June 01, 2022

When Private Foundations Reach the End of the Road

Many families have created Private Foundations during their lifetime or at the death of a family member to carry out the family’s charitable intentions for an extended period of time. Black’s Law Dictionary defines Private Foundation as An organization which is operated privately for the advancement of charitable or educational purposes. An organization generally exempt from taxation that is subject to additional statutory restrictions on its activities and on contributions thereto. As a requirement, a private foundation must receive less than 1/3 of its support from members of the public. Many Private Foundations last for decades and/or multiple generations of a family. However, Private Foundations are not required to exist in perpetuity.

Internal Revenue Code § 507(a)(1) states how a Private Foundation can be terminated. There are only a limited number of options available as listed below:

  1. Conversion to a Public Charity: If the Private Foundation would like to expand its reach to operating programs and activities instead of just funding such items, then converting to a public charity is a good option. This option requires that the IRS be notified in writing of the intended change of structure.
  2. Conversion to a Taxable Entity: This is not usually a voluntarily action. Most often this means that the IRS terminated the tax-exempt status of the Private Foundation for some wrongful action or for some failure to take an action, such as failure to file an income tax return for three consecutive years (that would be a Form 990-PF). When a Private Foundation is terminated in this manner, an extremely harsh termination tax under Internal Revenue Code § 507 of up to 100% will be imposed.
  3. Merger with another Private Foundation: IRS Revenue Ruling 2002-28 describes how to merge two Private Foundations into one. The IRS must be notified of such action unless one of the Private Foundations will continue to remain in existence with no assets.
  4. Split into Multiple Private Foundations: When the managing Board of a Private Foundation begins to disagree or splinter, it is possible to create additional Private Foundation by breaking the existing Private Foundation into two or more Private Foundations.
  5. Distribute Assets to Public Charities: This usually occurs when the purpose of the Private foundation has been satisfied or the Board no longer wishes to operate the Private Foundation. This is the easiest option. No formal notice needs to be given to the IRS other than the filing of a final Form 990-PF. The assets of the Private Foundation can be distributed to one or more public charities of the Board’s choosing.

There are a few other options, but they may be difficult or involve loss of control of the assets. There have been a few Private Foundations that have converted into charitable trusts, but that action required a time consuming and expensive private letter ruling from the IRS. A number of Private Foundations have been turned into a Donor Advised Fund when the governing board has grown tired of the administrative duties of running the Foundation on a day-to-day basis. There are current considerations in Congress that could change the ability to covert a Private Foundation into a Donor Advised Fund, so one should pay attention to any new laws that might come into effect.

When terminating or converting a Private Foundation, one must be very careful. There are IRS penalties between 10% and 200% for taking the wrong action. One would be smart to follow one of the five safe harbors listed above when considering shutting down or converting a Private Foundation.

Contact Revis, Hervas & Goldberg P.A.

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