Private Foundation Rules to Remember
Private foundations must follow a variety of rules to avoid the imposition of potentially onerous penalty taxes on the foundation and its related parties:
Distributions. Private foundations must make minimum qualifying distributions each year and distributions can only be made for exempt purposes (religious, charitable, scientific, literary or educational). Qualifying distributions include grants to most public charities and payment of a private foundation’s reasonable administrative expenses. To determine whether a potential grantee is eligible, the private foundation should follow the process outlined below in the Quick Guide to Grant-Making section.
Prohibition on Self-Dealing. A private foundation may not enter into any direct or indirect transactions with disqualified persons (i.e., trustees, directors, substantial contributors, and persons and entities who are related to the trustees, directors or substantial contributors). The self-dealing rules are quite strict, so we recommend that you consult with us before your private foundation engages in any dealings with a disqualified person.
Political Activities. A private foundation cannot participate or intervene in any political campaigns. Attempts to influence legislation (i.e., lobbying activities) are subject to penalty taxes and may jeopardize the private foundation’s 501(c)(3) status.
Contributions to the Foundation. Each time a contribution over $250 is made to a private foundation, the foundation must send a letter to the donor acknowledging the gift and stating that no goods or services were provided in exchange for the contribution. This is true even for contributions coming from the founder of the foundation.
Net Investment Income. A private foundation will be subject to a tax of 2% of its net investment income for each tax year. In some cases the tax may be reduced to 1% depending upon the amount of charitable expenditures the private foundation has made.
Public Disclosure. A private foundation must make its three most recent tax returns and its application for tax-exempt status available for public inspection at its principal office upon request or by posting the materials on its website.
Prohibition on Excess Business Holdings. There are strict limitations on a private foundation’s holding of interests in a business entity controlled by substantial contributors or trustees and/or members of their families. Thus, for example, a private foundation should not hold stock or similar interests in any entity controlled by a substantial contributor and/or his/her family.
Prohibition on Jeopardizing Investments. A private foundation should avoid making speculative investments which might jeopardize the foundation’s ability to carry out its mission. If a private foundation’s assets are to be invested in a traditional portfolio of stocks and debt instruments, this should be an easy rule with which to comply.
Tickets to Charity Events. Private foundations often purchase or receive tickets to charitable fundraising events, which may result in self-dealing if the tickets are given to disqualified persons or their spouses or family members. An argument can be made that attendance by an officer, trustee or board member representing the foundation in an official capacity is reasonable and necessary to his or her performance of functions that carry out the charitable purpose of the foundation. However, impermissible self-dealing may arise if the tickets are given to spouses and family members. We generally recommend that a private foundation decline to accept tickets to charitable events if possible or at the very least only accept tickets for foundation staff and directors who have monitoring and administrative responsibilities for the relevant grants to the charity. Spouses of disqualified persons who wish to attend a fundraising event should purchase tickets in their individual capacity and not through the foundation.
Quick Guide to Grant-Making
Private foundations may make grants to most types of 501(c)(3) public charities. Many private foundations choose to only make grants to these types of 501(c)(3) public charities.
Under certain circumstances, a private foundation may also make grants for charitable purposes to organizations that are not 501(c)(3) public charities, including foreign charitable entities. However, doing so would require the foundation to exercise “expenditure responsibility” over the grant. In the case of foreign grants, the private foundation may either exercise expenditure responsibility or make an “equivalency determination” that the grantee is the equivalent of a U.S. public charity.
In addition, a private foundation may make scholarship grants and other grants to individuals for travel or study only if it has obtained advance approval of the grant-making procedures from the Internal Revenue Service. If your foundation is interested in making grants to non-501(c)(3) entities or to individuals, please contact us and we can provide additional information on these procedures.
Procedure for Making Grants to 501(c)(3) Public Charities
The following steps should be followed with respect to each potential grant to a charitable organization:
STEP 1: Confirm that the grant would be in furtherance of the foundation’s charitable purposes.
STEP 2: Confirm that there are no conflicts of interest with respect to the grant.
STEP 3: Determine the 501(c)(3) status and type of the potential grantee. A private foundation must be certain of the public charity status of a grantee prior to making a distribution. If the foundation cannot determine the public charity status of a potential grantee, please contact us and we will verify the charity’s status.
In general, grants to 501(c)(3) organizations are permissible. However, grants to certain 501(c)(3) organizations, namely (i) private foundations and (ii) public charities that are classified as “non-functionally integrated Type III supporting organizations,” would require the grant-making foundation to exercise expenditure responsibility over the grant. If your foundation would like to make such grants, please contact us to ensure the expenditure responsibility requirements are met.
In order to determine a potential grantee’s 501(c)(3) status:
A. Request a copy of the potential grantee’s IRS determination letter; and
B. Check the IRS Exempt Organizations Select Check Tool to confirm 501(c)(3) status and determine the type of 501(c)(3): http://apps.irs.gov/app/eos/. Select Check will list a code for each entity:
Code Type of Organization Action PC Public Charity meeting the public support test Grant is permissible, no further action required PF Private Foundation Grant would require expenditure responsibility SO Type I, Type II, or functionally integrated Type III supporting organization Grant permissible, no further action required SONFI A non-functionally integrated Type III supporting organization Grant would require expenditure responsibility SOUNK A supporting organization, unspecified type The IRS has not specified the type of supporting organization and the private foundation should request more information from the potential grantee to determine the type
STEP 4: If the grant is in furtherance of the private foundation’s charitable purposes, there are no conflicts of interest and the grantee has been determined to be a 501(c)(3) public charity meeting the public support test, or a Type I, Type II or functionally integrated Type III supporting organization, the foundation may make the grant. Records should be kept with regard to each grant.