Thursday April 25, 2024

7.2.8 Reorganization and Termination

Reorganization and Termination

Conversion to a Public Charity:  A private foundation may determine that its organizational structure, programs and activities, method of operation or projected sources of support serve to qualify it as a public charity.

Conversion to a Taxable Organization:  There are two ways that a private foundation might "convert" to a taxable (rather than tax-exempt) organization.

Merger with Another Private Foundation:  In some circumstances, it is efficient or appropriate for two or more private foundations to merge.

Split Into Two or More Private Foundations:  Other circumstances present reasons to divide and separate the assets of a private foundation into two or more private foundations.

Termination by Distribution of Assets to Public Charity:  When the purpose of a private foundation is satisfied or operation of a private foundation is no longer necessary or desirable, the simplest solution is for the private foundation to terminate and transfer "all of its right, title, and interest in and to all of its net assets" to one or more specific public charities.
As circumstances change, a private foundation may need or want to reorganize by converting to a public charity, converting to a taxable organization, merging with another private foundation, splitting into two or more private foundations or terminating by distributing its assets to a public charity. Specific rules apply when any of these reorganizations occur.

Conversion to a Public Charity
A private foundation may determine that its organizational structure, programs and activities, method of operation or projected sources of support serve to qualify it as a public charity. If this occurs, the private foundation may wish to convert to a public charity to take advantage of the more flexible operating rules and more favorable contribution rules that apply to public charities.

A private foundation may terminate its private foundation status by:

  1. notifying the IRS of its intent to convert;


  2. operating as a "public charity" for a continuous 60-month period thereafter (the 60-month period must begin with the first day of a taxable year); and


  3. at the end of the 60-month period establishing that it did successfully operate as a public charity the entire time.


Reg. 1.507-2.

Conversion to a Taxable Organization
There are two ways that a private foundation might "convert" to a taxable (rather than tax-exempt) organization. The first is involuntary and the second is voluntary. Sec. 507(a).

An involuntary conversion occurs when the IRS revokes a private foundation's status as a charity for repeatedly failing to operate within the rules applicable to private foundations. When the IRS revokes a private foundation's status as a charity, the private foundation must pay a "termination tax" imposed by Sec. 507(c). Termination tax is equal to the lesser of the value of the foundation's assets or the aggregate tax benefit the foundation has received by reason of its tax exempt status. When a private foundation loses its tax exempt status, it still must operate according to its organizational documents. Generally, this means that it still must distribute its assets for proper charitable purposes and cannot use them to benefit private individuals. Sec. 507(g) describes certain circumstances when termination tax may be abated.

A private foundation can voluntarily give up its status as a charity and become a taxable organization by notifying the manager of the IRS tax exempt organizations division. As in the case of an involuntary conversion, a private foundation that converts to a taxable organization must pay a termination tax and must still operate according to the requirements in its organizational documents.

Merger with Another Private Foundation
In some circumstances, it is efficient or appropriate for two or more private foundations to merge. Rev. Rul. 2002-28 describes how such a merger must occur. Specifically, a private foundation that transfers all of its assets to another private foundation must either 1) notify the IRS of the transfer and indicate that it plans to terminate its private foundation status (a voluntary termination described above) or 2) remain in existence as a private foundation that has no assets (essentially, an empty shell that still exists but doesn't do anything). If a private foundation chooses to terminate after it transfers all of its assets to another private foundation, it is subject to the termination tax, but if the private foundation has no assets on the day it provides notice (because it has already transferred its assets to the private foundation it is merging into), the termination tax will be zero.

Split Into Two or More Private Foundations
Other circumstances present reasons to divide and separate the assets of a private foundation into two or more private foundations. Most often such a split occurs as a result of differences among trustees as to the best way to invest and distribute a foundation's assets. Sec. 507(b)(2) provides that new foundations formed by reason of a split possess certain attributes and characteristics of the original private foundation, including being entitled to a pro-rata portion of the original private foundation's aggregate tax benefit not exceeding the fair market value of the transferred assets at the time of the proposed transfer. When structured properly, no termination tax applies to a private foundation that splits into two or more private foundations.

Termination by Distribution of Assets to Public Charity
When the purpose of a private foundation is satisfied or operation of a private foundation is no longer necessary or desirable, the simplest solution is for the private foundation to terminate and transfer "all of its right, title, and interest in and to all of its net assets" to one or more specific public charities. Sec. 507(b)(1) provides that when a private foundation terminates by distributing its assets to a qualified public charity it does not need to notify the IRS and is not subject to termination tax.

Private Letter Rulings

PLR 200025057 Merger of Two Public Foundations Approved:   Public Foundation J and Public Foundation K are contemplating a merger, with K being the surviving entiry and changing its name to the L Foundation. Foundation J will cease to exist. L will continue to promote educational and scientific purposes.

PLR 200027055 Too Many Private Foundations:   This ruling shows an excellent example of a sophisticated family with philanthropic intentions. Siblings X, Y and Z each created a private foundation A, B and C. The family also created for-profit corporation E and a subsidiary for-profit corporation K. Each of the for-profit corporations acts in effect as a combination of a trust company and a financial planning firm.

PLR 200046041 Private Foundation Split Three Ways:   The taxpayer in this ruling operated private foundation P. The taxpayer desires to distribute assets from private foundation P to private foundations S, T and U. While the ruling does not discuss the family relationships, it appears possible that parents intend to distribute their private foundation assets to the private foundations of their three children.

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 200508018 Private Foundation Winds Up Affairs:   A private foundation was granded 501(c)(3) status in the year 2000 to promote private sector development in a foreign nation. It received millions of dollars from one donor and used the funds for loans and grants. By 1998, the purposes of the private foundation had largely been achieved and the board of directors made plans to distribute the balance of its funds and close down the private foundation.

PLR 200543060 Termination of PF Not Subject to Tax:   The Xavier Private Foundation (Xavier) proposed to transfer all of its assets to another private foundation, Yaks. The two private foundations have substantially the same trustees and operate for similar purposes. Xavier requested a private letter ruling allowing it to distribute all of its assets to Yaks and for the distribution to be considered a "transfer" not a termination of its tax-exempt status.

PLR 200625044 Merger of Private Non-operating Foundations Permitted:   B and C are Sec. 501(c)(3) private non-operating foundations. Both foundations were established in 1993 with contributions from D and E, who, at the time were married.

PLR 200644050 Private Foundation Merges Into Trust:   L is a private foundation under Sec. 501(c)(3). O and his wife P are the only substantial contributors to L. O and P have established M as a charitable trust that is classified as a private foundation under Sec. 509(a).

PLR 200701033 Private Foundation Will Meet Termination Requirements Under Sec. 507:   G is classified as a private foundation under Sec. 4942(j)(3) of the Code. G provides youth and adult programs to promote physical and social health in the community. G sought to begin a 60-month termination of its private operating foundation status. During the 60-month transition, G intends to operate as a public foundation under Sec. 509(a)(1) of the Code.

PLR 200708087 Private Foundation May Exchange Burial Lots -- Donor May Rest in Peace:   F is an exempt organization under Sec. 501(c)(3) of the Code and is classified as a public charity under Sec. 509(a)(1). F's charitable purpose is to preserve and restore the history and architecture of C, a cemetery. C is of historical importance to the area and has been the focus of study reflecting American funeral architecture trends from the late 19th to early 20th century.

PLR 200708088 Private Foundation Asset Transfer:   A incorporated Y and Z, recognized as two private foundations (PFs) under Sec. 509(a). A has two sets of grandchildren, the B grandchildren and the C grandchildren. Currently A, one B grandchild and one C grandchild control PF Y. A's B and C grandchildren have different charitable goals, so A proposes that PF Y transfer one-half of its assets, comprised of corporate stocks and bonds, to PF Z.

PLR 200715014 Reorganization of Private Foundation Not Self-Dealing or Subject to Tax:   M is a private foundation (PF). M was established to provide support for "religious and charitable, scientific or literary education purposes." Many years into M's existence, the directors disagreed on how to use M's required expenditures and how best to manage M's affairs.

PLR 201349020 IRS Modifies Foundation’s Classification:   ORG was formed as a private foundation under 509(a) of the Code.  ORG’s purpose is to organize, direct and sponsor youth football, cheerleading and pom-pom programs for youths between the ages of 5 and 14 years old.

PLR 201606030 Foundation's Asset Transfer is Not Self-Dealing:   Foundation 1 is classified as an exempt 501(c)(3) organization and a private foundation under section 509(a). Its directors are B, C and D. After a disagreement regarding how to carry out Foundation 1’s exempt purpose, B created Foundation 2 (which was recognized by the IRS as a 501(c)(3) private non-operating foundation).


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