Organizations that begin their existence as private foundations may well find themselves wanting to change that status for a number of reasons. However, such a transition is complex and requires careful attention to detail to avoid potential penalties. This post will discuss operation as a public charity as an option for terminating private foundation status, while an upcoming post will discuss transfers of net assets.
In General. To begin, the foundation must be prepared to operate as a public charity for a continuous 60-month period beginning with the first day of any taxable year. An organization that is planning to seek public charity status as a publicly supported organization under Section 509(a)(2), for example, should be comfortable that its current and foreseeable sources of support will allow it to qualify as a public charity under that section.
Notice and Request for Advance Ruling. Next, the foundation must notify the IRS that it is planning to terminate its private foundation status and operate as a public charity before the beginning of its 60-month period. This notice typically is accomplished through the filing of Form 8940, and checking option h, “Termination of private foundation status under section 507(b)(1)(B)—advance ruling request.” The foundation will need to provide the following information as part of its notice to the IRS:
- Its name and address;
- A statement of its intention to terminate its private foundation status;
- The Code section under which it seeks classification as a public charity, including the particular subsection of 170(b)(1)(A) (if applicable);
- The date its regular taxable year begins; and
- The date of commencement of the 60-month period.
Additionally, in order to seek an advance ruling from the IRS that it can be expected to satisfy the requirements of Section 507(b)(1)(B) during the 60-month period, the foundation will need to provide additional information including descriptions of past, current and proposed activities, and how it plans to attract public support; proposed budgets for the 60-month termination period; and other information specific to the type of public charity status it is pursuing. While a private foundation does not technically need to request an advance ruling, doing so provides the additional benefit of obtaining a ruling that donors and grantors can rely on during the 60-month period for purposes such as deductibility under Section 170 and grantmaking oversight requirements (i.e., expenditure responsibility) under Section 4945. As such, it is recommended that private foundations take this step—particularly because foundations must continue to file a Form 990-PF during the first four years of its 60-month period. Donors and grantors can be confused by this apparent discrepancy, and the advance ruling can help answer questions and ease reluctance to donate to the foundation during this transition period.
In addition, the foundation will need to file a consent for statute of limitations purposes, which extends the amount of time that the IRS has to assess deficiencies for the Section 4940 net investment income tax. This is accomplished through the filing of Form 872-B, which the IRS typically sends to the private foundation to sign after receiving the Form 8940 and any related attachments. Private foundations do not need to pay the net investment income tax during their 60-month period, but if they ultimately do not successfully complete the termination process, such tax would be due. However, because nonpayment during the 60-month period is due to reasonable cause, no penalties will apply.
Notice of Completion of Termination Period. In order to complete the termination process, a private foundation needs to establish to the IRS’ satisfaction that it met all requirements during the 60-month period. In order to do so, the foundation must file certain information with the IRS using Form 8940 within 90 days after the expiration of its 60-month period, including a complete description of the foundation’s current operations as a public charity, as well as any changes during the 60-month period; as well as other information specific to the type of public charity status it is pursuing.
Foundations that fail to establish that they successfully met all the requirements during the 60-month period face the potential of being treated as a private foundation for that entire period. However, there are two key exceptions. First, as discussed above, even if a foundation ultimately has to pay the Section 4940 net investment tax for years covered under the 60-month period, it won’t owe interest or penalties. Second, if a foundation can establish that it did meet all requirements for certain years under the 60-month period, it will be treated as public charity for those specific years—and grants and contributions made to the organization during the specific years will be treated as made to a public charity.
Provided that a foundation has submitted the above information to the IRS within the 90-day period, it should file a Form 990 or 990-EZ for the final year of its 60-month period. This is the case even if the IRS has not yet confirmed that the organization has terminated its private foundation status and been reclassified as a public charity.
When the IRS has processed the notice of completion of the 60-month period, and has determined that the organization has met all requirements, it will issue a revised determination letter to that effect. The letter will reflect the organization’s specific public charity classification, and will note that the public charity classification is retroactive to the beginning of the 60-month period. In addition, the organization’s status will be updated in the IRS business master file extract and IRS Select Check to reflect the applicable public charity status.
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