One Private Foundation Becomes Three: Law Consequences

By Bruce R. Hopkins, EditorDecember 14, 2012 | Print

The IRS ruled that the division of a private foundation into three foundations, to alleviate board-member conflicts, will be a significant disposition of assets qualifying as a transfer under the private foundation reorganization rules (IRC § 507(b)(2)) and that none of the private foundation rules (IRC Chapter 42) will thereby be violated (Priv. Ltr. Rul. 201244020).

A standard grantmaking private foundation is governed by a four-member board of directors, consisting of A, B, C, and D. All board members are related parties. A and B are married to each other. B and C are siblings. D is their cousin. Several other family members serve as “grant advisors.”

There is a “divergence of charitable interest” among this foundation’s directors. As a result, “administration and achievement of [the foundation’s] charitable goals has been increasingly difficult.” To resolve this conflict in management, two foundations are being established. The private foundation will distribute one-third of its assets to each of these new foundations.

C and D will resign from the foundation’s board. C will serve as the director of one of the new foundations. D will serve as a director of the other new foundation. The grant advisors will resign and become officers of the new foundations. (The ruling is silent as to whether the new foundations will have additional directors.) A and B will fill the vacant board and officer positions in the original foundation with family members.

All of this is contingent on recognition by the IRS of the tax-exempt status of the two new foundations. It is represented that this foundation has never willfully repeated acts (or failures to act) or committed a willful and flagrant act (or failure to act) that gives rise to tax under any provision of IRC Chapter 42.

Thus, in addition to the proposed partial transfer of assets in accordance with the private foundation termination rules (IRC § 507), the IRS ruled that acts of self-dealing will not occur, the transfers will be qualifying distributions, there will not be any jeopardizing investment, and the transfers will not be a sale or other distribution of property for purposes of the tax on net investment income. Also, the IRS held that the transfers to the two new foundations will not be taxable expenditures as long as expenditure responsibility is exercised. [5.7(b), 12.4(f)]

Commentary: From a governance law standpoint (not at issue in this case), the board composition of the private foundation seeking this ruling would, on the basis of recent years’ private letter rulings from the IRS, constitute inherent, rampant private benefit, causing the foundation to lose its tax-exempt status. We know, however, that the IRS does not follow this policy (which is incorrect) in the context of family foundations. The IRS has never explained how the private benefit issue goes away, just because the charitable entity is private rather than public.

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