PRIVATE

FOUNDATIONS
AND
UBIT

APRIL 8, 2021
EXAM
• Wednesday, May 5, 8am
• 24-hour take home
• 50 questions
• Multiple choice with ability to explain answer
• Administered through Blackboard
• Open book
• Reading assignments
• Practice questions (last week of class) / review session
(Weekend? Monday, May 3?)
PRIVATE FOUNDATION
EXCISE TAXES
• Goal of these excise taxes is to discourage certain
conduct that Congress viewed as abusive
1. Tax on self dealing (Section 4941)
2. Taxon failure to distribute income (Section 4942)
3. Tax on excess business holdings (Section 4943)
4. Tax on jeopardizing investments (Section 4944)
5. Tax on “taxable expenditures” (Section 4945)
JEOPARDIZING INVESTMENTS
(SECTION 4944)
• Pg: 513
– “In theory, the income distribution requirements and the sanctions
against excess business holdings and state law standards of
fiduciary duty should guarantee a diversified and reasonably
productive investment portfolio. But Congress also was
concerned that a private foundation’s governing board might
make investments that would jeopardize the foundation’s
endowment. To ensure that the foundation’s portfolio strategy
creates no more than a tolerable level of risk, Section 4944
imposes an excise tax of five percent on any amount invested by a
private foundation ‘in such a manner as to jeopardize the carrying
out of any of its exempt purposes.’”
JEOPARDIZING INVESTMENTS
(SECTION 4944)
• Examples on Pg. 513
• Standards to be applied on audit are not precise
• Despite extensive Treasury Regulations, the determination
of jeopardy turns on all the facts and circumstances
• Regulations give some guidance relating to types of
investments that will receive close scrutiny
TREAS. REG. 53.4944-1(A)
(2)(i)
 JEOPARDIZING INVESTMENTS
(SECTION 4944)
• PF’s are prohibited from investing any amount
in such a manner as to jeopardize the PF’s
ability to carry out its exempt purpose
• Purpose: to ensure PF’s portfolio strategy
creates no more than a tolerable level of
risk
• An investment is considered to jeopardize the
PF’s exempt purpose if it is determined that the
foundation managers (directors, officers,
employees with power to act), in making the
investment, have failed to exercise ordinary
business care and prudence, under the facts
and circumstances, prevailing at the time of
making the investment, in providing for the long-
term and short-term financial needs of the PF
• No per se jeopardizing investments
exist, but the IRS will usually closely
scrutinize the following types of
investments:
• Buying securities on margin;
trading in commodity futures;
investments in working
interests in oil and gas wells;
purchases of “puts” and “calls”
and “straddles;” purchase of
warrants, and selling short
• Jeopardizing status determined at
time of the investment and not
subsequently on the basis of
hindsight
 JEOPARDIZING INVESTMENTS
(SECTION 4944)
• Section 4944 imposes on the PF an initial tax equal to 10% of the amount of
the jeopardizing investment
• Second-level tax imposed on PF (at rate of 25%) if investment is not
removed from jeopardy
• Removal from jeopardy means investment is sold or otherwise disposed of
• Tax at rate of 10% (cap $10,000) also can be imposed on foundation managers
(director, officer, employees with power to act) if such foundation manager
knowingly participated in the investment, unless participation was not willful
and due to reasonable cause
• Second-level tax imposed on foundation manager if refusal to agree in part
or all of the removal from jeopardy
JEOPARDIZING INVESTMENTS
(SECTION 4944)
• Exception for program-related investments
– Example: Pg. 514
• Legal advice / investment advice
– Pg. 514: “Under the regulations, however, managers are protected
if they act on the advice of legal counsel expressed in a reasoned
written legal opinion that the particular investment will not
jeopardize the foundation’s exempt purposes. Similarly, reliance
upon the advice of investment counsel, expressed in writing, that
a particular investment will provide for the ‘long-and short-term
financial needs of the foundation’ will provide a defense to the
penalty even though the investment turns out badly.”
TAXABLE EXPENDITURES
(SECTION 4945)
• Pg. 515:
– “Section 4945 penalizes a private foundation for making certain
expenditures that Congress considered to be inappropriate even
when the expenditures may be consistent with the foundation’s
charitable purposes. The obligations created by Section 4945 are
constant, necessitating evaluation of each foundation grant or
expenditure against the requirements of the statute. Some
expenditures are forbidden entirely, while others are permitted if
the foundation satisfies additional guidelines. Section 4945 thus
may influence some private foundations to limit their grants to
public charities to escape the burdens of oversight responsibility
and the possibility of penalty.”
TAXABLE EXPENDITURES
(SECTION 4945)
• Types of taxable expenditures
– Pg. 516-517
– Lobbying (unless exception) (p.516)
– Elections and Voter Registration (narrow exception for voter
registration)
– Grants to organizations not public charities (unless expenditure
responsibility)
• Pg. 518: “Public charities have benefitted from the burden of the
expenditure responsibility requirement. Indeed, many private foundations,
as a matter of policy, decline to make grants to organizations other than
public charities to avoid the expenditure responsibility requirement.”
– Expenditures for non-charitable purposes
LOBBYING TESTS WE
PREVIOUSLY DISCUSSED
• Pg. 230:
– “As a practical matter, the lobbying restrictions are relevant only
to Section 501(c)(3) organizations classified as public charities. A
far more restrictive regime applies to private foundations, which
are subject to punitive excise tax penalties if they engage in any
lobbying regardless of its relationship to the foundation’s
charitable program.”
• Pg. 237
– Section 501(h) election not available to private foundations
TAXABLE EXPENDITURES
(SECTION 4945)
• Tax imposed on PF is 20% of the amount
spent
– Second tax of 100% if not corrected
• There is also a tax imposed on foundation
manager – initially 5% of amount involved (cap
at $10,000), if the manager knowingly and
willfully agreed to the expenditure
– Second tier tax of 50% (cap at $20,000)
imposed on foundation manager if the
manager refuses to agree to correct the
taxable expenditure
UNRELATED
BUSINESS
INCOME TAX
(UBIT)
 REMEMBER WHAT WE PREVIOUSLY
LEARNED ABOUT COMMERCIAL ACTIVITIES

• 501(c)(3) can engage in unlimited commercial activities (even if highly

profitable) if it furthers the exempt purpose of the organization
• And 501(c)(3) does not necessarily lose its tax-exempt status by engaging in
unrelated commercial activities; it can engage in insubstantial amounts
– UBIT deals with the insubstantial commercial activities not in furtherance of
the organization’s exempt purpose – even though no loss of tax-exempt status,
tax is imposed on these activities (unless an exception applies)
– The tax is called UBIT (UBIT imposed on UBTI)
• Purpose of UBIT is so no unfair competition with for profit entities; also
brings in idea of non-profit purpose
UBIT: STARTS WITH IRC
SECTION 511
• § 511 (explains the tax)
– “There is hereby imposed for each taxable year on the unrelated
business taxable income (as defined in section 512) of every
organization described in paragraph (2) a tax computed as
provided in section 11 . . . .”
UBIT: THEN IRC § 512
• § 512 (defines UBTI)
– “Except as otherwise provided in this subsection, the term
‘unrelated business taxable income’ means the gross income
derived by any organization from any unrelated trade or business
(as defined in section 513) regularly carried on by it, less the
deductions allowed by this chapter which are directly connected
with the carrying on of such trade or business . . . .”
UBIT: THEN IRC § 513
• § 513 (defines unrelated trade or business)
– “The term ‘unrelated trade or business’ means, in the case of any
organization subject to the tax imposed by section 511, any trade
or business the conduct of which is not substantially related . . . to
the exercise or performance by such organization of its charitable,
educational, or other purpose or function constituting the basis for
its exemption under section 501 . . . .”
 PLAIN ENGLISH UBTI
ELEMENTS
• If 501(c)(3) has income from the conduct of a trade or
business not substantially related to the exercise or
performance of its exempt purpose, and it is regularly carried
on, then there is UBTI upon which UBIT is imposed
– If UBTI insubstantial, then no risk of losing tax-exempt status
– If UBTI substantial, then risk of losing tax-exempt status