Private Foundation Self-Dealing

Private Foundation Self-Dealing

News story posted in Technical Advice Memoranda on 11 April 2001| comments
audience: National Publication | last updated: 18 May 2011


IRS is barred by the 3-year statute of limitations from taking action against a private foundation and disqualified person for a self-dealing transaction.

TAM 200114035


In this situation, a disqualified person ("DQP") with respect to a private foundation discovered that the foundation was delinquent in liquidating an obligation to a public charity. The DQP desired a charter membership (of tenuous value) in the public charity and negotiated this perquisite as a quid pro quo for getting the foundation to pay its obligation. The DQP went to the foundation Board and urged it to make a grant to the public charity that would extinguish the foundation's debt. The DQP was a family member of a substantial contributor to the foundation, but was not a foundation manager or trustee. The Board considered the request, made the grant without knowledge of the DQP's deal with the public charity, and timely reported the grant on its tax return. In an audit of the foundation more than three years (but less than six years) later, the IRS uncovered these facts and considered revoking the foundation's tax-exempt status for participating in an act of self-dealing and imposing self-dealing excise tax penalties on the foundation managers and the DQP.

Upon analysis, the Service concluded it could not proceed against either party for the following reasons: (i) the 3 year statute of limitation bared the IRS from taking action against the foundation because the foundation timely, accurately and without fraud reported the grant on its Form 990-PF such that the IRS had adequate notice, the grant was to further the charitable purposes of a 501(c)(3) organization, the Board was not legally bound to take the recommendation of the DQP and had no knowledge of the DQP's deal with the public charity; (ii) once the statute of limitations has expired with respect to a foundation's Form 990-PF, self-dealing arising from transactions occurring in the relevant taxable year are foreclosed, precluding the Service from initiating an action for self-dealing excise taxes against any disqualified person; and (iii) even if the foundation had known about the DQP's arrangement with the charity, causing the 6 years statute of limitations to apply, the membership benefit he received was of such questionable and incidental value that the foundation would not have been obliged to report it.


Date: November 20, 2000


EO Area Manager: * * *
Taxpayer's Name: * * *
Taxpayer's Address: * * *

Taxpayer's Identification No: * * *
Years Involved: * * *
Date of Conference: * * *

"B" = * * *
"C" = * * *
"D" = * * *
"E" = * * *
"F" = * * *
"G" = * * *
"m" = * * *
"n" = * * *
"o" = * * *
"p" = * * *
"q" = * * *
"r" = * * *
"s" = * * *
"t" = * * *
"u" = * * *
"v" = * * *


1. Whether the three-year or six-year statute of limitations applies with respect to possible penalties to a disqualified person in connection with a grant made by a private foundation to a public charity?

2. Under these facts was the IRS sufficiently appraised of the nature of an expenditure where the private foundation's Form 990-PF gives the donee organization's name and the amount of the grant?

3. If the six-year statute does not apply, is the Service precluded from requiring correction from "B" of the grant of "m" to the "D"?


"C" is an organization described in section 501(c)(3) of the Internal Revenue Code and is a private foundation. "C" is listed in Publication 78. At the time of the grant to "D", "D" was recognized as a public charity under section 501(c)(3).

In "p" "C" gave an unrestricted grant of "m" to "D." "C's" trustees made the decision to give the grant based on the recommendation of "B." "B" is a disqualified person with respect to "C" because "B" is a member of the family of "F", a substantial contributor to "C". "B" was not a trustee of "C" and had no grant- making authority over "C."

Prior to the grant to "D", there was correspondence between "B" and "E". "E" is a * * * organization. The correspondence, * * * "q", from "E" to "B", indicated "B" had discussed giving a donation to "E" from "C's funds. * * *

As a result of the grant, "D" was able to pay its debt to "E"; "E" gave "B" a charter membership in "E" for "B's part in obtaining the payment. The Agent valued the benefit of the charter membership as "n". The benefit included the "m" grant plus the "o" required to become a charter member of "E". While "E" gives charter memberships to persons who donate "O", it also awards charter membership gratis. The charter memberships confer no rights or privileges of any value to the member.

In "r", "C" reported the unrestricted grant of "m" to "D" on the Form 990-PF. The list of grants stated the grants were paid to assist each organization in carrying out its exempt purpose.

In "s", an examination of "C's "q" return as well as "B"'s tax return was conducted to determine whether each was liable for excise taxes on the grant to "D". The Service proposed to assess "C", a section 4945 10% Tax and to revoke the exemption under 501(c)(3) of the Code based on the "m" grant to "D". The Service also proposed to assess tax on "B".

In January "t", "B" signed, with respect to "B"'s own tax liability, Form 872, Consent to Extend the Time to Assess Tax, to extend the time to collect any federal excise (Chapter 42) tax due from any years that are fully or partially within the taxable period that began January 1, "u".

In a November 18, "t," letter, "B"'s attorneys contended that the statute of limitations on any such assessment expired in "v", well before the Service's "T" request for a consent to extend the statute of limitations. At that time, as "B" did not agree with the Service position, "B" asked that technical advice be sought from the IRS National Office.


Section 6501(a) of the Internal Revenue Code establishes the general rule that "the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed."

Section 6501(l)(1) of the Code discusses the special rule for Chapter 42 and similar taxes. The section clarifies how that rule applies to "prohibited transaction" taxes. For purposes of any tax imposed by section 4912, by chapter 42 (other than section 4940), or by section 4975, the return referred to in this section shall be the return filed by the private foundation, plan, trust, or other organization for the year in which the act giving rise to liability for such tax occurred.

Section 301.6501(e)-1(c)(3)(ii) of the Income Tax Regulations provides that if a private foundation or trust discloses an item in its return in a manner sufficient to alert the district director, or director of a service center of the existence and nature of such item, the three year limitation shall apply with respect to taxes imposed under section 4941(a), 4942(a), 4943(a), 4944(a), and 4945(a). If the private foundation or trust fails to so disclose an item in its return or statement attached thereto, the tax arising from such transaction not disclosed may be assessed any time within 6 years after the return was filed.

Section 301.6501(n)-1 of the regulations established that the return filed by a private foundation "with respect to any act giving rise to a tax imposed by chapter 42 . . . shall be considered, for purposes of section 6501, to be the return of all persons required to file a return with respect to any such tax arising from such act. . ." The regulation provides the following example:

In 1973, D, an individual taxpayer who was a disqualified person under the provision of section 4946(a)(1), participated in an act of self-dealing with a private foundation and incurred a tax under section 4941(a)(1). On May 15, 1974, the private foundation files a Form 990-PF and answers all the questions thereon with regard to any acts of self-dealing (as defined in section 4941(d)) in which it may have engaged in 1973. Assuming that the foundation's return was not a false or fraudulent return nor made with the willful attempt to defeat tax, the period of limitations on assessment and collection under section 6501(a) shall start with respect to any tax under section 4941(a) or section 4941(b) imposed on D arising out of that transaction with such foundation.

Section 4941(a)(1) of the Code provides for the imposition of a tax on each act of self-dealing between a disqualified person and a private foundation. The rate of the tax shall be equal to 5 percent of the amount involved with respect to the act of self- dealing for each year (or part thereof) in the taxable period. The tax imposed shall be paid by any disqualified person who participates in the act of self-dealing.

Section 4941(b)(1) of the Code provides that in any case in which an initial tax is imposed by subsection (a)(1) on an act of self-dealing by a disqualified person with a private foundation and the act is not corrected within the taxable period, there is a tax equal to 200 percent of the amount involved. The tax will be paid by any disqualified person who participated in the act of self-dealing.

Section 4941(c)(1) of the Code provides that if more than one person is liable under any paragraph of subsection (a) or (b) with respect to any one act of self-dealing, all such persons shall be jointly and severally liable.

Section 4941(d) of the Code defines, in part, self dealing as any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation.

Section 4945(a) of the Code imposes on each taxable expenditure a tax equal to 10 percent of the amount thereof. The tax imposed by this paragraph shall be paid by the private foundation.

Section 4945(b) of the Code imposes an additional tax of 100 percent on the foundation when the initial tax is imposed on a taxable expenditure and such expenditure is not corrected within the taxable period.

Section 4945(d) of the Code defines taxable expenditures. Taxable expenditures include any amount paid or incurred by a private foundation to carry on propaganda, or otherwise to attempt, to influence legislation through an attempt to affect the opinion of the general public or any segment thereof, and any attempt to influence legislation through communication with any member or employee of a legislative body.

Section 4946(a)(1) of the Code defines, in part, the term "disqualified person" with respect to a private foundation, as a person who is [a] member of the family of any individual who is a substantial contributor to the foundation, a foundation manager, or an owner of more than 20 percent other total combined voting power.

In Virginia M. Cline, T.C. Memo 1988-14, the issue was whether the 3-year or the 6-year statute of limitations applied to the Commissioner's attempt to assess excise taxes under section 4941 on the basis that the compensation paid by the museum in question was excessive. The amount of compensation paid to a disqualified person was reported on the museum's Forms 990-PF for the years in question. The museum also indicated that no such acts of self-dealing had occurred. The Service argues that those answers were factually incorrect. The Tax Court found that the disclosure was adequate and the taxpayer had no responsibility to report the self-dealing had occurred. The Service had "3 years to question the legitimacy of the disclosures."

In Colony, Inc. v. Commissioner, 357 U.S. 28 (1958), The Supreme Court addresses section 1939, section 275(c), the predecessor of section 6501(e) and concludes the purpose of the statute is to extend the limitations period in a situation when the Commissioner is at a special disadvantage to detect errors because of the taxpayer's omission to report some taxable item. Such a situation exists when the return on its face provides no clue to the existence of the omitted item. When an error in reporting the omitted item is disclosed on the face of the return, the Commissioner is at no such disadvantage.

In George Quick Edward Trust, 54 T.C. 1336 (1970), aff'd per curium, 444 F.2d 90 (8th Cir. 1971), the Tax Court stated: The touchstone in cases of this type is whether respondent has been furnished with a "clue" as to the existence of the error . . . Concededly, this does not mean simply a "clue" which would be sufficient to intrigue a Sherlock Holmes. But neither does it mean a detailed revelation of each and every underlying fact.

In Electra Radio, Inc., the taxpayer sold television sets with a service contract whereby maintenance service was provided for one year after the purchase. The service contract charges were paid in advance so the taxpayer allocated the service income of the life of the contract and failed to include in his return those portions of the lump sums received which it considered unearned. The Tax Court held that an item in the return listed as deferred income on service contracts" [sic] was sufficient to alert the Commissioner that the taxpayer was deferring some of its income on service contracts, thereby barring the deficiency assessment since it was not made within the normal 3 year period.

In Benderoff v. U.S., 398 F.2d 132 (8th Cir. 1968), the court held that where a balance sheet attached to a Subchapter S corporation's return disclosed that its beginning balance of undistributed income account was the same as the amount of distribution to stockholders during the fiscal year, and that the ending balance was the same as taxable income reported for that year, the Commissioner was given an adequate clue that there had been a distribution of the shareholders' undistributed taxable income.

In University Country Club, Inc., 64 T.C. 460 (1975), the taxpayer attached to its initial return a balance sheet that showed a capital stock account comprised of two classes of common stock and a capital surplus account; a reconciliation schedule of the capital surplus account that showed the component parts of the account to be general membership. The court held the breakdown of the capital surplus account and the taxpayer's inclusion of items in that account which are apparently income related constitutes an adequate clue for the Commissioner to observe, heed, investigate and reasonably follow- up. Consequently, the assessment of the additional tax was barred by the running of the 3-year limitation period.


The issue as to whether there was adequate disclosure on "C"'s "q" Form 990-PF and whether the 3-year or 6 year statute of limitations applies is a question of fact. Many cases are distinguishable because they are factually different.

"C" disclosed the grant to a section 501(c)(3) organization, "D", on its return in the same manner it disclosed all other grants as a grant for section 501(c)(3) purposes. There is no indication that the grant was anything other than an unrestricted grant. The Trustees were apparently unaware that "D" would use its funds to pay off a debt to "E", a * * * organization. There was no evidence that there was fraud by "C" in reporting the expenditure on the Form 990-PF. In fact, "C" gave the grant to an organization recognized under section 501(c)(3) and stated on the Form 990-PF that the grant was to assist the organization in carrying out its exempt purpose. The fact that "E" suggested "C" make the grant did not guarantee that the section 501(c)(3) organization would use the funds to repay a loan to the * * * organization, as the grant was unconditional.

Although "B" is a disqualified person as defined in section 4946(a)(1), he is not a trustee nor does he have authority to make grants for "C". The Trustees did solicit family members for recommendations as to its donations, but the Trustees were under no legal obligation to follow those recommendations. The Trustees stated that on occasion they have not followed the recommendations. There was no requirement for "C" to include the fact that "B" had recommended the grant, as the grant was to a section 501(c)(3) organization.

Section 301.6501(e)-1(c)(3)(ii) of the regulations established that, for the 3-year rule to apply to Chapter 42 taxes arising from a return, the foundation must disclose the item in question in a manner sufficient to alert the district director or director of a service center of the existence and nature of such item. The return was not a false or fraudulent return. The grant of "m" to "D" was fully disclosed in a schedule attached to the return.

This issue is similar to the one in Virginia M. Cline, supra, in which the Service argued that there was not adequate disclosure. In the court case, the Tax Court held the disclosure was adequate and the taxpayer had no responsibility to report that self- dealing had occurred. The Court held the Service had 3 years to question the legitimacy of the disclosures. Here, the benefits "B" enjoyed are tenuous. Section 53.4941(d)-(2)(f)(2) of the regulations provide that when a disqualified person receives an incidental or tenuous benefit from the use by a foundation of its income or assets will not, by itself, make such use an act of self-dealing. Thus there was no need for "C" to disclose any private benefit to "B". In both cases, basic information was given concerning the transaction in question. In this case, "C" disclosed the unrestricted grant in question by amount and by grantee.

It should be noted that the six-year statute of limitation would apply if "C" had been clearly aware of the activity that was causing "D" to lose its tax exempt status at the time of the grant or the filing of the return. In this case "C" was apparently not aware of any reason that "D" should lose its tax exempt status at the time it filed the return.

Further, once the statute of limitations has expired with respect to a foundation's Form 990-PF, self-dealing and other Chapter 42 issues arising from transactions occurring in the relevant taxable year are foreclosed. The Service may not thereafter initiate an action against a disqualified person with respect to a Chapter 42 excise tax liability that arises from a transaction with respect to which the foundation's statute of limitations has expired.


As the Service was sufficiently appraised of the nature of the unrestricted grant, the three-year statute of limitations applies. As the six-year statute does not apply, the Service is precluded from requiring correction from "B" of the grant.

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