Introduction

The 990-PF (PF) is an old document that has not had a recent overhaul. A minor change was made to the form to acknowledge that there is now a flat, 1.39% tax on net excise income in place of the former 1%/2% tax. But other than that, the form is still clumsy and poorly arranged. The form PF is used for a myriad of purposes:

• Calculate excise tax
• Calculate the required minimum distribution
• Calculate the actual distribution
• Provide a cumulative total of under- or overdistribution
• Detail the expenses of the organization
• List the grants with descriptive information about the grantees and grant usage
• List the grants where the foundation provided expenditure responsibility
• Provide remuneration information on the disqualified individuals and key staff, as well as the five highest paid other staff
• Provide details on the five highest paid contractors
• Provide answers to questions aimed at discovering self-dealing

This article is focused on the last item – whether the organization had any transactions that might be a case of self-dealing. This article is based on a presentation I gave at the Exempt Organization Conference in December 2022. If you want to fact-check any assertions I make, I used the 990-PF for 2021 and the related Instructions.

Part VI-A
Statements Regarding Activities

Line 1

 

1a - Attempt to influence any legislation or participate or intervene in any political campaign

An organization will be regarded as attempting to influence legislation if it contacts, or urges the public to contact, members or employees of a legislative body for the purpose of proposing, supporting, or opposing legislation, or if the organization advocates the adoption or rejection of legislation.

Organizations may, however, involve themselves in issues of public policy without the activity being considered as lobbying. For example, organizations may conduct educational meetings, prepare and distribute educational materials, or otherwise consider public policy issues in an educational manner without jeopardizing their tax-exempt status.

A worry here is about social media and the accidental use of the private foundation identified account instead of a personal one. Employees can voice any personal opinion, but with multiple accounts they should ensure they are not doing so in the name of the foundation.

b - Spend more than $100 (directly or indirectly) for political purposes?

Political purposes – directly or indirectly accepting contributions or making payments to influence the selection, nomination, election or appointment of any individual to any federal, state or local public office or office in a political organization or election of Presidential of Vice Presidential electors (whether or not successful). Since this is spending at the foundation level, it should be easier to make sure that the foundation does not disburse funds for political purposes. The foundation should be careful if it provided matching funds for donations made by employees that the matched donation was not for political purposes.

c - Did the foundation file Form 1120-POL?

An exempt org that is not a political org must file 1120-POL if it is treated as having political org taxable income. This is a rather inarticulate way to say that if you have political org taxable income, then you will be treated as a political org and have to file an 1120-POL.

d - Tax on political expenditures imposed during the year:

On the foundation, on foundation managers

In this section, the foundation will provide the dollar amounts of tax on political expenditures that was levied on the foundation and on the foundation managers.

e - Reimbursement paid by the foundation during the year for political expenditure tax imposed on foundation managers

 

Line 2

Engage in any activities not previously reported to IRS? Attach detailed description

With the passage of time, a foundation might drift into new activities. It should periodically check their current activities against what their organizing documents say and, if necessary, amend the documents.

Line 3

Made any changes not reported to IRS in governing instrument, articles of incorporation, bylaws, or other similar instruments? Attach conformed copy of changes

A conformed copy is one that agrees with the original. If not signed, the foundation would need to include a written declaration signed by an authorized officer noting that it is certifying that the copy is a complete and accurate copy of the original document. If the foundation is e-filing, it will have to mail the conformed copy and certification.

 

Line 4

4a - Have unrelated gross business income > $1,000?

Some organizations have a threshold they use – say, a tax liability of $1,000. This question is about gross business income – not net. Gross income will likely be very different than taxable income, and even more different from the tax liability.

b - If “Yes,” was 990-T filed?

Line 5

Was there a liquidation, termination, dissolution or substantial contraction? Attach statement

In a significant down market, assets might decrease by the threshold that defines a substantial contraction (25%) – but the contraction has to arise from disposition, not loss of value. It would not be unusual for there to be both loss of value and dispositions, so be careful in attributing the decline. For instance, there could be a decline in the value of the investment assets due to both dispositions and market declines in the ending value of the assets still held. The contraction threshold of 25% applies to only the decrease due to dispositions, not including the decrease due to market declines.

 

Line 6

Are requirements of Sec 508(e) satisfied by:

- language in governing instrument

- state legislation that effectively amends governing instrument so no mandatory directions that conflict with state law remain?

These are the provisions that the PF will not engage in acts of self-dealing, have excess business holdings, or make investments that jeopardize their charitable purpose. Original governing documents may not contain the language, but the state in which the foundation is organized in may be subject to state law that has the same effect as having the language in the governing documents.

Line 7

Are there $5,000 in assets at any time? Complete Part II, col (c) and Part XIV

Line 8

 

 

8a - Enter the states who get reports or where registered

The instructions say to include any reporting in any way about the organization, assets or activities and with which the PF has registered. The form states “or” in place of “and.” So according to the form, you should enter the states if you report to the state or if you are registered with the state. The instructions say you should enter the state if you report to the state and you are registered in the state – a higher burden since both must be present, as opposed to either. The form also says to “See instructions,” which I interpret to mean that in the event of differences, the instructions prevail.

A further question exists about whether UBI reporting is enough to trigger the state reporting clause. The instructions say “… reports in any about its organization, assets or activities …” Does filing a state UBI return constitute reporting about the foundation’s activities? I would think not, but that is opinion, not precedent.

b - If yes to Line 7, was 990-PF sent to the AG (or designee) of each state? If not, attach explanation

This is pretty straightforward – if you had to send the PF to the state and didn’t, attach an explanation.

 

Line 9

Claiming status as a private operating foundation? If “Yes,” complete Part XIII

Line 10

Did any persons become substantial contributors during year? If “Yes,” attach schedule listing names and addresses

A substantial contributor is any person whose contributions or bequests during the current and prior tax years total more than $5,000 and are more than 2% of the total contributions and bequests received by the foundation from its creation through the close of the tax year. This calculation can be a high hurdle. Suppose the foundation was started in the early 1900s – most probably did not maintain detailed donation records to be able to record the cumulative contributions. The foundation may just have to make an educated guess.

Line 11

At any time did the foundation directly or indirectly own a controlled entity? If “Yes,” attach schedule

A controlled entity is where the PF owns >50% of the:

1. Stock (by vote or value) in a corporation

2. Interest (profit or capital) in a partnership

3. Beneficial interest of any other entity

Issues can arise when a fund manager establishes a subfund where the foundation is the sole investor (a fund of one). It may be possible to argue that the fund is not an entity.

Line 12

Make a distribution to a donor-advised fund over which the foundation or disqualified person had advisory privileges? If “Yes,” attach statement

The language here is tricky. The foundation is making a distribution to a donor advised fund and checking “Yes” is required when the foundation or a disqualified person had advisory privileges. It does not appear that the issue is whether a disqualified person made the contribution that is being matched, but simply whether the foundation or disqualified person had advisory privileges. If neither the foundation nor disqualified person had advisory privileges, then you would not have to check “Yes.”

 

 

Line 13

Did the foundation comply with public inspection requirements for annual return and exemption app?

Provide website address

The PF must be available for public inspection. There are three ways that it must be made available:

• By office visitation
• By providing copies
• By internet posting

The offices that are required to have the PF include the principal office, as well as regional and district offices, during regular business hours. Because most offices have internet access and printers, the office could always download a copy when asked (or e-mail the file to someone who stops in), if acceptable to the person making the inspection.

An office qualifies as a regional or district office if the office has management staff who management responsibilities are not confined to the operations of the office. A foundation that does not have a permanent physical office can meet the in-person inspection requirement by making the PF (and/or the exemption application, if required) as a reasonable location of its choice, within a reasonable time frame (generally two weeks) and as a reasonable time of day. As an alternative, the foundation could mail the document(s) within two weeks; it could charge a reasonable fee if the requester agrees to the charge. This paragraph also applies in the situation where the foundation has a permanent office but no office hours or very limited office hours.

The application for exemption must also be made available unless it was filed before July 15, 1987, unless the foundation had a copy of the application on July 15, 1987.

Line 14

Books in care of / telephone / located at / Zip +4

Self-explanatory

Line 15

Sec 4947(a)(1) nonexempt charitable trusts filing 990-PF in lieu of Form 1041, check here

Self-explanatory

Line 16

Interest in or signature  or other authority over a bank, securities or other financial account in a foreign country?

The combined value of all accounts was >$10,000 at any time

Or

Own more than 50% of the stock of any corporation

Determination of where the financial account is located can be difficult – is it based on the address of the manager, where the holdings are, etc.? Some investment funds have U.S. addresses but foreign holdings, and some investment funds with foreign addresses (e.g., offshore investments) may hold U.S. securities. It would seem that any investment or bank account with a foreign address would qualify, but the possibility exists that in some circumstances, so would an account with a U.S. address.

Part VI-B
Statements Regarding Activities for Which Form 4720 May Be Required

Line 1a

 

 

1a - Did (directly or indirectly)

1 - Engage in sale or exchange, or leasing property with disqualified person?

      Self-explanatory

2 - Borrow, lend or extend credit (or accept it) from a disqualified person?

A potential issue exists when a disqualified person has a foundation credit card and accidentally uses it for a personal charge. The foundation has made a loan to the disqualified person (the amount of time from the purchase by the disqualified person to the time when they made payment). One possible way to avoid this issue is to obtain a deposit from a disqualified person who has been given a foundation credit cards so that if one accidentally used the card to make a personal charge, the foundation already had the funds.

3 - Furnish goods, services, or facilities (or accept) from a disqualified person?

I have seen people take the position that if the disqualified person uses the foundation’s phone to make a non-foundation related call, then they have received facilities, or if they ask someone to make a reservation or order a car, they have received services.

I have also seen situations where the foundation had paid for a hotel room and the guest cancelled at the last minute. The foundation let a disqualified person use the room on the basis that it did not cost the foundation anything. The standard is whether the disqualified person received a benefit, not whether it was a sunk cost to the foundation.

4 - Pay compensation to, or pay or reimburse the expenses of, a disqualified person?

It is OK to pay a reasonable stipend to a board member for Board and Committee service. It is also OK to reimburse the expenses of the disqualified person, provided that the expenses were incurred as part of fulfilling one’s duties as trustee.

Spousal travel of a disqualified person is not allowed – unless that person has a bona fide responsibility within the foundation to fulfill. I have seen cases where an administrative assistant tried to justify the reimbursement by saying that the spouse attended the board dinner and could ask a question. That is not a bona fide responsibility.

The current hot topic is gala attendance – when the tickets were purchased by the foundation or if the foundation funded the gala and received tickets. Some say that best practice is to avoid having any staff attend with the tickets; I am more inclined to only exclude disqualified persons. An exception exists if there is a bona fide foundation purpose in having the disqualified person attend, but I find the reasoning tends to be tortured – the disqualified person should just personally pay for the tickets and avoid the issue entirely, unless the business purpose is without question.

5 - Transfer any income or assets to disqualified person (or make either available of benefit or use of disqualified person)?

Transferring of income or assets is more obvious than making the income or assets available for use by a disqualified person.   

6 - Agree to pay money or property to a government official?

There are quite a few exceptions that would allow a foundation to pay money to a government official, such as reimbursing travel expenses (subject to some limitations). Check the instructions to the PF for a link to the exceptions.

One thing to watch for is where a disqualified person is not a government official at first, but later qualifies as a government official. The foundation should have a mechanism to verify annually that it knows all the disqualified persons and when (if) they become government officials.

 

 

b - If “Yes” to 1a(1)-(6), did any fail to qualify under exceptions?

Most foundations will reimburse travel expenses to disqualified persons, so they have to check “Yes” to question 1a(4). The answer to this question would be “No” (meaning that an exception applies), if the reimbursed expenses were pursuant to foundation business.

c - Check if relying on a current notice regarding disaster assistance

Self-explanatory

d - Did the foundation engage in prior year in acts above that were not corrected before the first day of year?

Self-explanatory

Line 2

 

 

Taxes on failure to distribute income:

a - At end of the tax year, was there any undistributed income from before current year? If so, list

Basically, this is asking if the foundation failed to clear the undistributed income from the prior year – which is the first use of the current year’s distribution

b - Are there any years listed above for which the foundation is not applying the provisions relating to incorrect valuation of assets?

Because the required distribution is based on average assets, any incorrect valuation would affect the calculation of the required distribution. Incorrect valuations often happen when investments such as private equity have a delay in reporting updated values. Should this describe the situation, the foundation can avoid the issues arising from undistributed income by checking “no.”

c - Applying to any of the years, list

the years when there should have been a correction of asset values.

 

Line 3

a - Hold more than a 2% direct or indirect interest in any business enterprise at any time during year

This area is very complex, with twists and turns worthy of a horror novel.

A business enterprise is an entity engaged in a trade or business. It excludes a trade or business that derives 95% or more of its gross income from passive activities.

A foundation can own up to 2%. Once the foundation hits 2%, the aggregate threshold of 20% (which will include the interests of disqualified persons and related foundations) comes into play. A foundation can hold up to 20%, reduced by the percentage owned by disqualified persons. If the disqualified person owns 20%, then the foundation cannot own anything. If there is no control, then the foundation can own 35%, reduced by disqualified person ownership percentage.

Exception:

100% of voting stock is held by the foundation and

All of the interest was acquired by means other than purchase

And

The business enterprise distributes to the foundation its net operating income within 120 days after the close of the tax year

And

Rules on ownership and management overlapping with foundation directors

And

No loan between the business enterprise and a substantial contributor or family member of such contributor

b - If “Yes,” was it a result of:

(1)   any purchase by foundation or disqualified person after May 26, 1969?

Self-explanatory

(2) lapse of the five-year period (or longer period approved by Commissioner)?

Self-explanatory

Line 4

a - Did invest in any amount in a manner that would jeopardize charitable purposes?

A jeopardizing investment is an investment where ordinary business care was not exercised concerning the provision of the long- and short-term financial needs of the foundation.

I would view excessive concentration as being a jeopardizing situation – which can get complicated when thinking about the hierarchy of investing – manager/fund/holdings. I think we can agree that a foundation that invested 100% with Madoff probably made a jeopardizing investment – not because it lost money, but because of the concentration. I would call that a jeopardizing investment even when Madoff was solvent and paying high returns. But suppose  instead of Madoff it was a large investment manager and the investments were spread over 15 funds with considerable diversification. This type of arrangement is fairly typical – where a manager has a single, multi-strategy fund that it sells as an “OCIO solution.” There is diversification throughout, except at the manager level. There is one manager, but multiple funds, multiple sectors, geography, currency, etc.

b - Make any investment in a prior year (but after December 31, 1969) that could jeopardize its charitable purpose that have not been removed from jeopardy before the first day of year

Hopefully, the foundation cured the jeopardizing investment.

Line 5

 

5a - During year, did foundation pay or incur any amount to:

(1) Carry on propaganda or attempt to influence legislation?

Carrying on propaganda is a little harder to pin down than attempting to influence legislation. This question involves paying or incurring amounts related to propaganda or influencing legislation.

(2) Influence the outcome of any specific public election or to carry on directly or indirectly any voter registration drive?

This is similar to what was discussed before.

(3) Provide a grant to an individual for travel, study or other similar activity?

“Other similar” purposes include scholarships, fellowships, certain prizes and awards, grants to achieve a specific objective, produce a report or similar product, or improve a literary, artistic, musical scientific, teaching, or other similar skill of grantee.

These are taxable expenditures unless the grant is awarded on an objective and nondiscriminatory basis under a procedure approved in advance by the IRS.

(4) Provide a grant to an organization other than, e.g., a charitable organization?

Grants to a public charity or an exempt operating foundation isn’t a taxable expenditure if the foundation doesn’t earmark the grant for 5a(1)-(5) and there is no agreement (written or oral) that may cause the grantee to engage in any such prohibited activity.

(5) Provide for any purpose other than religious, charitable, scientific, literary or educational purposes or for the prevention of cruelty to children or animals?

Self-explanatory

b - If “Yes” to any above, did any fail to qualify under exceptions?

Self-explanatory

c - If relying on current notice regarding disaster assistance, check here

Self-explanatory

d - If “Yes” to 5(a)(4), do you claim exception due to maintaining expenditure responsibility?

The two ways to handle grants to organizations that are not 501(c)(3) organizations is by determining equivalency or by maintaining expenditure responsibility. Making an equivalency determination is basically checking to see if the grantee would be considered a tax-exempt charity in the United States if the fact pattern was presented. It might be impossible for some entities to obtain an equivalency determination (e.g., because they are for-profit).

Maintaining expenditure responsibility should not be taken lightly. The rules are best laid out in the attachment required by New York City.

 

Line 6

a - Did the foundation receive funds, directly or indirectly, to pay premiums on a personal benefit contract?

A personal benefit contract is any life insurance, annuity or endowment contract that benefits (directly or indirectly) the transferor,  any member of their family or any other designated by the transferor. This question asks if the foundation received funds in order to pay the premiums.

b - Did the foundation pay premiums, directly or indirectly, on a personal benefit contract?

This question asks if the foundation paid the premiums.

Line 7

a - Was the foundation party to a prohibited tax shelter transaction?

A prohibited tax shelter transaction is a listed transaction and any prohibited reportable transaction.

A listed transaction is one that is the same or similar to a transaction that the Secretary has identified in published guidance as a tax avoidance transaction.

A prohibited reportable transaction is any confidential transaction or any transaction with contractual protection that is a reportable transaction.

b - If “Yes,” did the foundation receive any proceeds or have any net income attributable to the transaction?

Self-explanatory

Line 8

Is the foundation subject to tax on payments of more than $1 million in remuneration or excess parachute payments?

This applies to covered employees – generally the five highest paid – and includes pay from tax-exempt employer and any related organizations.

Remuneration means wages less any Roth contribution, and includes any amounts required to be included in gross income.

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Jeffry Haber, PhD, CPA, is a professor at the LaPenta School of Business at Iona University, New Rochelle, N.Y., and the senior director, finance, at The Commonwealth Fund.