% (15% + 25% - 35%) for 2009, 7% for 2010 (15% + 27% - 35%), and 9% for 2011 (15% + 29% - 35%). The table below shows the value of the excess stock for each year and the amount of tax.

Tax year Total value Excess % Excess value Tax rate Tax Civil penalty
200912 2,895,000.00 5% 144,750.00 10% 14,475.00 10,856.25
201012 4,256,000.00 7% 297,920.00 10% 29,792.00 22,344.00
201112 3,748,000.00 9% 337,320.00 10% 33,732.00 25,299.00

You determine that abatement under IRC 4962 does not apply in this case. You issue your report Dec. 1, 2012. Note that IRC 4943(a) taxes are not imposed until the end of each year in the taxable period, unlike excise taxes under IRC 4941(a), 4942(a), and 4944(a). You would issue the following initial report where you solicit correction, or as part of your formal report after there is full correction.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Kilo [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4943(a) 4943(a) 4943(a)
1. Adjustments Excess business holdings in PHC 144,750.00 297,920.00 337,320.00
       
       
       
       
       
2. Total adjustments 144,750.00 297,920.00 337,320.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 144,750.00 297,920.00 337,320.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 14,475.00 29,792.00 33,732.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 14,475.00 29,792.00 33,732.00
9. Additional tax (minimum) 0 0 0
10. Penalties (Code section 6663) 10,856.25 22,344.00 25,299.00
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Kilo  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2009 12/31/2010    
  12/31/2011      
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4943(a) 12/31/2009 14,475.00   6663 10,856.25
4943(a) 12/31/2010 29,792.00   6663 22,344.00
4943(a) 12/31/2011 33,732.00   6663 25,299.00
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-10 
IRC 4943: Second Tier Tax Example

Take the example presented in Exhibit 4.76.4-9. The following Form 4883 reflects how the second tier tax is proposed. Note that under IRC 4943(b), the second tier tax is on the amount of the excess business holdings at the end of the taxable period. This tax is assessed once for the amount of uncorrected excess business holdings. Report the second tier tax on the last year for which there is a tax assessment.

Note that the civil penalty under IRC 6663 is on the entire amount of tax. The penalty substantially increases when accounting for the second tier tax.

IRC 4943(a) civil penalty computation
Tax year Total value Excess % Excess value Tax rate Tax Civil penalty
200912 2,895,000.00 5% 144,750.00 10% 14,475.00 10,856.25
201012 4,256,000.00 7% 297,920.00 10% 29,792.00 22,344.00
201112 3,748,000.00 9% 337,320.00 10% 33,732.00 25,299.00
IRC 4943(b) civil penalty computation
Tax year Excess value Tax rate Tax Penalty arising from 2nd tier tax Penalty arising from 1st tier tax Total penalty
201112 337,320.00 200% 674,640.00 505,980.00 25,299.00 531,279.00

Without correction, you would issue the following formal report of examination that includes the second tier tax with a 30-day letter (Letter 3614).

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Kilo [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Kilo
  Taxable Years Ended
12/31/2009 12/31/2010 12/31/2011
Internal Revenue Code Section for Proposed Adjustment 4943(a) 4943(a) 4943(a)
1. Adjustments Excess business holdings in PHC 144,750.00 297,920.00 337,320.00
       
       
       
       
       
2. Total adjustments 144,750.00 297,920.00 337,320.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 144,750.00 297,920.00 337,320.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 14,475.00 29,792.00 33,732.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 14,475.00 29,792.00 33,732.00
9. Additional tax (minimum) at 200% (4943(b))     674,640.00
10. Penalties (Code section 6663) 10,856.25 22,344.00 531,279.00
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Kilo  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2009 12/31/2010    
  12/31/2011      
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4943(a) 12/31/2009 14,475.00   6663 10.856.25
4943(a) 12/31/2010 29,792.00   6663 22,344.00
4943(a) 12/31/2011 33,732.00 674,640.00 6663 531,279.00
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-11 
IRC 4944: First Tier Tax Example

On July 1, 2010, Foundation Manager Papa makes an investment in an international hedge fund, using funds from Private Foundation Quebec. The foundation has a portfolio valued at $25,575,000, which consists of cash, common stocks of companies on the Dow Jones Industrial Index, mutual fund investments, and Build America Bonds issued by a very large metropolitan city. At the time of the investment, the foundation had $15,000 in cash. FM Papa is the newest foundation manager for PF Quebec, having been on the job six months. FM Papa previously worked at a larger private foundation for two years.

FM Papa acquires a loan from a bank using the bonds as collateral. The loan is for $16,500,000, which FM Papa invests in the hedge fund. The expected return from the hedge fund is 10% per year, which should generate sufficient revenue to repay the loan, which has an APR of 4%.

FM Papa made the investment on advice obtained from a friend, who received their advice from another friend, who in turn received it from a local celebrity. The celebrity is more known for appearaning and succeeding on a national syndicated reality competition show than for financial acumen. FM Papa has performed a few discrete searches on the web, finding a website for the fund, and a few mentions in the foreign press. FM Papa printed the web pages for PF Quebec's records.

The hedge fund's business address is located in the Philippines, and the fund manager operates out of Hong Kong. The hedge fund manager is not affiliated with any domestic or international brokerage or investment firms. There is little information available about the fund manager.

Upon inspection, you determine that after receipt of an initial series of four $5,000 dividend payments no further funds were received. The foundation manager retained the investment on the Form 990-PF for 2010, but was unable to contact the hedge manager to inquire about the investment. The foundation has taken no actions with respect to the investment.

You determine that PF Quebec is subject to IRC 4944, and develop the case for asserting the foundation manager tax on FM Papa. FM Papa is a calendar year taxpayer. See the table below for the tax computations.

Tax Year Investment Tax Rate Tax FM Tax Rate FM Tax
201009 16,500,000.00 10% 1,650,000.00 10% 10,000.00
201109 16,500,000.00 10% 1,650,000.00 10% 0.00
201209 16,500,000.00 10% 1,650,000.00 10% 0.00
Reminder: The tax for any one investment caps at $10,000 for 4944(a)(2).

You determine that abatement under IRC 4962 does not apply in this case. You issue your reports May 1, 2012. You would issue the following initial reports where you solicit correction, or as part of your formal reports after there is full correction.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)woul
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Quebec [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
9/30/2010 9/30/2011 9/30/2012
Internal Revenue Code Section for Proposed Adjustment 4944(a)(1) 4944(a)(1) 4944(a)(1)
1. Adjustments Jeopardizing investment - Hedge Fd 16,500,000.00 16,500,000.00 16,500,000.00
       
       
       
       
       
2. Total adjustments 16,500,000.00 16,500,000.00 16,500,000.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 16,500,000.00 16,500,000.00 16,500,000.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 1,650,000.00 1,650,000.00 1,650,000.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 1,650,000.00 1,650,000.00 1,650,000.00
9. Additional tax (minimum)      
10. Penalties (Code section )      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Foundation Manager Papa [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Quebec
  Taxable Years Ended
12/31/2010    
Internal Revenue Code Section for Proposed Adjustment 4944(a)(2)    
1. Adjustments Jeopardizing investment - Hedge Fd 16,500,000.00    
       
       
       
       
       
2. Total adjustments 16,500,000.00    
3. Amount reported on return or as previously adjusted 0    
4. Total amount as corrected 16,500,000.00    
5. Applicable tax rate % 10%    
6. Initial tax liability as corrected (line 4 x line 5) * 10,000.00    
7. Initial tax liability reported 0    
8. Increase (or decrease) in tax 10,000.00    
9. Additional tax (minimum)      
10. Penalties (Code section )      
Explanation of Adjustments
See attached Explanation of Items
*Subject to $10,000 limit on tax
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Quebec  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
9/30/2010 9/30/2011    
  9/30/2012      
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4944(a)(1) 9/30/2010 1,650,000.00      
4944(a)(1) 9/30/2011 1,650,000.00      
4944(a)(1) 9/30/2012 1,650,000.00      
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Foundation Manager Papa Private Foundation Quebec
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2010   9/30/2010  
         
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4944(a)(2) 12/31/2010 10,000.00      
           
           
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-12 
IRC 4944: Second Tier Tax Example

Taking the example in Exhibit 4.76.4-11 a step further, you determine that PF Quebec and FM Papa are subject to the failure to file and failure to pay penalties under IRC 6651(a). You establish Substitute for Returns for the Form 4720 on IDRS. The failure to file penalty, normally 5% per month for up to five months, is limited to 4.5% per month when the failure to pay penalty is also imposed, at the 0.5% rate for each month or part of a month the tax isn't paid. You issue your report of examination via a 30-day letter on September 1, 2012. The return due dates for the years ending 201009 and 201109 were February 15, 2011 and February 15, 2012. (The due date for the 201209 return is February 15, 2013, thus no failure to file or failure to pay penalties apply to the proposed assessment for the 201209 return.) The penalties for the foundation are computed as follows:

Tax Year Tax Amount Penalty Rate Months Late Penalty
201009 1,650,000.00 4.5% 5 371,250.00
201009 1,650,000.00 0.5% 34 280,500.00
Total Penalty 651,750.00
201109 4,125,000.00 4.5% 5 928,125.00
201109 4,125,000.00 0.5% 22 453,750.00
Total Penalty 1,381,875.00

Note that under IRC 4944(b), the second tier tax is on the amount of the investment, provided that the investment is not corrected by the end of the taxable period. This tax is assessed once per uncorrected jeopardizing investment. Report the second tier tax on the last year for which there is a tax assessment. The second tier tax on management is 20% of the investment, not to exceed $20,000.

You issue a Thorne letter to FM Papa requesting correction. (See Exhibit 4.76.4-16 for sample language used in a Thorne letter for a theoretical IRC 4945 scenario.) You receive no response to the certified letter. You subsequently learn from a call from SB/SE Collection that FM Papa is being sought for an IRC 4941 tax assessment from 200412. Using the W-2 information from PF Quebec, SB/SE found the -L freeze on PF Quebec's Form 990-PF, and pulled an AMDISA print to find your group. Because FM Papa was previously liable for a chapter 42 tax, you propose the IRC 6684 penalty on him after conferring with Area Counsel. The penalties for FM Papa are:

Tax Year Tax Amount Penalty Rate Months Late Penalty
201012 10,000.00 4.5% 5 2,250.00
201012 20,000.00 4.5% 5 4,500.00
201012 10,000.00 0.5% 34 1,700.00
201012 20,000.00 0.5% 34 3,400.00
201012 (IRC 6684) 10,000.00 100% N/A 10,000.00
201012 (IRC 6684) 20,000.00 100% N/A 20,000.00
Total Penalty 41,850.00

Without correction, you would issue the following formal reports of examination that includes the second tier tax with a 30-day letter (Letter 3614).

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Quebec [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
9/30/2010 9/30/2011 9/30/2012
Internal Revenue Code Section for Proposed Adjustment 4944(a) 4944(a) 4944(a)
1. Adjustments Jeopardizing investment 16,500,000.00 16,500,000.00 16,500,000.00
       
       
       
       
       
2. Total adjustments 16,500,000.00 16,500,000.00 16,500,000.00
3. Amount reported on return or as previously adjusted 0 0 0
4. Total amount as corrected 16,500,000.00 16,500,000.00 16,500,000.00
5. Applicable tax rate % 10% 10% 10%
6. Initial tax liability as corrected (line 4 x line 5) 1,650,000.00 1,650,000.00 1,650,000.00
7. Initial tax liability reported 0 0 0
8. Increase (or decrease) in tax 1,650,000.00 1,650,000.00 1,650,000.00
9. Additional tax (minimum) at 25% (4944(b)(1))     4,125,000.00
10. Penalties (Code section 6651(a)) 651,750.00 1,381,875.00  
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Foundation Manager Papa [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Quebec
  Taxable Years Ended
12/31/2010    
Internal Revenue Code Section for Proposed Adjustment 4944(a)(2)    
1. Adjustments Jeopardizing investment 16,500,000.00    
       
       
       
       
       
2. Total adjustments 16,500,000.00    
3. Amount reported on return or as previously adjusted 0    
4. Total amount as corrected 16,500,000.00    
5. Applicable tax rate % 10%    
6. Initial tax liability as corrected (line 4 x line 5) * 10,000.00    
7. Initial tax liability reported 0    
8. Increase (or decrease) in tax 10,000.00    
9. Additional tax (minimum) at 5% (4944(b)(2)) 20,000.00    
10. Penalties (Code section 6651(a), 6684 ) 41,850.00    
Explanation of Adjustments
See attached Explanation of Items
*Subject to $10,000 limit on tax on 4944(b)(1), $20,000 limit on tax under 4944(b)(2).
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Quebec  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
9/30/2010 9/30/2011    
  9/30/2012      
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4944(a)(1) 9/30/2010 1,650,000.00   6651(a)(1) 371,250.00
  9/30/2010     6651(a)(2) 928,125.00
4944(a)(1) 9/30/2011 1,650,000.00   6651(a)(1) 280,500.00
  9/30/2011     6651(a)(2) 453,750.00
4944(a)(1) 9/30/2012 1,650,000.00 4,125,000.00    
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Foundation Manager Papa Private Foundation Quebec
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2010   9/30/2010  
         
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4944(a)(2) 12/31/2010 10,000.00 20,000.00 6651(a)(1) 6,750.00
  12/31/2010     6651(a)(2) 5,100.00
  12/31/2010     6684 30,000.00
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-13 
IRC 4945: First Tier Tax Example

Be aware that some transactions may trigger multiple excise taxes. A common occurrence is for a tax to be both a self-dealing transaction and a taxable expenditure.

Take the same example as presented in Exhibit 4.76.4-2. The expenditure doesn't meet any exception listed in IRC 4945 (IRM 7.27.19.7.2, Permitted Expenditures). The transaction is a taxable expenditure. The table below shows how the tax is computed for the foundation and the foundation manager.

Description Amount
10/10/2009 Transaction 25,000.00
Foundation Tax at 20% 5,000.00
Foundation Manager Tax at 5% (Cap at $10K) 1,250.00

Expanding upon the example, assume that Private Foundation Bravo subsequently files a late Form 4720. The Form 4720 is filed ten days after you issued your initial audit appointment letter on July 2, 2012. The foundation reports only $5,000 as a taxable expenditure. Upon further inquiry, you find that the $20,000 not reported was placed into an IRC 529 tuition plan. The foundation didn't report any taxes on the foundation manager. Your resulting adjustment is computed below.

Description Amount
10/10/2009 Transaction 25,000.00
Amount reported 5,000.00
Adjusted transaction amount 20,000.00
Foundation Tax at 20% 4,000.00
Foundation Manager Tax at 5% (Cap at $10K) 1,250.00

Due to PF Bravo's filing of the late Form 4720, you are unable to propose failure to file or failure to pay penalties. (IRM 4.8.9.16.2.2, Failure to Pay Penalty). With respect to DP Charlie, you establish the substitute for return on IDRS and propose the failure to file and failure to pay penalties. You issue your report on December 3, 2012. The penalties are computed as follows:

Taxpayer Tax Penalty Rate Months Late Penalty
DP Charlie 1,250.00 4.5% 5 281.25
DP Charlie 1,250.00 0.5% 25 156.25

You determine that abatement under IRC 4962 does not apply in this case. You would issue the following initial reports where you solicit correction, or as part of your formal reports after there is full correction.

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Bravo [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
6/30/2010    
Internal Revenue Code Section for Proposed Adjustment 4945(a)(1)    
1. Adjustments Taxable expenditure (birthday gift) 20,000.00    
       
       
       
       
       
2. Total adjustments 20,000.00    
3. Amount reported on return or as previously adjusted 5,000.00    
4. Total amount as corrected 25,000.00    
5. Applicable tax rate % 20%    
6. Initial tax liability as corrected (line 4 x line 5)* 5,000.00    
7. Initial tax liability reported 1,000.00    
8. Increase (or decrease) in tax 4,000.00    
9. Additional tax (minimum)      
10. Penalties (Code section )      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Bravo [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Bravo
  Taxable Years Ended
12/31/2009    
Internal Revenue Code Section for Proposed Adjustment 4945(a)(2)    
1. Adjustments Taxable expenditure (birthday gift) 25,000.00    
       
       
       
       
       
2. Total adjustments 25,000.00    
3. Amount reported on return or as previously adjusted 0    
4. Total amount as corrected 25,000.00    
5. Applicable tax rate % 5%    
6. Initial tax liability as corrected (line 4 x line 5)* 1,250.00    
7. Initial tax liability reported 0    
8. Increase (or decrease) in tax 1,250.00    
9. Additional tax (minimum)      
10. Penalties (Code section 6651(a)) 437.50    
Explanation of Adjustments
See attached Explanation of Items
*Tax on foundation managers is capped at $10,000.
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Bravo  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
6/30/2010      
         
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4945(a)(1) 6/30/2010 4,000.00      
           
           
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Bravo Private Foundation Bravo
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2009   6/30/2010  
         
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4945(a)(2) 12/31/2009 1,250.00   6651(a)(1) 281.25
  12/31/2009     6651(a)(2) 156.25
           
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-14 
IRC 4945: Second Tier Tax Example

Continuing with the example in Exhibit 4.76.4-13, you issue a Thorne letter to Foundation Manager Bravo, who refuses to make correction. (See Exhibit 4.76.4-16 for a sample language used in a Thorne letter for a theoretical IRC 4945 scenario.) DP Charlie disputes that he is liable under IRC 4945(a)(2), and plans to file a formal protest to Appeals upon receipt of your report, issued on January 2, 2013.

In Exhibit 4.76.4-2, DP Charlie was found to be a CPA who worked for a decade for a large public charity. After consulting Area Counsel, you determine that DP Charlie is further liable for both the IRC 6684 and 6663 penalties for a willful and flagrant violation and for fraud on the Form 4720. The computations for DP Charlie's liability are shown below:

IRC Code 2nd Tier Tax Penalty Rate Months Late Penalty
6651(a)(1) 12,500.00 4.5% 5 2,812.50
6651(a)(2) 12,500.00 0.5% 26 1,625.00
6663 12,500.00 75% N/A 9,375.00
6684 12,500.00 100% N/A 12,500.00

As the transaction is not corrected, Private Foundation Bravo is subject to the second tier tax on the entire amount of the transaction. Without correction, you would issue the following formal reports of examination that includes the second tier tax with a 30-day letter (Letter 3614):

 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Private Foundation Bravo [Insert EIN] 1
Name of Exempt Organization (if different from taxpayer)  
 
  Taxable Years Ended
6/30/2010 6/30/2010  
Internal Revenue Code Section for Proposed Adjustment 4945(a)(1) 4945(b)(1)  
1. Adjustments Taxable expenditure (birthday gift) 20,000.00 25,000.00  
       
       
       
       
       
2. Total adjustments 20,000.00    
3. Amount reported on return or as previously adjusted 5,000.00    
4. Total amount as corrected 25,000.00    
5. Applicable tax rate % 20%    
6. Initial tax liability as corrected (line 4 x line 5)* 5,000.00    
7. Initial tax liability reported 1,000.00    
8. Increase (or decrease) in tax 4,000.00    
9. Additional tax (minimum) at 100% (4945(b)(1))   25,000.00  
10. Penalties (Code section )      
Explanation of Adjustments
See attached Explanation of Items
 
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations Excise Tax Audit Changes
(Chapter 41, Chapter 42, and Section 170(f)(10)(F) Excise Taxes)
Name of Taxpayer Employer ID No. Schedule or Exhibit
Disqualified Person Bravo [Insert SSN] 1
Name of Exempt Organization (if different from taxpayer)  
Private Foundation Bravo
  Taxable Years Ended
12/31/2009    
Internal Revenue Code Section for Proposed Adjustment 4945(a)(2)    
1. Adjustments Taxable expenditure (birthday gift) 25,000.00    
       
       
       
       
       
2. Total adjustments 25,000.00    
3. Amount reported on return or as previously adjusted 0    
4. Total amount as corrected 25,000.00    
5. Applicable tax rate % 5%    
6. Initial tax liability as corrected (line 4 x line 5)* 1,250.00    
7. Initial tax liability reported 0    
8. Increase (or decrease) in tax 1,250.00    
9. Additional tax (minimum) at 50% (4945(b)(2)) 12,500.00    
10. Penalties (Code sections 6651(a), 6663, 6684) 26,312.50    
Explanation of Adjustments
See attached Explanation of Items
*The tax is capped at $10,000 for 4945(a)(2) and $20,000 for 4945(b)(2).
 
 
Form 4883 (Rev. 1-2004) Catalog Number 42083F Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720 [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Private Foundation Bravo  
[Insert street address]  
[Insert city, state, and zip code]  
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
6/30/2010      
         
[Insert EIN]          
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of a foundation manager or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4945(a)(1) 6/30/2010 4,000.00 25,000.00    
           
           
           
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov
 
Exempt Organizations - Report of Examination
(Proposed Tax Changes)
1 Form No. 2 Area Office 3 Date of Report
4720-A [Insert name of your area] [Insert date]
4 Name and Address of Taxpayer 5 Name and Address of Private Foundation or Other
Exempt Organization (If different from Item 4)
Disqualified Person Bravo Private Foundation Bravo
[Insert street address] [Insert street address]
[Insert city, state, and zip code] [Insert city, state, and zip code]
6 Social Security Number or
Employer Identification Number
7 Tax Period(s) Ended 8 Private Foundation's or other
Exempt Organization's
Employer Identification Number
(If different from Item 6)
9 Tax Period(s) Ended
12/31/2009   6/30/2010  
         
[Insert SSN]     [Insert EIN]    
10 Report Preparer's Name 11 Agreement Secured (Check one.)
[Insert your name] Yes No
12 Findings Discussed with (Name and Title) 13 Agreement Date
[Insert name of taxpayer or representative] [Leave blank]
14a. Summary of Proposed Adjustments 14b. Penalty
Internal Revenue
Code Section
(1)
Period Covered
by Examination
(2)
Amount of Tax
(3)
Additional Tax
(4)
Internal Revenue
Code Section
(1)
Amount
(2)
4945(a)(2) 12/31/2009 1,250.00 12,500.00 6651(a)(1) 2,812.50
  12/31/2009     6651(a)(2) 1,625.00
  12/31/2009     6663 9,375.00
  12/31/2009     6684 12,500.00
           
           
           
           
15 Remarks
See attached Explanation of Items
 
 
 
16 Attachments
 
Form 4621 (Rev 1-2004) Catalog Number 41830Q Department of the Treasury-Internal Revenue Service
www.irs.gov

Exhibit 4.76.4-15 
IRC 507 Termination Tax Example

Because of a Form 5666 filed during a previous audit, you are inspecting the records of Private Foundation Echo. The trustees, Sierra, Tango, and Uniform, were previously assessed IRC 4941 taxes for transactions in 200512, 200612, and 200712.

According to the Form 5666, on the day after inception in 2005, PF Echo loaned 75% of its cash to Victor, a corporation wholly owned by Sierra, Tango, and Uniform. There had been no loan instrument on file. The corporation later corrected the transaction, paying the money back on 12/1/2008, with additional interest computed at prime rate. The previous agent pro-rated the tax assessments on the trustees based on their shares of ownership. The agent also assessed IRC 4945 taxes on the foundation for taxable expenditures not serving an IRC 170(c)(2)(B) purpose.

During your audit of 201012 through 201112, you find that PF Echo has since paid 80% of its cash to the trustees reported as notes receivable on Forms 990-PF. Each trustee took turns signing the notes receivable, as shown below:

Date Amount Signed for PF Echo Signed as recipient
12/2/2008 $575,000 DP Tango DP Sierra
12/2/2008 $498,000 DP Uniform DP Tango
12/2/2008 $452,000 DP Sierra DP Uniform

All the notes have 30 year terms, with payment in full upon maturity. The notes fail to specify any amount of interest or any interim payments.

After consulting with Area Counsel, you propose revocation and involuntary termination. Using Online SEIN, you retrieve the Forms 990-PF from 2005 onward. You also pull the IMFOLR prints for each trustee's Forms 1040 from 2005 to the present. The following tables show the amounts donated by each trustee (Form 990-PF Schedule B), adjusted gross income, contribution amount deducted, and individual income marginal tax bracket for each year from 2005 through 2011. None of the trustees made any contributions in 2011.

Note:

The tables below do not in