7.26.1 Introduction to Private Foundations and Special Rules Under IRC 508

Introduction to Private Foundations

  1. The Tax Reform Act of 1969 introduced the classification of "private foundation" into the Internal Revenue Code and added a wide array of restrictions, requirements, taxes, and penalties affecting organizations so classified (and certain people associated with them).

  2. IRC 509(a) defines a private foundation as an organization described in IRC 501(c)(3) other than an organzation described in IRC 509(a)(1), (2), (3), or (4). IRC 509(a) thus divides organizations described in IRC 501(c)(3) into two classes:

    1. private foundations, and

    2. organizations other than private foundations (sometimes called "public charities," by way of distinction— see Reg. 1.501(h)–1(a)(2)).

  3. Public charities are not subject to the restrictive rules applicable to private foundations.

    1. Organizations described in IRC 509(a)(1) and (2) are also known as "publicly supported organizations." See Reg. 1.509(a)–4 (a)(5).

    2. Public charities generally are either organizations that have broad public support or that actively function in a supporting relationship to publicly supported organizations. See Reg. 1.509(a)–1.

  4. Once an organization becomes a private foundation, it retains its status as a private foundation (even if it becomes no longer described in IRC 501(c)(3)) until its private foundation status is terminated under IRC 507. See IRC 509(b).

  5. The main Code sections affecting private foundations are IRC 507–509 and 4940–4948 (the latter sections commonly referred to as chapter 42 provisions). These Code sections cover:

    1. IRC 507— Termination of private foundation status

    2. IRC 508(b)–(e)— Special rules (notice requirements, disallowance of charitable deductions, governing instrument requirements)

    3. IRC 509— Private foundation defined

    4. IRC 4940— Excise tax based on investment income

    5. IRC 4941— Taxes on self-dealing

    6. IRC 4942— Taxes on failure to distribute income

    7. IRC 4943— Taxes on excess business holdings

    8. IRC 4944— Taxes on investments which jeopardize charitable purpose

    9. IRC 4945— Taxes on taxable expenditures

    10. IRC 4946— Definitions and special rules (disqualified persons)

    11. IRC 4947— Application of taxes to certain non-exempt trusts

    12. IRC 4948— Application of taxes and denial of exemption with respect to certain foreign organizations

  6. Other provisions relate to the enforcement of the taxes on private foundations, including requirements that private foundations publicly disclose their exemption applications and returns.

Special Rules Under IRC 508 for Private Foundations

  1. IRC 508 contains several rules regarding private foundations, in addition to the exemption application requirement under IRC 508(a) for all 501(c)(3) organizations:

    1. IRC 508(b) presumes that a 501(c)(3) organization is a private foundation unless it notifies the Service to the contrary.

    2. IRC 508(e) requires the governing instrument of a private foundation to observe the rules of IRC 4941–4945.

    3. IRC 508(d) disallows charitable deductions for contributions to private foundations under certain circumstances.

508(b) Presumption of Foundation Status and Required Notice

  1. IRC 508(b) provides generally that a 501(c)(3) organization is presumed to be a private foundation unless it files a timely notice to the contrary with the Service.

  2. An organization ordinarily files its notice by filing a properly completed Form 1023 application (which contains questions determining whether the organization is a private foundation or a private operating foundation). See Reg. 1.508-1(b)(2)(iv) and (5)(i).

    1. Organizations determined before July 14, 1970 to be exempt were advised by the Service to file their notice of private foundation status on Form 4653. That form is no longer in use; however, any such organization that did not file Form 4653 may presently establish public charity status by submitting a request for a determination letter under Rev. Proc. 76–34, 1976–2 C.B. 656. Form 1023 schedules may be used for submitting pertinent information.

    2. The procedures for a 4947(a)(1) trust to establish its private foundation status are set forth in Rev. Proc. 72–50, 1972–2 C.B. 830, superseded in part by Rev. Proc. 76–34.

  3. The IRC 508(b) regulations set forth a 15-month filing deadline, like that for IRC 508(a). See Reg. 1.5081(b)(2)(i). However, the presumption of private foundation status is rebuttable. Even if the deadline is not met, the organization may subsequently submit information establishing its status as a public charity. See Rev. Rul. 73–504, 1973–2 C.B. 190.

  4. Most organizations exempt from the IRC 508(a) notice requirement are also exempt from the IRC 508(b) notice requirement (including 4947(a)(1) trusts). See Reg. 1.508–1(b)(7).

    1. The sole exception is for organizations organized before Oct. 10, 1969 (i.e., such organizations are not exempt from the IRC 508(b) notice requirement).

  5. Usually, an organization cannot be a private foundation unless it is exempt under IRC 501(c)(3).

    1. Thus, if an organization is required under IRC 508(a) to file a Form 1023 application, fails to do so in a timely manner, and is recognized as exempt only from the filing date of the application, then it will be a private foundation (or a public charity) only from the date it is recognized as exempt under IRC 501(c)(3). See Rev. Ruls. 77–207, 1977–1 C.B. 152; 77–208, 1977–1 C.B. 153.

    2. Financial support for periods prior to the filing date is not considered in determining the organization’s private foundation status; depending on the circumstances, the organization might be eligible only for an advance ruling. See Rev. Rul. 77–208, 1977–1 C.B. 153.

    3. Certain nonexempt trusts described in IRC 4947 are treated as private foundations for certain purposes even if they have not met the IRC 508(a) notice requirement.

    4. Private foundations that lose their exempt status remain private foundations until they terminate such status under IRC 507.

  6. An organization’s filing of a timely notice under IRC 508(b) cannot be relied on by the organization, its contributors, or others to prove that the organization is not a private foundation. Only a determination letter by the Service may be relied on. See Regs. 1.508-1(b)(3)(i), (5)(ii), and (6); 1.509(a)-7; Rev. Proc. 82–39, 1982–1 C.B. 759.

    1. An exception applies for certain community trusts. See Rev. Proc. 77–20, 1977–1 C.B. 585.

508 (e) Governing Instrument Requirements

  1. In general, a private foundation is not exempt under IRC 501(a) for the year (pursuant to IRC 508(e)(1)), and contributors may not deduct contributions to the private foundation made in the year (IRC 508(d)(2)(A), discussed in the following section), unless the private foundation’s governing instrument requires it to conduct itself so as to avoid tax liability (both for itself and its disqualified persons) under IRC 4941–4945. See IRC 508(e)(1); Reg. 1.508-3(b)(1). There are many exceptions to this rule, discussed below.

    1. The "governing instrument" is the "articles of organization" under Reg. 1.501(c)(3)–1(b)(2). Bylaws do not qualify. See Reg. 1.508–3(c).

  2. The governing instrument is deemed to meet the IRC 508(e)(1) requirements if State law requires such conduct (or, equivalently, treats the governing instrument as requiring such conduct). See Reg. 1.508-3(d)(1).

    1. As a practical matter, most domestic private foundations do not need IRC 508(e) provisions in their governing instruments, since the laws of most States satisfy the requirements. See Rev. Rul. 75–38, 1975–1 C.B. 161.

  3. The laws of many States do not satisfy IRC 508(e) if such coverage is specifically disclaimed in one of the following documents:

    • the governing instrument

    • a court decree

    • a notification/election by the private foundation to an appropriate State official

  4. State law does not satisfy IRC 508(e) if it does not apply to a clause in the governing instrument that conflicts with IRC 508(e)(1). See Reg. 1.508–3(d)(5).

    1. A clause prohibiting distribution of corpus conflicts with IRC 508(e)(1). See Reg. 1.508–3(b)(2).

    2. A clause empowering the trustee to make investments without being limited to those investments authorized by law does not confict. See Reg. 1.508–3(d)(3).

    3. In Trust Under the Will of Bella Mabury v. Commissioner, 80 T.C. 718 (1983), the court held that a California law requiring private foundations to meet the requirements of IRC 4942 did not automatically supersede a conflicting provision in a pre-1969 testamentary trust that required accumulation of income, but allowed for the trustee to bring a judicial proceeding to reform the trust in compliance with IRC 4942.

  5. If the State law by its terms does not apply to a governing instrument with a mandatory conflicting direction, or allows private foundations to elect out of the law, then the private foundation must indicate on its annual return whether the State law applies. See Reg. 1.508–3(d)(3) and (4).

  6. In general, where State law does not satisfy IRC 508(e), the governing instrument must specifically refer to each of sections 4941, 4942, 4943, 4944, and 4945. See Reg. 1.508–3(b)(1).

    1. For examples of language satisfying the requirements, see Rev. Ruls. 70–270, 1970–1 C.B. 135; 74–368, 1974–2 C.B. 390 (for 4947 trusts).

    2. The governing instrument cannot expressly prohibit the distribution of capital/principal/corpus. Reg. 1.508–3(b)(2).

    3. Language that satisfies the organizational test under Reg. 1.501(c)(3)–1(b) will not necessarily suffice for IRC 508(e) purposes. See Reg. 1.508–3(b)(1).

    4. Conversely, language sufficient for IRC 508(e)(1) purposes does not necessarily satisfy the 501(c)(3) organizational test. See Rev. Rul. 85–160, 1985–2 C.B. 162.

  7. In States where State law does not satisfy IRC 508(e), governing instruments generally meet the IRC 508(e)(1) requirements for a tax year only if they meet the requirements by the end of the year. See Reg. 1.508–3(a). Several exceptions apply:

    1. In certain situations where a court declares a State law meeting the requirements of IRC 508(e)(1) invalid with respect to a class of private foundations, a private foundation will have one year to amend its governing instrument. See Reg. 1.508–3(d)(2)(ii)–(iv).

    2. If an organization originally is classified as a public charity and later is classified as a private foundation, then it has one year from the date of receipt of the final private foundation ruling to amend its governing instrument. See Reg. 1.508–3(b)(5).

    3. If an organization must institute a judicial proceeding to amend its governing instrument, then the IRC 508(e)(1) requirements are deemed satisfied within the one-year period if the proceeding is instituted within the period and within a reasonable time thereafter the organization in fact meets the IRC 508(e) requirements. See Reg. 1.508–3(b)(6). If the organization was organized prior to Jan. 1, 1970 and institutes a necessary judicial proceeding within the year, then IRC 508(e)(1) does not apply after the judicial proceeding if the court does not allow the reformation. See Reg. 1.508–3(b)(6).

  8. Charitable trusts described in IRC 4947(a)(1) that are subject to the private foundation rules must comply with IRC 508(e). Split-interest trusts described in IRC 4947(a)(2) are also subject to the IRC 508(e) requirements to the extent that the chapter 42 provisions apply to them. See Reg. 1.508–3(e).

    1. Such trusts must comply with IRC 508(e) to avoid the disallowance of deductions under IRC 508(d)(2)(A) for contributions to such trusts. For additional details, see Regs. 1.508–3(e)(2) and (3).

Exceptions to 508(e) Requirements
  1. If an organization whose governing instrument was executed before Jan. 1, 1970 instituted a necessary judicial proceeding in a court of proper jurisdiction by Dec. 31, 1971 to reform its governing instrument to comply with IRC 508(e), then IRC 508(e)(1) does not apply to the organization before, during, and (if the court did not allow the governing instrument to be reformed to comply with IRC 508(e)(1)) after the judicial proceeding. See IRC 508(e)(2); Reg. 1.508–3(f).

    1. The court in Trust Under the Will of Bella Maburv v. Commissioner, supra, applied a similar rule under IRC 4942 to excuse the trust from compliance with IRC 508(e) and 4942 where it filed a timely judicial proceeding and the State court did not allow reformation. This transitional rule under IRC 4942 allowed certain pre-existing trusts to accumulate income where courts were determining the validity of an accumulation provision.

  2. A similar exception applies to organizations for tax years beginning before a certain transitional date, and to any periods after the transitional date during a judicial proceeding to reform the governing instrument instituted before the transitional date (and thereafter if the court did not allow reformation of the governing instrument). See Reg. 1.508–3(g), as originally published (T.D. 7232, 1973–1 C.B. 252), and as amended.

    1. The transitional date is the earlier of (1) the date 91 days after the organization received a final ruling that it is a private foundation, or (2) the date 91 days after the final regulations for public charity status under IRC 170(b)(1)(A) (Reg. 1.170A–9) were published.

    2. The latter date is Feb. 10, 1977 (in the case of community trusts), May 21, 1976 (in the case of medical research organizations), or March 30, 1973 (in the case of all other organizations).

  3. Foreign organizations that have received substantially all of their support (other than gross investment income) from sources outside the United States are exempt from IRC 508(e). See Reg. 1.508-1(a)(2)(vi) and IRC 4948(b).

  4. Certain transitional/savings/grandfather provisions set forth in the Tax Reform Act of 1969 override IRC 508(e). See Reg. 1.508–3(b)(3).

508 (d) Disallowance of Charitable Deductions

  1. IRC 508(d) disallows charitable deductions under the income, estate, and gift tax provisions of the Code for contributions to private foundations (and trusts described in IRC 4947(a)(1) and (2)) under certain circumstances:

    1. IRC 508(d)(1) disallows deductions for certain contributions made to a private foundation or 4947 trust that has been assessed for tax under IRC 507(c).

    2. IRC 508(d)(2)(A) disallows deductions for certain contributions made in taxable years for which the private foundation or IRC 4947 trust fails to meet the IRC 508(e)(1) requirements.

  2. The charitable deduction Code sections contain provisions equivalent to or cross-referencing IRC 508(d). See IRC 170(f)(1) and Reg. 1.170A–1(h)(2); IRC 681(b) and Reg. 1.681(b)–1; IRC 2055(e)(1) and Reg. 20.2055–5; and IRC 2522(c)(1) and Reg. 25.2522(c)–2.

  3. IRC 508(d)(2)(B) contains a similar rule disallowing deductions for contributions made to an organization during a period that the organization is not exempt under IRC 501(c)(3) by reason of IRC 508(a).

508(d)(1) Disallowance
  1. Under IRC 508(d)(1) and Reg. 1.508–2(a), charitable deductions for contributions to an organization are disallowed where all of the following circumstances exist:

    1. Either (1) the contribution is made after the organization or the Service gives notice under IRC 507(a), or (2) the contribution is made by a substantial contributor in his tax year which includes the first day on which the organization takes action which culminates in the 507(c) tax (or any subsequent tax year).

    2. The IRC 507(c) termination tax has been imposed on the organization but has not yet been fully paid or abated. (Under IRC 509(c), an organization generally has a fresh start for private foundation purposes beginning on the day after IRC 507 termination.)

    3. The entire unpaid amount of the IRC 507(c) tax is not abated after the contribution is made.

508(d)(2)(A) Disallowance
  1. The "taxable year" referred to in IRC 508(d)(2)(A) is that of the donee organization. If it meets the IRC 508(e)(1) requirements by the end of the taxable year in which the gift is made, the donor’s charitable deduction will not be disallowed under IRC 508(d)(2)(A). See Reg. 1.508–2(b)(1)(ii) and (iii).

    1. For a bequest to an organization not in existence at the date of the testator’s death (but created by the testator’s will), the "taxable year" is the first taxable year of the organization. See Reg. 1.508–2(b)(1)(ii).

  2. In general, the exceptions that apply under IRC 508(e) (to both private foundations and 4947 trusts) also apply for purposes of IRC 508(d)(2)(A). Thus, if an organization is exempt from (or is considered to meet) the IRC 508(e) requirements for its tax year in which a contribution is made, then the deduction is not disallowed under IRC 508(d)(2)(A) to the contributor; conversely, if IRC 508(e) is not satisfied for the year, then the deduction is disallowed. However, there are some special rules for IRC 508(d)(2)(A) purposes:

    1. A contribution to an IRC 4947(a)(2) trust, whose governing instrument is executed after March 22, 1973 and that (by its terms) will become an IRC 4947(a)(1) trust, will be disallowed unless the trust provides that it will comply with all of the chapter 42 provisions when it becomes an IRC 4947(a)(1) trust. See Reg. 1.508–2(b)(1)(vii).

    2. Where a State law meeting the IRC 508(e) requirements applies retroactively, it does not apply to contributions made more than two years before the enactment of the State law. See Reg. 1.508–3(d)(6).

    3. Reg. 1.508–3(g) applies only to contributions made before the transitional date. See Reg. 1.508–3(g)(2).

    4. Special transitional rules apply to certain property placed in trust before Oct. 10, 1969 or passing by will executed before such date. See Reg. 1.508–2(b)(2).