CHAPTER TWELE
Tax Compliance and Administrative Issues
p. 556, fourth complete paragraph. Insert as last two sentences:
The public disclosure copy of the Form 990-PF must include Schedule B on which donors are listed with the amounts of their contributions for the year. This schedule can be omitted from the Form 990.
§ 12.1 SUCCESSFUL PREPARATION OF FORM 990-PF
p. 560. Insert as third complete paragraph:
Contemporary investment practices—hedge funds, private equity partnerships, puts and calls, currency leverages, and others—add complexity to tax compliance efforts for a private foundation. This supplement adds new checklists and sample work papers to aid in making the calculations and satisfying the much enhanced reporting required by these investments. The Checklist for Alternative Investments attached at the end of the supplemental materials for this chapter covers the myriad of issues raised in contemplating type of investment, as follows:
- Fiduciary responsibility for prudent investing is tested with questions that ask whether the character, risk, and expected return on the investments might result in a jeopardizing investment penalty.16.1
- Possibility for excess business holdings is considered with the suggestion that holdings of disqualified persons be documented and added to the proposed ownership interest of the private foundation.16.2 Annual monitoring of this issue is also recommended.
- Impact on the calculation of the required annual qualifying distributions must be anticipated. The fair market value of all non-exempt function assets (investments) is taken into account to make the calculation due to the fact that valuations are often not available until several months after the end of the reporting year.16.3
p. 562. Insert following third complete paragraph, before heading:
Foundation expenses, such as office supplies, rent, furniture and equipment, and other facility expenses for that portion of foundation space dedicated to management of charitable programs and an allocable portion of staff salaries and associated costs, legal, accounting, consultants and other professional fees are treated as disbursements for charitable purposes. Costs associated with the foundation's grant-making program, such as travel and other costs of site visits, surveys and other tools for grantee evaluations, fees for strategic planning, electronic media resources, meetings and conferences, dues, books, and other reference resources also typify charitable purpose expenses.
Under the cash method of accounting, the foundation records financial transactions. Special accounting issues present a challenge for reporting of a foundation's creation of books, educational tools, films, computer programs, or other items that should be reported using an inventory method. Financial accounting rules are designed to accurately measure the increase or decrease in a foundation's net assets, or its available resources to satisfy its financial obligations. The accrual method of accounting is designed to achieve this result. Transactions for money received and disbursed are presented in the period in which net assets are impacted. A matching concept applies to match the expense with the period in which revenue resulting from its disposition is earned. Some expense might be delayed and identified as prepaid or conversely recorded as expense before the item is actual paid for. Similarly, recognition of income may be either delayed or accelerated so that the foundation reports of the transactions as they occur rather than when the obligation to pay or receive occurs. Additionally, accounting standards provide that items acquired that will be used or benefit the foundation over a period of time, such as a building or its furnishings, be recorded as an expense proportionately during the period those items will be used or benefit the foundation, referred to as depreciating the asset over its useful life. Thus, both cash and accrual-basis reporting foundations report acquisition of long-term assets using the depreciation method. The cost is captured and reflected as an asset and a provision for the wasting away of the asset—called depreciation expense—would be reported in the financial accounts. But the cost is counted as a qualifying distribution in the year purchases are made as noted below.
A refinement of the accrual system is the use of an inventory to account for items that will be useful, and possibly produce revenue, over a period of time. A classic example occurs in the case of a book or film that will be sold or otherwise distributed over a period of years. In that instance, the total cost of the publication would be capitalized, or reported as an asset. Then a cost of each book is calculated dividing the total cost by the number of books produced. As each book is sold or distributed, a tally is maintained for the accounting year and the number sold times the cost would be reported as a current expense.
Assume, for example, that a foundation produces 2,000 copies of a local history book at a cost of $10 each ($20,000), which are recorded as an asset entitled Inventory. During the reporting year, 500 books are sold for $20 each ($10,000) and 100 are given to area schools. The accounting entry used to match the sales revenue moves $5,000 (cost of 500 books) from the asset to an expense customarily called cost of goods sold. The $1,000 cost of books granted would be reported in Part III as a reduction of net assets. As noted below, the original cost of the book would have already been reported as a qualifying distribution in Part XII in the year the cash was expended, as explained below.
Private foundation accounting rules apply different timing rules for reporting inventory. A publication project would customarily be serving an exempt, rather than an investment, purpose. Thus all of the expenses paid toward the project would be reported as a qualifying distribution in the year the cost of the books is paid in Part XII or possibly in column (d) on page one. The cost recoupment, if any, equal to any sales would reduce current year qualifying distributions in that part.
p. 564, first complete paragraph. Insert as third sentence:
A detailed listing of the individual sales of marketable securities is not required. In the past, it was customary to attach the list furnished with Form 1099 at year end by the financial institution.
(b) Line-by-Line Instructions
Line 11. Other Income
p. 566. Add another example at end of first sentence for Line 11, Other Income:
Although unusual for a private foundation, the proceeds of a fundraising event identified as revenue for providing goods and services, and therefore not reporting on line 1 as a contribution, are reported on line 11.
p. 566. Add at end of second sentence at top of page:
Partnership income or loss items identified with code 20 on Form K-1 and Subchapter S corporation income from the K-1 are reported in column (a) but not in column (b). Instead, those income items are reported on the Form 990-T.34.1 Alternative investments discussed above for column (a) may have highly complex reporting of various types of reportable income on the K-1. A worksheet to aid in analyzing these items of income now appears at the end of this chapter.
p. 567. Add as last sentence:
It deserves repeating that an abbreviated schedule listing major categories of assets, such as buildings, furniture, and equipment (no details) only for investment assets is requested for column (b). We see far too many detailed schedules and even some unnecessary Form 4562s in Form 990-PFs we review.
Line 19. Depreciation
p. 568. Add at end of paragraph for Line 23, Other Expenses:
Costs of goods and services, promotion, and other expenses paid in connection with a fundraising event are reported here.
Line 25. Contributions, Gifts, Grants Paid
p. 568. Add new sentence at end of third paragraph before bullet list:
The 2014 Form 990-PF instructions prompt the foundation to identify each grant listed with the following codes:
| IRS CHART of Foundation Status of Recipient Use the Following Codes: | |
| PF | Private non-operating foundation (section 509(a)) |
| POF | Private operating foundation (section 4942(j)(3)) other than an EOF |
| EOF | Exempt operating foundation (section 4940(d)) |
| PC | Public charity described in section 509(a)(1) or (2) |
| GOV | Domestic or foreign government (including Indian tribal governments) or instrumentality, or international organization designated by Executive Order under 22 U.S.C. 288 |
| SO-DP | Type I, Type II, or Type III functionally integrated supporting organization if a disqualified person of the private foundation controls the supporting organization or a supported organization (sections 509(a)(3) and 4942(g)(4)) |
| SO I | Type I supporting organization (sections 509(a)(3) and 509(a)(3)(B) (i)) other than an SO-DP |
| SO II | Type II supporting organization (sections 509(a)(3) and 509(a)(3)(B) (ii)) other than an SO-DP |
| SO III FI | Functionally integrated Type III supporting organization (sections 509(a)(3), 509(a) (3)(B)(iii), and 4943(f) (5)(B)) other than an SO-DP |
| SO III NFI | Non-functionally integrated Type III supporting organization (sections 509(a)(3), 509(a)(3)(B)(iii), and 4943(f) (5)(B)) |
| TPS | Testing for public safety organization (section 509(a)(4)) |
| NC | Organization not otherwise classified |
| I | Individual person |
p. 574. Add new bullet:
- Any gain or loss resulting from recovery of program-related investment is reported here, since not shown as a gain or loss in Part I.
(m) Part XV, Supplemental Information
p. 590. Insert after second full paragraph:
The IRS now requires codes to identify the “foundation status of the recipient,” as reflected in the following chart:
| Foundation Status of Recipient Use the Following Codes: | |
| PF | Private non-operating foundation (§ 509(a)) |
| POF | Private operating foundation (§ 4942(j)(3)) other than an EOF |
| EOF | Exempt operating foundation (§ 4940(d)) |
| PC | Public charity described in § 509(a)(1) or (2) |
| GOV | Domestic or foreign government (including Indian tribal governments) or instrumentality, or international organization designated by Executive Order under 22 U.S.C. 288 |
| SO-DP | Type I, Type II, or Type III functionally integrated supporting organization if a disqualified person of the private foundation controls the supporting organization or a supported organization (§ 509(a)(3) and § 4942(g)(4)) |
| SO I | Type I supporting organization (§ 509(a)(3) and § 509(a)(3)(B)(i)) other than an SO-DP |
| SO II | Type II supporting organization (§ 509(a)(3) and § 509(a)(3)(B)(ii)) other than an SO-DP |
| SO III FI | Functionally integrated Type III supporting organization (§ 509(a)(3), § 509(a)(3)(B) (iii), and § 4943(f)(5)(B)) other than an SO-DP |
| SO III NFI | Non-functionally integrated Type III supporting organization (§ 509(a)(3), § 509(a) (3)(B)(iii), and § 4943(f)(5)(B)) |
| TPS | Testing for public safety organization (§ 509(a)(4)) |
| NC | Organization not otherwise classified |
| I | Individual person |
§ 12.2 REPORTS UNIQUE TO PRIVATE FOUNDATIONS
(n) Part XVI-A, Analysis of Income
Columns (a) and (b). Unrelated Business Income
p. 591. Insert following third paragraph:
Losses reported by a partnership on Form K-1 have resulted from passive activities, such as certain rental property management. Importantly for a private foundation organized as a trust, such losses are subject to the Passive Activity Loss rules that limit deduction of such losses against other investment income. An article discussing this important topic has been added at the end of the supplemental materials for this chapter.
§ 12.3 COMPLIANCE ISSUES
(a) Document Dissemination Rules
p. 599. Add to Copies from the IRS paragraph:
WHERE TO FILE
Use the following chart to determine where to fax or mail (depending on the service needed) Form 4506-A.
| IF you want… | THEN file Form 4506-A with the… |
| To inspect a return, report, notice, or exemption application at an IRS office*16.1 | Internal Revenue Service Disclosure Scanning Operation - Stop 93A P.O. Box 621506, Atlanta, GA 30362-3006 |
| To inspect a return, report, notice, or exemption application at IRS National Headquarters | Internal Revenue Service Attn: Freedom of Information Reading Room 1111 Constitution Avenue NW Washington, DC 20224 |
| A copy of an exemption application, Form 1023, Form 1024, Determination Letter, or updated Determination Letter (includes all supporting documents) | Internal Revenue Service Attn: Correspondence Unit P.O. Box 2508, Room 4024 Cincinnati, OH 45201 Fax no. 513-263-3434 |
| A copy of a return, report, or notice | Internal Revenue Service RAIVS Unit MS: 6716 Ogden, UT 84201 Fax no. 801-620-7896 |
* The office handling your request will contact you to schedule an appointment when the item is available for inspection.
How Long Will It Take?
Generally, it may take up to 60 days for us to process your request.
How Much Will It Cost?
You may inspect a return, report, notice, or exemption application at an IRS office free of charge.
If you want a photocopy of a return, report, notice, or an exemption application, see the chart below.
Note. The IRS will send you a bill for the photocopy cost. If your cost is over $250, we will ask for payment in advance.
| IF you are… | THEN the charge for paper copies is… |
| A commercial user | $.20 per page |
| An educational institution, media, non-commercial scientific institution, or all other requesters | First 100 pages free, $.20 per page thereafter |
(b) Where and When to File Form 990-PF
p. 599. Delete note 131.
p. 600, first complete paragraph, third sentence. Insert note at end of sentence:
131.
A foundation is organized as a nonexempt charitable trust (see § 3.6). It was assessed with a penalty (IRC § 6652(c)) for late filing of its annual information return. The foundation's trustee made several arguments (all unsuccessful) in urging the U.S. Tax Court to not sustain the penalty. One of these contentions was that the foundation is not a tax-exempt organization and thus does not file returns pursuant to the general rule as to these annual information returns. But the court pointed out that the Internal Revenue Code provides that these entities file these returns as if they are exempt organizations (IRC § 6033(d)(1), (2)) (Grace Found. v. Commissioner, T.C. Memo. 2014-229 (Nov. 6, 2014)).
p. 667. Include Exhibits 12.9, Checklist of All Alternative Investments, and 12.10, K-1 Analysis for Unrelated Business Income Reporting Purposes here.
CHECKLIST OF ALTERNATIVE INVESTMENTS, PART 1
This checklist is designed to make tax-exempt organizations aware of the tax issues posed by investments in ventures not taxed as normal corporations. Investors must report the income and corresponding deductions from such entities on Forms 990 and 990-PF, and possibly Form 990-T, according to information reported on Form K-1.
Form of Investment Entity
| 1. | Is the investment entity a partnership or LLC taxed as a partnership (income passes through with same character, i.e., ordinary, dividend, interest, capital gain)? | __________ |
| 2. | Is the investment entity a Subchapter S corporation (all income taxed as UBI)? | __________ |
| 3. | Is investment entity a corporation taxed itself on the income generated (no UBI)? | __________ |
| 4. | Is the entity an offshore company that reports no U.S. taxable income? | __________ |
Character of Income
| 1. | Is the organization's share of distributable income comprised of passive interest, dividends, rents, and royalties? [IRC § 512(b) and § 4940] | __________ |
| 2. | If ordinary taxable income distributed, are there any deductible (allocable) expenses, such as the investment management fees and legal and accounting fees? | __________ |
| 3. | Is current income or gains from options, futures, derivatives, currency transactions, and other types of alternative investment income taxable? | __________ |
| 4. | Does the venture have indebtedness or operate an active business (creates UBI)? | __________ |
| 5. | Does the partnership agreement provide UBI protection for exempt partners? | __________ |
| 6. | Does the venture operate outside the United States [special rules apply]? | __________ |
Fiduciary Responsibility/Jeopardizing Investment
| 1. | Does the organization engage independent investment advisors? | __________ |
| 2. | Were the investments purchased under a plan to diversify the organization's investments following the Prudent Investor Rules? [IRC § 4944] | __________ |
| 3. | What portion of the organization's overall investment assets do the alternative investments comprise? | __________ |
| 4. | If purchased by a private foundation, was an opinion of independent counsel that the investments would not be jeopardizing sought? [IRC § 4944] | __________ |
| 5. | Is the investment readily marketable? “No” answer means more risk. Does lock-in (cannot withdraw money from venture) mean valuation should be discounted? | __________ |
Tax Basis/Gain on Disposition
| 1. | Does the capital account reported on Form K-1 reflect the organization's actual tax basis? Is a system in place to record annual changes in tax basis? | __________ |
| 2. | Does the venture book increases and decreases in value into the capital accounts? | __________ |
| 3. | Do special allocations of deductions apply? | __________ |
| 4. | Does the investment entity have assets purchased with indebtedness? [IRC § 514] | __________ |
| 5. | Will gain on sale be taxable due to acquisition indebtedness? | __________ |
Valuation Issues
| 1. | Does manager provide periodic valuation information for calculation of average values for minimum investment return purposes? [IRC § 4942] | __________ |
| 2. | Is the investment marketable? Do the terms of the investment limit sale of withdrawal so that a discount in value is indicated? | __________ |
| 3. | For PF purposes, must the investment be valued monthly or annually? | __________ |
Excess Business Holdings
| 1. | Does the organization own more than 2 percent of the venture? What percentage do the organization's insiders own? [IRC § 4943] | __________ |
| 2. | Is more than 95 percent of the income produced by the investment passive? | __________ |
Form 990-T
| 1. | Must the income be reported and taxed on Form 990-T? | __________ |
| 2. | Does K-1 report information regarding unrelated business character of distributions? | __________ |
| 3. | Must the organization make deposits of estimated income tax? | __________ |
Completed by ____________________________________
Discussed with client _______________________ (name) ______________ date
© J. Blazek, 2015.
CHECKLIST OF ALTERNATIVE INVESTMENTS, PART 2
Form of Investment Entity—Foreign
(1) If the investment entity is a foreign corporation: |
|||
| a. | Was more than $100,000 transferred to the corporation within a 12-month period? (Form 926 may be required if “yes.”) | __________ | |
| b. | Is the investment at least 10 percent of the corporation? (Forms 926 and 5471 may be required if “yes.”) | __________ | |
| c. | During the tax year was the investment interest reduced from more than 10 percent to less than 10 percent? (Form 5471 may be required if “yes.”) | __________ | |
| d. | Did the exempt organization own 50 percent or more of the corporation for at least 30 consecutive days during the tax year? (Form 5471 may be required if “yes.”) | __________ | |
| e. | Is the entity a Passive Foreign Investment Company (PFIC)? (Form 8621 may be required if “yes.”) | __________ | |
(2) If the investment entity is a foreign partnership: |
|||
| a. | Was more than $100,000 transferred to the partnership within a 12-month period? (Form 8865 may be required if “yes.”) | __________ | |
| b. | Is the investment at least 10 percent of the partnership? (Form 8865 may be required if “yes.”) | __________ | |
| c. | During the tax year, did the partnership interest increase or decrease by at least 10 percent, e.g., from 11 percent to 21 percent or vice versa? (Form 8865 may be required if “yes.”) | __________ | |
| d. | During the tax year, did the partnership interest decrease from at least 10 percent to less than 10 percent, e.g., from 12 percent to 8 percent? (Form 8865 may be required if “yes.”) | __________ | |
| (3) | Is the investment entity a foreign disregarded entity? (Form 8858 may be required if “yes.”) | __________ | |
| (4) | Does the exempt organization have a financial interest in or signatory authority over foreign financial accounts, the aggregate value of which exceeds $10,000? (Form 90-22.1 may be required if “yes.”) | __________ | |
| (5) | Does EO own more than 50 percent of stock of corporation that has legal title to foreign financial accounts, the aggregate value of which exceeds $10,000? (Form 90-22.1 may be required if “yes.”) | __________ | |
| (6) | Does EO hold a more than 50 percent partnership interest that has legal title to foreign financial accounts, the aggregate value of which exceeds $10,000? (Form 90-22.1 may be required if “yes.”) | __________ | |
CAVEAT: These questions represent a brief summary of potential reporting obligations for foreign investments. The lengthy set of rules governing the reporting of foreign investments is highly technical. Each foreign investment should be reviewed to determine whether there is a reporting obligation. © J. Blazek, 2015.
Exhibit 12.9. Checklist of All Alternative Investments.
FORM K-1 ANALYSIS FOR UNRELATED BUSINESS INCOME REPORTING PURPOSES
Name of Partnership __________
| Check if Yes | ||
| Part III, Line 20 lists Code V | □ | Yes here indicates UBI; amounts should be shown and explained. |
| Part II, Line I type not Exempt Organization | □ | If corporation, trust, or individual listed, K-1 preparer should be asked to furnish Code V information, if any. |
| Part II, Line K reflects indebtedness | □ | Acquisition debt turns otherwise non-UBI passive income (lines 5–9) into UBI. Partnership should be asked to provide Code V information. |
| Part II, Line L checks box “Tax basis” or “704(b) basis” | □ | Capital account cannot be used for MIR calculations. Foundation should request that partnership provide annual valuations of net assets and/or overall partnership values. |
| Part II, Line L checks box “GAAP basis” | □ | Capital account CAN be used for MIR calculations. |
| Part III, Line 1 reflects “Ordinary income” | □ | Certain security transactions realized by a security trader may pass through as UBI, but the PF should rely on Code V info. |
| Part III, Line 2, Net rental income (loss) | □ | Indebted real property or unindebted hotel or service-providing facilities produce UBI. Again, PF should be able to rely on Code V information. |
| Part III, Line 3, Other net rental income (loss) | □ | Rental of personal property produces UBI whether or not there is debt. PF can rely on the Code V info unless it has knowledge personal property is rented. |
| Part III, Line 4, Guaranteed payments | □ | If PF renders no services, such as family limited partnership, no UBI results. |
| Part III, Lines 5–9 reports investment income | □ | Interest, dividends, rents, royalties, and capital gains normally not UBI (see Part II, line M). |
| Part III, line 10 §1231 gain | □ | This gain results from sale of business-use assets and could be UBI, but again PF should be able to rely on Code V absent other information. |
| Part III, Line 11, Other income | □ | Code C (Contracts/straddles) and F (Other income) probably deserve investigation if amount is more than 10 percent of PF's income, or $10,000, whichever is lower. |
| Part III, Line 20, Other information | □ | Code V identifies UBI income, but some K-1s present UBI with Code W. |
Instructions: Complete this form for each K-1 501(c) entity receives.
Combined unrelated income/loss of $1,000 necessitates filing Form 990-T.
Total of all income/deductions on K-1 should be reported on Line 11 of Form 990-PF, except for capital gains (report on lines 6–7).
If no Code V or UBI information is provided and indebtedness shown, K-1 preparer should be asked to provide UBI information.
© 2015 Blazek & Vetterling
Exhibit 12.10. K-1 Analysis for Unrelated Business Income Reporting Purposes.