Thursday April 25, 2024

5.4.1 Jeopardizing the Charitable Interest

Jeopardizing the Charitable Interest

Purpose of Jeopardizing the Charitable Interest Rules:  Private foundations and charitable remainder trusts are subject generally to the rules on jeopardizing the charitable interest.

Definition of a Jeopardizing Investment:  There is no specific definition of an investment that is termed a "jeopardizing" investment.

Jeopardizing Investment Taxes:  If a private foundation makes an investment that jeopardizes its exempt purpose, there is a tax of 10% on the amount invested.

Purpose of Jeopardizing the Charitable Interest Rules
Private foundations and charitable remainder trusts are subject generally to the rules on jeopardizing the charitable interest. If a foundation manager or trustee were to invest in highly risky ways, it is possible that the investments could result in the loss of the foundation or trust principal. In that case, there would be nothing available to charity.

To minimize the temptation for trustees to engage in high-risk investments, Sec. 4944 creates several rules intended to facilitate prudent investment practices. These rules were created in response to the activities by some private foundation managers who used the private foundation assets to invest in high-risk businesses operated by friends or family. Since many of these businesses failed, the principal was lost, to the detriment of philanthropy. Thus, the guidelines are designed to encourage appropriate investment practices.

Definition of a Jeopardizing Investment
There is no specific definition of an investment that is termed a "jeopardizing" investment. The foundation manager is expected to consider the expected return (including both income and appreciation of capital), the risks of rising and falling price levels and the need for diversification.

While no specific investment is excluded, there is a class of risky investments that will be closely scrutinized. These include trading in securities on margin; trading in commodity futures; investments in working interests in oil and gas wells; the purchase of "puts," "calls," "straddles" and warrants and selling short. Reg. 53.4944-1(a)(2).

Jeopardizing Investment Taxes
If a private foundation makes an investment that jeopardizes its exempt purpose, there is a tax of 10% on the amount invested. The 10% could be levied each year on the jeopardizing investments.

In addition, the manager who makes the investment could potentially be subject to 10% tax on that investment, up to $10,000. The tax for a manager applies if the manager "knowing" the risky nature of the investment decides to move forward with that particular asset. Knowing is defined as actual knowledge of sufficient facts, awareness that the circumstances may violate the federal tax law or negligence in attempting to understand the risks involved.

If the 10% tax is imposed on a foundation and the foundation does not transfer the investment, there could be a second-level tax equal to 25% of the amount of the investment. This tax would also be paid by the private foundation.

Private Letter Rulings

PLR 200050048 Private Foundation Distributes to Donor Advised Fund (DAF) and New Private Foundation (PF):   Creator "B" established a private foundation (PF). Since there now are two separate family groups that have different charitable purposes, "B" proposes to divide the foundation and distribute one half to public charity "C" for a Donor Advised Fund (DAF) and the second half to new PF "D."

PLR 200218038 Foundation's Investment in Futures Market Not Jeopardy Investment:   Private foundation (PF) created limited partnership (LP) to benefit Supporting Organization. PF invested a substantial amount of its assets in LP. LP subsequently invested its assets in the futures and commodities markets.

PLR 200232036 Foundation May Own and Pay Premiums on Life Insurance Policy Contributed by Donor:   Donor created a private foundation and an irrevocable trust during his life. Donor now wishes to have his trust transfer a term life insurance policy to his foundation. The term life insurance policy requires annual premiums, is convertible into a whole life policy, has no cash value and is not subject to a policy loan. Because the policy has no cash value, no one can possibly borrow against it.

PLR 200331005 Foundation May Invest in Rebuilding of City Downtown:   M is a private foundation that provides significant grants to charitable organizations located in City. Specifically, M provides funds for the economic development and revitalization of City. A local government entity determined that the downtown area of City was blighted.

PLR 8745013 Insurance Policy as Unitrust Investment:   Taxpayer desired to fund a two-life unitrust with appreciated property, sell the property and purchase an insurance policy. The Service permitted the use of an insurance policy as a unitrust investment.

Related Topics on Jeopardizing the Charitable Interest

3.10.10  Investments of Unitrust Corpus:    One of the major decision points when creating a charitable remainder trust (CRT) is developing an investment strategy. Under the four-tier accounting rules, the type of income paid out of the trust is determined by the trust investments.

3.10.11  Disclosure UT - SEC Exemption:    The Philanthropy Protection Act of 1995 is a fairly comprehensive statute. It deals specifically with securities regulation issues.

3.10.5  Selecting the Trustee:    Generally, there are three options for the trustee of a charitable trust. These are a corporate trustee, a charity serving as trustee or a private individual trustee. Before the trust is funded, the donor should understand the three options sufficiently well to make a reasoned decision.

3.5.9  Disclosure LT - SEC Exemption:    The Philanthropy Protection Act of 1995 is a fairly comprehensive statute. It deals specifically with securities regulation issues.

      Quiz-Basic



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