Section 507(b) Termination of Private Foundation Status, Special Rules

An organization described in IRC Section 501(c)(3) that was classified as a private foundation can terminate its private foundation status only by using one of the methods described in Section 507. The statutory framework provides for two types of terminations, Section 507(a) and Section 507(b). This Snapshot will focus on termination of private foundation status described in Section 507(b). Section 507(b) sets forth two types of terminations:

  • Distribution of net assets to certain public charities Section 507(b)(1)(A)).
  • Operation as a public charity Section 507(b)(1)(B).

Private foundations terminating private foundation status under Section 507(b) are not subject to Section 507(c) tax.

Private foundation status exists independent of exempt status. Termination under Section 507 only terminates the private foundation status with the Internal Revenue Service. If a foundation is liquidating or dissolving then it should also notify the appropriate office in the state where it is organized about the foundation’s intent to dissolve, liquidate, or terminate.

IRC Section and Treasury Regulations

  • IRC Section 507(b) Termination of Private Foundation Status, Special Rules
  • Treas. Reg. Section 1.507-1 General rule
  • Treas. Reg. Section 1.507-2 Special rules; transfer to, or operation as, public charity
  • Treas. Reg. Section 1.507-3, Special rules; transferee foundations
  • Treas. Reg. Section 1.507-4, Imposition of tax
  • Treas. Reg. Section 1.507-5, Aggregate tax benefit; in general
  • Treas. Reg. Section 1.507-6, Substantial contributor defined
  • Treas. Reg. Section 1.507-7, Value of assets
  • Treas. Reg. Section 1.507-8, Liability in case of transfers
  • Treas. Reg. Section 1.507-9, Abatement of taxes

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)

IRM 7.26.7 Termination of Private Foundation Status

Revenue Ruling 2003-13, 2003-1 C.B. 305 describes several situations involving termination of a private foundation. The four situations are:

  • Situation 1. A private foundation is recognized as exempt from federal income tax under Section 501(c)(3). Pursuant to a plan of dissolution, it distributes all its net assets to a public charity described in Section 509(a)(1) which has been in existence for at least 60 months.
  • Situation 2. The facts are the same as Situation 1, except that X has been in existence for fewer than 60 calendar months immediately preceding the distribution.
  • Situation 3. The facts are the same as Situation 1, except that X is an organization described in Section 509(a)(2).
  • Situation 4. The facts are the same as Situation 1, except that X is an organization described in Section 509(a)(3).

In Situation 1, the private foundation transfers all its net assets to a public charity, which is described in Section 509(a)(1) and has been so described for a continuous period of at least 60 calendar months immediately preceding the distribution. Accordingly, the distribution is subject to the rules of Section 507(b)(1)(A), rather than the rules of Section 507(a)(1). Because the distribution is described in Section 507(b)(1)(A), the private foundation is terminated upon the distribution and the organization is not subject to the tax described in Section 507(c). The distributions in Situations 2, 3, and 4 are not described in Section 507(b)(1)(A) so in order to terminate the private foundation status the organization would need to provide notice under Section 507(a)(1) (See page 8 regarding Notice). If a foundation did not give notice and did not terminate, it would not be subject to the tax. However, if the foundation chose to give notice and terminate, it would be subject to the tax. If the foundation has no assets on the day it provides notice, the tax will be zero.

Rev. Rul. 2002-28, 2002-1 C.B. 941, provides that a transfer of assets described in Section 507(b)(2) does not constitute a termination of the transferor's private foundation status under Section 507(a)(1) unless the transferor voluntarily gives notice pursuant to Section 507(a)(1). Section 507(b)(2) provides that in the case of a transfer of assets of any private foundation to another private foundation pursuant to a liquidation, merger, redemption, recapitalization, or other adjustment, organization or reorganization, the transferee foundation shall not be treated as a newly created organization. This Revenue Ruling discusses three situations involving a transferor foundation which transfers all of its assets to one or more private foundations. The transfers are not for full and adequate consideration and are not distributions out of current income. Thus, the transfers in situations 1, 2 and 3 are Section 507(b)(2) transfers. A transfer of assets described in Section 507(b)(2) does not constitute a termination of the transferor's private foundation status under Section 507(a)(1) unless the transferor voluntarily gives notice pursuant, to Section 507 (a) (1). The transferor foundation is not required to provide such notice. In Situation 1, P's dissolution under state law has no effect on whether P has terminated its private foundation status for federal tax purposes.

Rev. Rul. 75-289, 1975-2 C.B. 215, provides that a corporation that remains in existence after terminating its private foundation status under Section 507(b)(1)(A) must, unless specifically excepted by Section 508(c), file an Application for Recognition of Exemption if it wishes to be treated as an organization described in Section 501(c)(3). A private foundation may terminate its private foundation status under Section 507(b)(1)(A) by distributing its total net assets to a public charity, in existence 20 months, formed from the consolidation of two public charities each of which would have been in existence for 60 months at the time of distribution had they not been consolidated.

Rev. Rul. 76-92, 1976-1 C.B. 160, states that a private foundation nonexempt charitable trust described in Section 4947(a)(1) must terminate its private foundation status pursuant to Section 507 before it can be excluded from such status under Section 509(a)(3).

Rev. Rul. 78-386, 1978-2 C.B. 179, provides that a private foundation that has commenced a 60-month termination period has received an advance ruling that it can reasonably be expected to satisfy the requirements of Section 507(b)(1)(B)(i) by operating as a public charity during the period. A private foundation that supports only such organization and otherwise qualifies under Section 1.509(a)-4 may be given an advance ruling that it can reasonably be expected to operate as a Section 509(a)(3) organization and satisfy the requirements of Section 507(b)(1)(B)(i) during its own 60-month termination period.

Termination of Private Foundation Status

ANALYSIS

How can a private foundation terminate its foundation status pursuant to Section 507(b) so that it does not incur excise taxes under Section 507(c)?

A private foundation has two ways to terminate its foundation status under Section 507(b) and that is Section 507(b)(1)(A) and Section 507(b)(1)(B). Generally, a termination under Section 507(b)(1)(A) is by a distribution of net assets to a public charity and a termination under Section 507(b)(1)(B) is by operation as a public charity.

Termination by distribution of net assets to public charity Section 507(b)(1)(A)

A foundation may terminate its private foundation status if it distributes its net assets to one or more public charities. To accomplish the termination in this manner:

  1. there have not been either willful, repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42;
  2. it must distribute all of its right, title, and interest in and to all of its net assets;
  3. the organization(s) to which it distributes must be a public charity as described in Section 170(b)(1)(A)(i)-(vi); and
  4. the public charity must have been so described for a continuous period of at least 60 months.

There have not been either willful, repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42

Section 1.507-1(c)(1) provides that the term "willful repeated acts (or failures to act)" means at least two acts or failures to act both of which are voluntary, conscious, and intentional. A "willful and flagrant act (or failure to act)" is one which is voluntarily, consciously, and knowingly committed in violation of any provision of Chapter 42, other than Section 4940 or 4948 (a), and which would appear to be a gross violation to a reasonable person. Section 1.507–1(c)(2).

Section 1.507-1(c)(4) provides that a failure to correct an act or acts (or failure or failures to act) which gave rise to Chapter 42 tax liability by the close of the correction period may be a willful and flagrant act (or failure to act). For an act (or failure to act) to be willful a motive to avoid the restrictions of the law or the incurrence of any tax is not necessary; however, there must be knowledge on behalf of the foundation or a manager that an act (or failure to act) is one of self-dealing, a taxable expenditure, or other act (or failure to act) to which Chapter 42 applies. Sections 1.507–1(c)(5) and 53.4945–1(a)(2)(iii)).

It must distribute all of its right, title, and interest in and to all of its net assets

Section 1.507-2(a)(7) provides that to terminate its private foundation status under Section 507(b)(1)(A), an organization is required to distribute all of its right, title, and interest in and to all of its net assets to one or more Section 509(a)(1) organizations in existence and so described for a continuous period of at least 60 calendar months preceding the distribution.

To effectuate a transfer of "all of its right, title, and interest in and to all of its net assets" within the meaning of Section 507(b)(1)(A), a transferor private foundation may not impose any material restriction or condition that prevents the transferee organization (the public charity) from freely and effectively employing the transferred assets, or derived income, in furtherance of its exempt purposes. Whether a condition or restriction imposed upon a transfer is "material " must be determined from all of the facts and circumstances of the transfer. Significant facts and circumstances to consider include whether the:

  • transferee is the owner in fee of the transferred assets;
  • transferred assets will be held and administered in a manner consistent with its exempt purposes;
  • governing body of the transferee has ultimate authority and control over the transferred assets and income derived from them; and
  • governing body of the public charity is organized and operated independently from the transferor. Relevant considerations in determining the independence of the transferee’s governing body include: whether the transferor or disqualified persons select members of the governing body of the transferee; whether the members of the governing body of the transferee are selected by public officials acting in their capacities as such; and, the length of time each member of the governing may serve as such.

Section 1.507–2(a)(7)(iii) and Section 1.507–2(a)(7)(iv) provides additional information on "material" restrictions or conditions.

The organization(s) to which it distributes must be a public charity as described in Section 170(b)(1)(A)(i)-(vi)

The distribution of net assets must be to one or more organizations described in Section 170(b)(1)(A)(i) through (vi). The types of organizations that generally qualify as distributees are:

  • Churches or conventions or associations of churches Section 170(b)(1)(A)(i);
  • Schools Section 170(b)(1)(A)(ii);
  • Hospitals Section 170(b)(1)(A)(iii);
  • Medical research organizations operated in conjunction with a hospital; Section 170(b)(1)(A)(iii);
  • Organizations receiving substantial public support or governmental support (exclusive of income received from the exercise or performance of their exempt function) and operated for the benefit of a college or university owned or operated by a governmental unit Section 170(b)(1)(A)(iv);
  • Governmental units described in Section 170(c)(1)- 170(b)(1)(A)(v); and
  • Organizations that normally receive a substantial part of their support (exclusive of income received from the exercise or performance of their exempt function) from the public or the government Section 170(b)(l)(A)(vi).

That has been a public charity for a continuous period of at least 60 months:

In addition, Section 1.507-2(a)(1) provides that a distributee organization must have been in existence and must have been so described for a continuous period of at least 60 calendar months immediately preceding the distribution. However, a distributee organization in existence less than 60 months prior to receiving distribution will qualify as a proper distributee where it was formed from the consolidation of two public charities each of which would have been in existence for 60 months at the time of distribution had they not been consolidated. Rev. Rul. 75–289, supra.

To terminate its private foundation status by distributing all of its net assets in compliance with the requirements of Section 507(b)(1)(A), the organization is not required to file the notification described under Section 507(a). Section 1.507-2(a)(1) states that the private foundation may, therefore, carry out the distributions without giving advance notice to the Service of its intent to terminate.

Applicability of Chapter 42 to foundations terminating under Section 507(b)(1)(A)

An organization that terminates its private foundation status pursuant to Section 507(b)(1)(A) will remain subject to the provisions of Chapter 42 until the distribution of all of its net assets to distributee organizations described in Section 507(b)(1)(A) has been completed.

Termination by operation as a public charity Section 507(b)(1)(B)

The basic requirements for terminating private foundation status under Section 507(b)(1)(B) are:

  • the organization has not been involved in willful repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42;
  • the organization meets the requirements of Section 509(a)(1), (2) or (3) for a continuous period of 60 calendar months (the transition period is over for the 12-month period referred to in the Code);
  • the organization notifies the Service, before the start of the 60-month period, that it is terminating its private foundation status; and
  • the organization, within 90 days after the end of the 60-month period, furnishes the Service sufficient information to allow a determination that the organization met the requirements of Section 509(a)(1), (2) or (3).

The organization has not been involved in willful repeated acts (or failures to act) or a willful and flagrant act (or failure to act) giving rise to liability for tax under Chapter 42.

See supra for discussion of this issue.

The organization meets the requirements of Section 509(a)(1), (2) or (3) for a continuous period of 60 calendar months (the transition period is over for the 12-month period referred to in the Code).

Whether the organization operates as a public charity is determined by whether it meets the requirements of Section 509(a)(1), (2) or (3) and the regulations thereunder.

Operating as a public charity for a continuous period of 60 months after giving appropriate notice: An organization may terminate its private foundation status under Section 507(b)(1)(B) if it meets the requirements of Section 509(a)(1), (2), or (3)) for a continuous 60-month period beginning with the first day of any tax year, and notifies the IRS before beginning the 60-month period that it is terminating its private foundation status.

The organization notifies the Service, before the start of the 60-month period, that it is terminating its private foundation status.

To notify the IRS:

  • To request an advance ruling that an organization can be expected to meet the requirements of Section 507(b)(1)(B)(i), submit Form 8940 along with the required information and user fee to the address indicated in the Form 8940 instructions, or
  • If not requesting an advance ruling, send the required information to Internal Revenue Service, Exempt Organizations Determinations, P.O. Box 2508, Cincinnati, OH 45201.

Both methods of notification of termination of private foundation status via operation as a public charity should include:

  • The name and address of the private foundation,
  • Its intention to terminate its private foundation status,
  • The Code section under which it seeks classification (Section 509(a)(1), (2), or (3)),
  • If Section 509(a)(1) applies, the specific type of Section 170(b)(1)(A) organization for which it seeks classification,
  • The date its regular tax year begins, and
  • The date the 60-month period begins (must be the beginning of a tax period).

An organization that seeks an advance ruling and files Form 8940 will be required to complete and submit Form 872-B agreeing to extend the statute of limitations for paying the 4940 excise tax on net investment income until after the end of the 60-month period. Form 872-B is optional for organizations not requesting an advance ruling but if the organization chooses not to submit the form it must pay the taxes on its investment income during the period. The organization also must establish immediately after the end of the 60-month period that it has met the requirements of Section 509(a)(1), (2), or (3). See Revenue Procedure 2017-5, updated annually, for further information.

The organization, within 90 days after the end of the 60-month period, furnishes the Service sufficient information to allow a determination that the organization met the requirements of Section 509(a)(1), (2) or (3).

To establish a successful termination, an organization must within 90 days after the expiration of the 12-month or 60-month period, file such information with the Service as is necessary to make a determination as to the organization’s status as an organization described under Section 509(a)(1), (2), or (3). Failure to supply, within the time required, all of the information required to make such a determination will not alone constitute a failure to satisfy the requirements of Section 507(b)(1)(B).

When information filed timely is incomplete, and additional information as requested by the Service is filed within the allowed time period, the original submission will be considered timely.

Issue Indicators or Audit Tips

  • Review the Form 990-PF because the terminating private foundation must continue to file Form 990-PF either in the year it distributes its assets and dissolves, or during the 60-month termination period. The applicable box for the particular type of terminating private foundation on the top of Form 990–PF should be checked. Section 1.507–2(a)(5).
  • Upon reviewing the foundation information, if it appears that a private foundation fails to accomplish an Section 507(b)(1)(B) termination during the 60-month period, it will be subject to Sections 507, 508, 509, and Chapter 42 for any taxable year or years within the 60-month period during which it does not satisfy the requirements of Section 509(a)(1), (2), or (3), and will be treated as an organization described in Section 509(a)(1), (2), or (3) for any taxable year or years in which it does satisfy those requirements, making Sections 507, 508, 509, and Chapter 42 inapplicable for that particular year(s).
  • An organization will keep its private foundation status even after its tax exempt status has been revoked and will still be required to file Form 990-PF return and subject to excise tax under Chapter 42 unless it has completed its private status termination under Section 507(a) or (b). See IRM 7.26.7.1.3.