Attorney Seeks to Have Grantors and Contributors Held Harmless Against Loss of Charity's Public Status

Attorney Seeks to Have Grantors and Contributors Held Harmless Against Loss of Charity's Public Status

News story posted in Comments on 13 November 2008| comments
audience: National Publication | last updated: 18 May 2011


In response to requests for public comments regarding proposed regulations implementing the redesigned Form 990, Morristown, N.J. attorney Edward Hein has suggested the form be modified to include language that a grantor or contributor is not considered responsible for the loss of public charity status based solely because of a grant or contribution.

Full Text:

October 28, 2008

CC:PA:LPD:PR (REG-142333-07), Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20024

Dear Sir or Madam:

These comments are submitted with respect to the proposed amendments to regulations under Internal Revenue Code sections 170(b)(1)(A)(vi) and 509(a)(2) incorporating by reference temporary regulations adopted by Treasury Decision 9423, both published in the Federal Register on September 9, 2008 and herein referred to as the "Proposal".

For the reasons discussed below, I respectfully recommend that the Proposal be modified by adding at the end of Proposed Regulations 1.170A-9(f)(5)(ii) and 1.509(a)-3(e)(2) the following sentence:

    A grantor or contributor will not be considered responsible for, or aware of the act or failure to act resulting in the loss of public charity status solely by reason of having made a grant or contribution or the amount thereof.
Without such modification, the Proposal, which requires retroactive reclassification to private foundation status when an organization fails to meet the public support tests, will reduce the circumstances in which donors may rely on the organization's published public charity status. This will both (i) expose significant donors to adverse consequences, including punitive excise taxes in the case of grant-making private foundations, contingent upon events subsequent to their contributions and beyond their control, and (ii) by creating such uncertainty, negatively impact the ability of potential donees to secure substantial donations.

Prior to the Proposal

Absent substantial and material changes in an organization's sources of support other than excludable unusual grants (herein "material changes"), an organization which satisfied one of the public support tests on the basis of its support and/or other factors during the four years preceding the current year qualified as a public charity for both the current year and the following year. Only a second consecutive failure subjected the organization to reclassification as a private foundation. Any such reclassification was effective only as of the beginning of the year following the end of the second test period during which the organization's support and/or other factors did not satisfy the tests.

For a year in which there were material changes, an organization could not rely on having satisfied the public support tests during either of the otherwise applicable four year test periods but had to satisfy one of the tests on the basis of its support and/or other factors during the period consisting of the current and four immediately preceding years.1 A single failure to satisfy this five year test caused retroactive reclassification to the beginning of the last year in the test period.2

Most donors were protected from adverse consequences of a donee's retroactive reclassification from public charity to private foundation by the general rule in Regulation 1.509(a)-7(a) that the treatment of grants and contributions made without knowledge of revocation of the ruling or determination of public charity status and prior to the IRS's publication of a notice of the change in status would not be affected by such reclassification. However, this general rule did not protect a grantor or contributor who was "in part responsible for, or was aware of the act, the failure to act or the substantial and material change on the part of the organization which gave rise to the revocation. . . ."

Provisions parallel to the general rule permitting reliance and the exclusion therefrom were also included in Regulations 1.170A-9(e)(4)(v)(b) and 1.509(a)-3(c)(1)(iii)(a) but the group of donors not protected was narrowed by Regulations 1.170A-9(e)(4)(v)(c) and 1.509(a)-3(c)(1)(iii)(b) providing that in certain instances a grantor or contributor would not be considered "responsible for, or aware of . . ." if the grant or contribution was made in reliance upon the recipient's written statement that such grant would not result in the grantee's loss of public charity status. Revenue Procedures 81-6, 1981-1 C.B. 620, and 89-23, 1989-1 C.B. 844, added further instances in which a grantor or contributor would not be considered to be responsible. Significantly, such Regulations and Revenue Procedures expressly dealt only with situations where retroactive loss of public charity status resulted from failure to satisfy the tests based on application, due to material changes, of the five year testing period including the current year.

The Proposal

The Proposal eliminates any reference to a year in which material changes occur and prescribes a uniform test period consisting of the current and four preceding years. While only a second consecutive failure causes reclassification of an organization as a private foundation, inclusion of the current year in the test period results in any such reclassification being retroactively effective as of the beginning of the year following the end of the first test period during which the organization's support and activities did not satisfy the tests.

The Proposal does not change the general rule permitting reliance by donors with respect to grants made prior to publication of a notice of change of status nor the exclusion therefrom of a grantor "responsible for, or aware of, the act or failure to act that resulted in" the loss of public charity status. However, it omits the provisions previously applicable to narrow the exclusion and appears to implicitly revoke Revenue Procedures 81-6 and 89-23 which further narrowed the exclusion.

The Proposal's increase in the possibility of retroactive reclassification and decrease in the ability of donors to rely on an organization's published status mutually reinforce the undesirable consequences of each of these changes. It is perplexing that the Preamble acknowledges that retroactivity may cause "unfair or inequitable" results to the reclassified organization and prescribes a procedure for it to seek relief but ignores the potentially harsher and even less justified consequences to a donor or grantor.


                Edward H. Hein
                Attorney at Law
                Morristown, New Jersey

1 The Preamble in T.D. 9423 twice erroneously refers to use of the five year test period as optional with the taxpayer.

2 On the other hand, if the five year test applied and was satisfied, an organization might preserve without interruption its public charity status despite its failure to meet the tests in either of the two preceding four year test periods.


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