Termination of Private Foundation Status: Distributions of Net Assets to a Public Charity

This week’s post continues last week’s discussion on options for termination of private foundation status, which can be complex. For private foundations that want to cease operations, rather than convert to public charity status as discussed last week, a transfer of all net assets to a certain type of public charity will allow them to terminate their private foundation status without being subject to the termination tax under Section 507(c). 

In General. Section 507(b)(1)(A) requires the transfer of all a private foundation’s net assets to an institutional public charity (e.g., a hospital, church or school), a governmental unit or a publicly supported charity under Section 170(b)(1)(A)(vi)—the recipient cannot be a Section 509(a)(2) public charity or a Section 509(a)(3) supporting organization. Importantly, a transfer to a donor-advised fund held by a sponsoring organization that qualifies under Section 170(b)(1)(A)(vi) would be allowable under Section 507(b)(1)(A). This can be a valuable option for foundation founders who perhaps want to maintain some involvement with mission on a smaller scale.

On the foundation’s final 990-PF for the year of the transfer, it would check box E, indicating it was terminated under Section 507(b)(1)(A), mark its return as “Final,” and provide the IRS with details of the transaction on that return. It is not required to provide notice of termination to the IRS and is not liable for tax under Section 507(c).

Material Restrictions. In order to transfer all its net assets, a private foundation must transfer all of its right, title and interest in and to those assets. This means that the private foundation may not impose any material restriction or condition that prevents the recipient charity from freely and effectively employing the transferred assets, or any related income, in furtherance of its exempt purposes.

In determining whether a condition or restriction is material, all facts and circumstances relative to the transfer are considered. The more significant facts and circumstances to be considered include the following:

  • Whether the recipient public charity is the owner in fee of the assets it receives;
  • Whether such assets are to be held and administered by the public charity in a manner consistent with its public purposes;
  • Whether the governing body of the public charity has the ultimate authority and control over the assets and related income; and
  • Whether, and to what extent, the governing body of the public charity is independent from the transferring private foundation.

The regulations set out certain adverse factors that will indicate the presence of a material restriction on the asset transfer. For instance, a foundation’s retention of the right to direct distributions of the assets on an ongoing basis to a particular organization, or to control the timing of distributions, is a material restriction. In addition, a material restriction is present if there is a requirement that the public charity take action, or refrain from action, with respect to the transferred assets that is not in furtherance of the charity’s exempt purposes.

Helpfully, the regulations also contain a listing of factors that do not adversely affect the determination of whether there is a material restriction. Specifically, having a name that is the same or similar to the private foundation’s is not problematic. Also, requiring that the assets be used only for one or more specific exempt purposes under 501(c)(3) is not a material restriction. Additionally, it is not a material restriction to require that the transferee public charity retain the assets if that is important to the accomplishment of charitable purposes due to the nature of the property (e.g., if land is transferred that is to serve as a public park for the community, and be maintained by the public charity).

The above post is an excerpt of the article “Maneuvering Through the Minefield of Private Foundation Termination” by Becky Seidel, reproduced with permission from Tax Management Estates, Gifts, and Trusts Journal, Vol. 42, No. 4, p. 204, 078/13/2017. Copyright © 2017 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com

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