COF Offers Draft Guidance on Pension Protection Act Provisions Affecting Charities

COF Offers Draft Guidance on Pension Protection Act Provisions Affecting Charities

News story posted in Regulations on 26 October 2006| comments
audience: National Publication | last updated: 18 May 2011
Print
||
Rate:

Summary

Janne Gallagher of the Council on Foundations has forwarded a draft of interim guidance on changes relating to the tax treatment of charities under the Pension Protection Act of 2006.

Full Text:

September 26, 2006

Susan Brown
Deputy Tax Legislative Counsel -- Regulatory Affairs
Department of the Treasury
1500 Pennsylvania Ave. NW
Washington, DC 20220

Dear Susan:

This letter follows up on the Council's August 16 request for guidance on certain provisions of the Pension Protection Act of 2006, a copy of which is enclosed for your convenience. Recognizing that the numerous charity provisions in that act create significant burdens for the Treasury Department, I asked our outside counsel at Caplin & Drysdale to prepare a draft of a Notice that the Internal Revenue Service could publish that provides interim guidance on the issues raised in our August 16 letter. I am enclosing a copy of their draft in the hope that you will find it of some assistance.

Our initial request focused principally on provisions of the PPA that had an immediate or a retroactive effective date. We are now preparing a second request that will cover provisions for which the effective date is the start of the organization's next tax year. We should have this to you in the next few weeks.

Please call me if I can provide additional background information or answer any questions about this request.

Sincerely,

Janne Gallagher
Vice President and General Counsel

Enclosures
Copies:

Steve Miller
Catherine Livingston
Lois Lerner
Theresa Pattara


SUPPORTING ORGANIZATION AND DONOR ADVISED FUND PROVISIONS
OF THE PENSION PROTECTION ACT OF 2006



Notice 2006-_

SECTION 1. PURPOSE

This Notice provides interim guidance regarding §§ 1231, 1242, and 1244 of the Pension Protection Act of 2006, Pub. L. No 109-208, which add §§ 4958(c)(3), 4958(f)(1)(D), and 4966 to the Internal Revenue Code and amend §§ 4942(g)(4) and 4945(d)(4)(A) of the Code.

New § 4966 establishes a statutory definition of a "donor advised fund" and imposes penalty taxes on certain proscribed distributions from donor advised funds. Section 4966(d)(2)(C) grants the Secretary authority to exempt certain types of funds from treatment as donor advised funds.

The amendments to §§ 4942(g)(4) deny qualifying distribution status to and grants by non-operating private foundations to certain organizations qualifying for public charity status as supporting organizations under § 509(a)(3). Section 4945(d)(4)(A) imposes taxable expenditure status on such grants unless the private foundation exercises expenditure responsibility.

New § 4958(c)(3) provides that certain payments from supporting organizations to their substantial contributors, certain parties related to substantial contributors, and entities in which the foregoing persons have 35% on greater ownership interests are excess benefit transactions.

SECTION 2. BACKGROUND


Donor advised funds.

Some charitable organizations (including community foundations) establish accounts to which donors may contribute and thereafter provide nonbinding advice or recommendations with regard to distributions from the fund or the investment of assets in the fund. Such accounts are commonly referred to as "donor advised funds." Donors who make contributions to charities for maintenance in a donor advised fund generally claim a charitable contribution deduction at the time of the contribution. Although sponsoring charities permit donors or other persons appointed by donors to provide nonbinding recommendations concerning the distribution or investment of assets in a donor advised fund, sponsoring charities must have legal ownership and control of such assets following the contribution If the sponsoring charity does not have such control (or permits a donor to exercise control over amounts contributed) the donor's contributions may not qualify for a charitable deduction, and the contribution may be treated as being subject to a material restriction or condition by the donor.

Prior to the enactment of the Pension Protection Act of 2006, status as a donor or donor advisor to a donor advised fund was not independently sufficient to cause a person to be a disqualified person under the intermediate sanctions rules of § 4958 with respect to transactions involving the use of the assets of the donor advised fund.

Donor advised funds have been commonly used by employers as a vehicle for establishing disaster relief and hardship relief funds for the benefit of employees and their families. The federal tax rules governing such funds prior to the Pension Reform 2006 are reviewed in R. Huetter & M. Friedlander, Disaster Relief and Emergency Hardship Programs, 1990 EO CPE Text, 219-242 at 240.


Supporting organizations

Section 501(c)(3) organizations are classified either as "public charities" or "private foundations." Private foundations generally are defined under § 509(a) as all organizations described in § 501(c)(3) other than an organization granted public charity status by reason of: (1) being a specified type of organization (i.e., churches, educational institutions, hospitals and certain other medical organizations, certain organizations providing assistance to colleges and universities, or a governmental unit); (2) receiving a substantial part of its support from governmental units or direct or indirect contributions from the general public; or (3) providing support to another § 501(c)(3) entity that is not a private foundation. This third category of public charities are referred to as "supporting organizations."

Because private foundations receive support from, and typically are controlled by, a small number of supporters, private foundations are subject to a number of anti-abuse rules and excise taxes not applicable to public charities. For example, the Code imposes excise taxes on acts of "self-dealing" between disqualified persons (generally, an enumerated class of foundation insiders) and a private foundation. In addition, private non-operating foundations are required to pay out a minimum amount each year as so-called "qualifying distributions." In general, a qualifying distribution is an amount paid to accomplish one or more of the organization's exempt purposes, including reasonable and necessary administrative expenses.

SECTION 3. DONOR ADVISED FUNDS


A. Taxable Distributions by Donor Advised Funds

The Pension Protection Act added to the Internal Revenue Code new § 4966 imposing penalty taxes on certain distributions by donor advised funds. More specifically, § 4966 imposes a tax on public charities (and certain non-charitable organizations) that sponsoring donor advised funds ("sponsoring organizations") if a donor advised fund maintained by the sponsoring organization makes a distribution:

  • to a natural person,
  • for a non-charitable purpose (i.e., for a purpose other than one enumerated in § 170(c)(2)(B)), or
  • to an organization that is either not described in § 170(b)(1)(A) or is a disqualified supporting organization described in § 4966(d)(4), unless the sponsoring organization exercises expenditure responsibility.

For purposes of § 4966, the term "distributions" refers to transfers from a donor advised fund that include a donative element -- that is, transfers for which the recipient of the transfer does not provide fair market value in goods or services. Thus, for this purpose, "distributions" do not include payments made to third parties for the purchase of goods and services needed to carry out the exempt purposes of a donor advised fund. Application of this rule is illustrated by the following example:


Example 1. A is a community foundation and is the sponsoring organization of numerous donor advised funds. B is a donor advised fund that supports arts organizations in the community served by A. C is the donor advisor of B. C has recommended, and A has approved, the use of funds from B to fund a fund-raising dinner to raise funds for B. A asks C to serve as the chair of the organizing committee responsible for the planning and conduct of the dinner. The organizing committee, on behalf of A, enters into contracts to rent a banquet hall, to cater the dinner, and for entertainment. All of these contracts are negotiated at arm's length and all payments reflect market prices for the services provided. A makes payments from donor advised fund B to meet its obligations under these contracts. Because these payments do not involve any donative element, they are not "distributions" for purposes of § 496(b). Accordingly, A is not required to exercise expenditure responsibility with respect to these payments.

B. Employer Disaster Relief and Hardship Assistance Funds

Employers commonly establish funds at community foundations or other public charities to provide disaster relief or hardship assistance grants to employees who are the victims of disasters or who have experienced other financial hardships. These funds are generally funded by contributions from both the employer and its employees, though in some cases they are funded exclusively by the employer. Typically the sponsoring charity appoints a committee comprised of employees of the employer to advise on the selection of individuals to receive disaster relief or hardship assistance grants from these funds.

? 4966(d)(2)(C) grants the Secretary the authority to exempt a fund from the definition of "donor advised funds":

(i) if such fund or account is advised by a committee not directly or indirectly controlled by the donor or any person appointed or designated by the donor for the purpose of advising with respect to distributions from such fund.

Pursuant to this authority, employer-sponsored disaster relief and hardship assistance funds are exempted from treatment as donor advised funds subject to the following conditions:

  • The fund must serve a charitable class;
  • Recipients of grants from the fund must be selected based on an objective determination of need; and
  • The fund is administered by a committee comprised either (i) of persons having no financial interest in the employer, or (ii) of persons representing a broad spectrum of employees who understand that they are acting in a personal capacity as agents of the organization rather than as representatives of the employer.

SECTION 4. SUPPORTING ORGANIZATIONS

A. Effective Date for Automatic Excess Benefit Transactions Rule

The Pension Protection Act amended § 4958 to provide that grants, loans, compensation, and similar payments by a supporting organization to a substantial contributor or a party related to a substantial contributor constitutes an automatic excess benefit payment. § 4958(c)(3). The statute provides that this new rule applies to transactions occurring after July 25, 2006.

Binding contract rule. For purposes of this effective date rule, post-July 2006 payments that a supporting organization is legally obligated to make under the terms of a contract entered into on or before July 25, 2006 and not materially modified by the parties after July 25, 2006 will be treated as attributable to a transaction entered into on or before July 25. Therefore, such payments will not be subject to the new rules on automatic excess benefit payments. Application of this rule is illustrated by the following examples:


Example 1. A substantial contributor is employed by a supporting organization pursuant to a binding two-year employment contract entered into before July 25, 2006. The contract has not been materially modified by the parties after July 25, 2006. Compensation and expense reimbursement payments that the supporting organization is required to make to the substantial contributor under this contract are treated as attributable to a transaction entered into on or before July 25, 2006 and therefore are not automatic excess benefit transactions.

Example 2. A supporting organization made a loan to a substantial contributor before July 25, 2006 pursuant to a legally binding loan agreement that has not been modified by the parties after July 25, 2006. Under the terms of the loan agreement, the substantial contributor is required to repay the loan over a five year period extending beyond July 25, 2006. The continued extension of credit by the supporting organization to the substantial contributor after July 25, 2006 is treated as attributable to a transaction entered into on or before July 25, 2006 and therefore is not an automatic excess benefit transaction.


At will employees.

For purposes of this effective date rule, compensation and expense reimbursement payments made by a supporting organization prior to September 1, 2006 to a substantial contributor who, under applicable state law, was an at will employee of the supporting organization on July 25, 2006 will be treated as attributable to a transaction entered into on or before July 25, 2006 provided that the payments are consistent with the terms under which the substantial contributor was employed on July 25, 2006. Application of this rule is illustrated by the following example:


Example 1. A substantial contributor was an at will employee of a supporting organization on July 25, 2006. Under the supporting organization's established compensation policy, the substantial contributor, like the supporting organization's other employees was paid bimonthly and was entitled to monthly reimbursement of reasonable business expenses. The supporting organization continued to employ the substantial contributor through the end of August 2006, with the substantial contributor receiving her final paycheck and final expense reimbursement on August 31, 2006. The supporting organization did not increase the substantial contributor's salary after July 25, 2006. These pre-September 1, 2006 payments to the substantial contributor are treated as attributable to a transaction entered into on or before July 25, 2006 and therefore are not automatic excess benefit transactions.

B. Payout and Taxable Expenditure Changes for Grants to Certain Supporting Organizations

The Pension Protection Act of 2006 amended §§ 4942 and 4945 with respect to the treatment of grants by non-operating private foundations to Type III supporting organizations other than those that are "functionally integrated" and to Types I and II supporting organizations if a disqualified person with respect to the grantor private foundation directly or indirectly controls the supporting organization or one of its supported organizations. Under § 4942(g)(4), such grants do not constitute qualifying distributions, and under § 4945(d)(4)(A) such grants constitute taxable expenditures unless the private foundation exercises expenditure responsibility.

Due diligence standards for determining tax status of grantee. Until such time as Publication 78 incorporates sufficient information to enable a private foundation to determine whether a prospective grantee is a supporting organization and, if so, whether it is a Type I, II, or III supporting organization, a private foundation may rely on the written good faith representation of a grantee with respect to:

  • whether it is a supporting organization,
  • if it is a supporting organization, whether it is a Type I, Type II, or Type III supporting organization, and
  • if it is a Type III supporting organization, whether it is "functionally integrated" within the meaning of § 4943(f)(5)(B).

Standard for determining whether disqualified persons with respect to a private foundation control a supporting organization or one of its supported organizations.

For purposes of the foregoing rules, the determination of whether a disqualified person with respect to a private foundation controls a supporting organization or one of its supported organizations will be made based on the control standards established in Treas. Reg. § 53.4942(3)-a(3)(a). Under this standard, an organization is "controlled" by one or more disqualified persons with respect to a foundation if any of such persons may, by aggregating their votes or positions of authority, require the supporting organization or supported organization to make an expenditure, or prevent the supporting organization or the supported organization from making an expenditure, regardless of the method by which the control is exercised or exercisable.

Type I supporting organizations whose supported organizations are designated by class rather than by name. Special considerations arise in applying the foregoing control rule to Type I supporting organizations whose beneficiaries are designated by class rather than by name.

To qualify as a Type I supporting organization, one or more publicly supported organizations must have the authority to elect or appoint a majority of the officers, directors, or trustees of the supporting organization. The relationship between these publicly supported organizations and the supporting organizations must be comparable to that of a parent and subsidiary. Treas. Reg. § 1.509(a)(4)(g). Provided this control relationship exists, the supporting organization's governing instrument may designate its supported organizations by class rather than by name.

Under this structure, the Type I supporting organization may support a broad class of charities. However, the great majority of these supported organizations have no ability to control or exercise substantial influence over the supporting organization's use of private foundation grant funds. This power is held only by the supported organization or organizations with authority to appoint the supporting organization's officers, directors, or trustees.

Accordingly, under this structure, only those supported organizations with the authority to elect or appoint officers, directors, or trustees of the supported organization will be taken into account for purposes of determining whether one or more disqualified persons with respect to a private foundation control a supported organization of a supporting organization to which the foundation makes a grant. The effect of this rule may be illustrated by the following example:


Example 1. A is a community foundation serving a major city. B is a section 501(c)(3) organization formed to serve as a community foundation for a rural county on the periphery of the city served by A. B's governing instruments states that it is organized and will be operated for the benefit of all public charities located in the county served by B. The directors of A have the authority to appoint a majority of the directors of B. Because A has the authority to appoint a majority of B's directors, B qualifies as a Type I supporting organization.

C is a private family foundation contemplating a grant to B. None of C's directors serve on the board of A or B, nor do they have any ability to influence the selection of the directors of either A or B. However, the family that has funded and controls C has also provided substantial funding for and comprise a majority of the board of D, a youth center serving disadvantaged youth in the county served by B.

As a public charity operating in the county served by B, D falls within the class of supported organizations designated by B's governing instrument and has, in fact, received grants from B. Under these facts, because A is the only supported organization with the ability to appoint the officers and directors of B, only A is taken into account for purposes of determining whether C's disqualified persons control any of the supported organizations of B. Because D has no ability to appoint the officers or directors of B, D is disregarded for purposes of this rule.

Accordingly, if C makes a grant to B, the grant qualifies as a qualifying distribution and C is not required to exercise expenditure responsibility.


SECTION 5. REQUEST FOR COMMENTS

The Service and the Treasury Department invite comments regarding this notice and suggestions for future guidance under §§ 4942(g)(4), 4945(d)(4)(A), 4958(c)(3), 4958(f)(1)(D), and 4966. Comments should refer to Notice 2006-___ and be submitted by ___, 2006, to:

Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Attn: ____
Room ____

Alternatively, comments may be submitted electronically via e-mail to the following address: Notice.Comments@irscounsel.treas.gov. All comments will be available for public inspection and copying.

SECTION 6. PAPERWORK REDUCTION ACT

[To be added]

SECTION 7. DRAFTING INFORMATION

[To be added]

Add comment

Login or register to post comments

Comments

Group details

Follow

RSS

This group offers an RSS feed.
 
7520 Rates: December 26% November 2.4% October 2.2%

Already a member?

Learn, Share, Gain Insight, Connect, Advance

Join Today For Free!

Join the PGDC community and…

  • Learn through thousands of pages of content, newsletters and forums
  • Share by commenting on and rating content, answering questions in the forums, and writing
  • Gain insight into other disciplines in the field
  • Connect – Interact – Grow
  • Opt-in to Include your profile in our searchable national directory. By default, your identity is protected

…Market yourself to a growing industry