Issue Title: IRC Section 4946 - Definition of Disqualified Person Description: The term "disqualified person" is critical to the treatment and status of exempt organizations classified as private foundations. Identifying the disqualified persons of a private foundation is needed to analyze whether various Chapter 42 excise taxes apply. It is also important in determining whether an organization qualifies for public charity status as a supporting organization or meets the public support test for IRC Section 509(a)(2). IRC Section and Treas. Regulation: IRC Section: IRC Section 4946, Definitions and Special Rules Treas. Regulation: Treas. Reg. Section 53.4946-1, Definitions and Special Rules Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources): Court Cases: In Rockefeller v. United States, 572 F. Supp. 9 (E.D. Ark. 1982), aff’d, 718 F.2d 290 (8th Cir. 1983), the court found that the taxpayer was a disqualified person with respect to a trust for purposes of IRC Section 4946. The court found the taxpayer to be a disqualified person because he was a family member (lineal descendant) of a deceased substantial contributor. The court also addressed challenges to the constitutionality of Section 4941 and the appropriateness of using Section 507 to define a substantial contributor, holding that the statute is constitutional and the use of Section 507 is exactly what Congress intended and wrote. The court’s holding that the first tier excise tax under Section 4941 should not accrue interest until assessed has been eclipsed by other cases, including Latterman v. United States, 872 F.2d 564 (3rd Cir. 1989), which held that interest began to accrue on the last date prescribed for payment, not after assessment. In Graham v. Commissioner, T.C. Memo 2002-24, the court concluded that the taxpayer's net transfer to a private foundation was insufficient to make him a substantial contributor, because the taxpayer had contributed less than 2 percent of the foundation’s total contributions. Accordingly, the taxpayer was not liable for any excise tax pursuant to Section 4941(a)(1) or (b)(1). Rev. Rul. 74-287 (I.R.S. 1974), provides that employees of a bank that is designated as the trustee of a private foundation, who have been delegated fiduciary responsibility for the day to day administration and distribution of the trust, are disqualified persons, even though they are ultimately responsible to the bank directors and officers for their actions with respect to the trust. Administrative Materials: Disqualified Persons Acts of self-dealing by private foundation Analysis: A basic concept of the tax law relating to private foundations is that of the disqualified person, as defined in Section 4946. The term appears prominently in Part VII-B of the Form 990-PF. Identifying the disqualified person is critical to certain Chapter 42 excise taxes. For example: Whether a transaction between a private foundation and another party might be an act of self-dealing under Section 4941 depends upon whether the other party is a disqualified person with respect to the foundation. In determining whether a private foundation has excess business holdings under Section 4943, the business holdings of the disqualified persons must be taken into account. Section 4946 provides a list of disqualified persons with respect to a private foundation. The following list identifies who constitutes a disqualified person for purposes of the statute: Substantial Contributors Foundation Managers Owner of more than 20 percent interest of certain organizations that are substantial contributors Family Members of persons described above (in 1-3) Corporations in which persons described above (in 1-4) hold more than a 35 percent voting power Partnerships in which persons described above (in 1-4) hold more than a 35 percent profit interest Trusts or Estates in which persons described above (in 1-4) hold more than a 35 percent beneficial interest Certain Private Foundations which are effectively controlled by the person or persons in control of the foundation in question Governmental Officials The following is a short summary of each type of disqualified person: 1. Substantial Contributor, which is defined in Section 507(d)(2), includes any person who contributes or bequeaths an aggregate amount of more than $5,000 to the private foundation, if such amount is more than 2 percent of the total contributions and bequeaths received by the foundation before the close of its taxable year in which the contribution or bequest is received from such person. For a trust, the creator is a substantial contributor, even though his contributions may not have exceeded the $5,000 and 2 percent limit. A donor is a substantial contributor as of the first date when he or she exceeded the $5,000 and 2 percent limit, even though the determination of the percentage of total contributions and bequests is not made until the end of the private foundation’s taxable year. Once a person is a substantial contributor with respect to a private foundation, he or she remains a substantial contributor even though he or she might not be so classified if a determination were first made at some later date. A person’s status as a substantial contributor will cease, however, if neither the substantial contributor nor his or her family member has made a contribution or bequest or been a foundation manager within a 10 year period ending at the close of the tax year, and the aggregate contributions or bequests by the substantial contributor are determined by the IRS to be insignificant when compared to the aggregate contributions or bequests by another person. 2. Foundation Manager is an officer, director or a trustee of a private foundation. A person is considered an officer of a foundation under the regulations if he or she is specifically so designated under the articles of incorporation, bylaws, or other constitutive documents of the foundation. A person is also considered an officer under the regulations if he or she regularly exercises general authority to make administrative or policy decisions on behalf of the foundation. Independent contractors such as lawyers, accountants, and investment managers and advisors, acting in their capacities as such, are not officers. However, employees of a bank designated as the trustee of a private foundation may be considered foundation managers and disqualified persons if they have been delegated fiduciary responsibility for the day to day administration and distribution of the trust fund. 3. 20 Percent Owners are persons who own more than 20 percent of the voting power, profits interest, or beneficial interest of an entity that is a substantial contributor to the foundation. These entities can be a corporation, a partnership, a trust, or an unincorporated enterprise. Attribution rules of Section 267 apply for determining ownership. 4. Family Members are spouses, ancestors, lineal descendants and spouses of lineal descendants of substantial contributors, foundation managers, and 20 percent owners. Legally adopted children of an individual are the lineal descendants of the individual under this definition. 5. A Corporation is a disqualified person if a substantial contributor, foundation manager, 20 percent owner, or the family members of any such individuals, own more than 35 percent of the total combined voting power in the corporation. This includes constructive holdings. 6. A Partnership is a disqualified person when a substantial contributor, foundation manager, 20 percent owner, or the family members of any such individuals, own more than 35 percent of the profits interest in the partnership. This includes constructive holdings. 7. Trusts or Estates are a disqualified person when more than 35 percent of the beneficial interest in the trust or the estate is owned by a substantial contributor, foundation manager, 20 percent owner and family members. This includes constructive holdings. 8. A Private Foundation, for purposes of Section 4943 only, is a disqualified person if it is effectively controlled by the same persons who control the foundation in question, or substantially all the contributions to it were made by the persons who make substantially all the contributions to the foundation in question and these persons are described in Section 4946(a)(1)(A), (B), (C), or (D) with respect to the foundation in question. Persons will be considered to have made substantially all of the contributions to a private foundation if they have made or bequeathed at least 85 percent of the total of contributions and bequests received by the foundation. Only persons who have contributed or bequeathed at least 2 percent of a foundation’s total contributions and bequests may be included among the persons considered to have made substantially all of the contributions to the foundation. 9. Government Officials may be a disqualified person with respect to a private foundation for purposes of the self-dealing rules in Section 4941 (not for purposes of other private foundation restrictions). Government officials include all elected executive or legislative officials, as well as any person who holds a position in the executive, judicial, or legislative branch above a certain grade level. Issue Indicators or Audit Tips: Issue Indicators: Identifying who are the disqualified persons is important for private foundations (in preparing and filing their Form 990-PF) and when auditing a private foundation because transactions with them will be subject to scrutiny Some of the challenges that will be faced: Loans made by a private foundation to a family member of a disqualified person may indicate a possible Section 4941 issue. Contributions made or bequeathed an aggregate amount of more than the higher of two percent of the total contributions and bequests or $5,000 by an individual may indicate substantial contributor status. In computing the two percent/$5,000 all contributions and bequests to the private foundation are counted. A person having authority to control the private foundation but who is not technically an officer or director may still be a foundation manager, depending on the facts and circumstances. Audit Tips: Determine relationships to the private foundation before undertaking a Chapter 42 analysis to determine which persons are the disqualified persons of the private foundation being examined. This involves identifying the contributors to the private foundation. Look closely at transactions between the organization and private individuals, corporations, partnerships and other potential disqualified persons. Transactions could include: Sale or exchange, or leasing, of property Lending of money or other extension of credit Furnishing of goods, services, or facilities Payment of compensation (or payment or reimbursement of expenses) Transfer to, or use by or for the benefit of, the income or assets of an organization There are situations in which transactions with disqualified persons may be allowed. The Code and Regulations provide many exceptions and should be researched when issues are identified.