Tax Practice Series: Exempt Organizations and Private Foundations 
  ¶ 6910: Taxes on Taxable Expenditures 
  Explanation 
  ¶ 6910.01. Taxable Expenditures

¶ 6910.01.E. Expenditures for Noncharitable Purposes 

The term taxable expenditure includes any amount paid or incurred by a private foundation for any purpose other than a charitable purpose.207 As a general guideline, an expenditure is a taxable expenditure if it is paid or incurred for an activity that would cause a private foundation to lose its tax-exempt status if the activity were carried on as a substantial part of its total activities.208
——————————————————————————————

207 § 4945(d)(5). See Regs. § 53.4945-6. E.g., Thorne v. Comr., 99 T.C. 67 (1992) (Grants to individuals for noncharitable purposes were taxable expenditures). The term charitable purpose refers to the purposes described in § 170(c)(2)(B). Under § 501(c)(3), to be eligible for tax exemption as a charitable organization, an organization must be operated “exclusively” for charitable purposes. The term “exclusively” has not been literally construed but has been interpreted to allow an insubstantial amount of nonexempt activities. Regs. § 1.501(c)(3)-1(c)(1). Thus, to retain its tax exemption, a private foundation must limit its nonexempt activities to the level permitted under § 501(c)(3). To avoid the taxes on taxable expenditures under § 4945, the foundation must refrain from any nonexempt activities resulting in expenditures described in § 4945(d)(5). A grant to a public charity described in § 509(a)(1), (2), or (3) does not constitute a taxable expenditure under § 4945(d)(5) if the grant is not earmarked by the private foundation for a noncharitable purpose described in § 4945(d)(5) and if there is no written or oral agreement by which the foundation may cause the grantee to engage in any activity for such a purpose or to select the recipient to which the grant is devoted. Regs. § 53.4945-2(a)(5)(i). In TAM 9240001, a private foundation made a grant to a public charity that was earmarked for use by a nonexempt community development organization. The IRS ruled that the grant was not a taxable expenditure because use of the funds by the community development organization furthered the foundation's charitable purposes. In PLR 200043052, the IRS ruled that a private foundation's grant to fund a public charity's purchase of an historic mansion did not constitute a taxable expenditure because the grant was earmarked for a use that would further the public charity's exempt purposes. In FSA 200022005, the National Office advised that a distribution of assets from a charitable remainder unitrust to settle the grantor's — a disqualified person who was to receive payments totaling a fixed percentage of the trust's value — tax liabilities would constitute a taxable expenditure as a distribution of assets for a purpose not described in § 170(c).

208 Regs. § 53.4945-6(a). E.g., TAM 9646002 (Expenditures by a private foundation attributable to the use of its property and facilities by a disqualified person were taxable expenditures).

——————————————————————————————

An example of an expenditure for a noncharitable purpose is an unreasonable administrative expense, including unreasonable compensation, consultant fees, or other fees for services rendered.209 However, an unreasonable administrative expense is not treated as a taxable expenditure if the private foundation can demonstrate that the expense was paid or incurred in the good faith belief that it was reasonable and that the payment or incurrence of an expense of such amount was consistent with ordinary business care and prudence.210
——————————————————————————————

209 Regs. § 53.4945-6(b)(2). E.g., Kermit Fischer Foundation v. Comr., T.C.Memo 1990-300 (Private foundation's payment of unreasonable compensation to a foundation manager and its payment of unnecessary expenses for automobiles, office space, and equipment were taxable expenditures). See Rev. Rul. 82-223, 1982-2 C.B. 301 (Private foundation's payments of premiums on liability insurance for a foundation manager were not taxable expenditures where the premium payments were treated as compensation and the total compensation package was not unreasonable); PLR 200342008 (Payments to trustees for compensation and reimbursement of litigation expenses did not constitute taxable expenditures where payments were reasonable and necessary).

210 Regs. § 53.4945-6(b)(2).

——————————————————————————————

Another example of an expenditure for noncharitable purposes is a grant to a noncharitable organization.211 However, a grant to a noncharitable organization is not a taxable expenditure if either of the following conditions is present:212 
• the making of the grant itself constitutes a direct charitable act or the making of a program-related investment; or

• the grantor private foundation takes appropriate steps so that it is reasonably assured that the grant will be used exclusively for charitable purposes.213

——————————————————————————————

211 Regs. § 53.4945-6(c)(1). For the treatment of transfers of assets in a reorganization described in Regs. § 1.507-3(c)(1), see Regs. § 53.4945-6(c)(3).

212 Regs. § 53.4945-6(c)(1). A grant to a government entity, state college or university, or foreign government described in Regs. § 53.4945-5(a)(4) is considered as made to a charitable organization. Id. A foreign organization that does not have an IRS ruling or determination letter that it is a charitable organization can be treated as a charitable organization if in the reasonable judgment of a foundation manager the foreign organization is a charitable organization. Regs. § 53.4945-6(c)(2)(ii). Rev. Proc. 92-94, 1992-2 C.B. 507, provides a procedure by which a private foundation may make a reasonable judgment concerning a foreign organization's public charity status based on a currently qualified affidavit prepared by the grantee for the grantor foundation or another grantor. In CCA 200504031, the Chief Counsel's Office examined standards governing charitable aspects of international grant-making activities by U.S. charities.

213 E.g., PLR 9306034 (Grant by a private foundation to a fraternity, which was an exempt organization described in § 501(c)(7), to assist in building and maintaining a fraternity house did not constitute a taxable expenditure, where the funds were required to be used exclusively for educational areas of the house and the foundation would carefully monitor the use of the funds to ensure exclusive use for educational purposes). The steps that must be taken in order for the grantor to be reasonably assured that the grant will be used only for charitable purposes are set forth in Regs. § 53.4945-6(c)(2)(i).

——————————————————————————————

The following types of expenditures are ordinarily not treated as taxable expenditures for noncharitable purposes:214 
• expenditures to acquire investments for the production of income or funds to be used in furtherance of charitable purposes;

• reasonable expenses with respect to such investments;215
 
• expenses to acquire or maintain property to be used in an exempt function;216
 
• payment of taxes;

• expenses that are deductible under the unrelated business income tax;

• payments that constitute qualifying distributions;217
 
• expenses that are deductible for purposes of the tax on investment income;218
 
• reasonable expenditures to evaluate, acquire, modify, and dispose of program-related investments; and

• business expenditures by the recipient of a program-related investment.

——————————————————————————————

214 Regs. § 53.4945-6(b)(1).

215 See PLRs 200545048-049 (Payments for legal, accounting, and other expenses associated with requesting a private letter ruling and with a § 507(b)(2) transfer of assets were not taxable expenditures).

216 E.g., PLR 200536027 (Expenses of making an internet-based teaching resource available to schools were in furtherance of foundation's exempt purpose of promoting education and were not taxable expenditures);PLR 200014040 (Payment of costs to remodel and operate art gallery, where costs were related to organization's exempt purpose).

217 E.g., PLR 200634016 (Grants to assist impoverished and financially desperate individuals were qualifying distributions and were not taxable expenditures); PLR 200527020 (Where foundation was formed to preserve certain lands, payments of expenses associated with maintaining the land, such as developing and implementing a stewardship program and creating public access, were qualifying distributions and were not taxable expenditures under § 4945(d)(5)); PLR 200332019 (Private nonoperating foundation's grants to public charity to fund scholarship program were qualifying distributions and were not taxable expenditures);PLR 200324056 (Private foundation's expenses to hold a conference that advanced its charitable purposes were qualifying distributions under § 4942 and were not taxable expenditures under § 4945(d)(5));PLR 200321023 (Private foundation's grant to foreign grantee was treated as qualifying distribution under § 4942 and not as taxable expenditure under § 4945 where private foundation treated grantee as not being described in § 501(c)(3), exercised expenditure responsibility with respect to grant, and required that grantee maintain grant funds in separate fund dedicated to one or more purposes described in § 170(c)(2)(B)); PLR 200207031 (Payments on compensation-related liabilities assumed by charity in merger were § 4942(g) qualifying distributions and, thus, were not § 4945(d) taxable expenditures); PLR 200026028 (Expenses incurred in investigating and designing a scholarship program were qualifying distributions under § 4942 and were not taxable expenditures under § 4945(d)(5));PLR 200010052 (Private foundation's grant to an educational institution to create a high technology research and business incubator was not a taxable expenditure under § 4945(d)(4) or (5) and it constituted a qualifying distribution); PLR 9616030 (Award paid by a private foundation to an individual in recognition of past achievements in a field that furthered the foundation's exempt purposes was not a taxable expenditure because the payment was not a grant for travel, study, or similar purposes and was not an expenditure for noncharitable purposes); PLR 9527034 (Private foundation's grant to a public charity for the preservation and renovation of an historic structure constituted qualifying distribution and was therefore not taxable expenditure). The term “qualifying distribution”is defined in § 4942(g). See ¶ 6880.

218 Such expenses are described in § 4940(c)(3). See ¶ 6860.

——————————————————————————————