Expanded Methods to Determine Public Charity Status

The Pension Protection Act of 2006 imposed important limitations on private foundations that make grants to public charities that are Section 509(a)(3) supporting organizations. Prior to these limitations, such grants were qualified distributions under Code Section 4942 (and thus such grants helped the foundation meet its minimum distribution requirements) and were not taxable expenditures under Code Section 4945 (which would be subject to a penalty excise tax). This may not be the case now, depending on the type of supporting organization that is involved and other factors. Many private foundations now seek to avoid distributions to supporting organizations entirely, to avoid running afoul of the new provisions. Distributions to supporting organizations from donor advised funds can also run into similar problems.

The IRS has made it a little easier for a private foundation to find out whether a recipient organization is a supporting organization. Previously, the IRS allowed a grant making private foundation to determine the supporting organization of a grantee by reviewing:

1. The IRS determination letter of the recipient organization can be reviewed. If one is not available, an updated one can be obtained from the IRS (1-877-829-5500)
   
2. The IRS Business Master File (BMF) can be reviewed online.
   

However, it is not easy to use the IRS BMF. In recognition of this, the IRS now allows taxpayers to acquire this information from third parties who access the IRS database. If a grant making organization receives a written report that contains required information from a third-party provider, the organization is allowed to rely on that report.

One major provider of these reports (for a fee, of course) is Guidestar (http://www.guidestar.org).

IRS EO Update , Issue Number 2007-8

GUIDANCE COMING ON DEDUCTIBILITY OF INVESTMENT FEES BY TRUSTS

Since the early 1990's, taxpayers and the IRS have been battling over the issue whether investment advisory fees paid by a trust are fully deductible, or deductible only to the extent that they exceed 2% of the trust's adjusted gross income (AGI). Taxpayers assert that the 2% limitation does not apply, due to Code Section 67(e)1) which provides that costs paid or incurred in connection with the administration of a trust that would not have been incurred if the property was not held in the trust are fully allowed as deductions in arriving at adjusted gross income.

The IRS and various court opinions are at odds as to the proper interpretation of the law. Acting in its role as arbiter of these conflicts, the U.S. Supreme Court agreed on June 25 to take on the issue, and hopefully provide the final word.

William L. Rudkin Testamentary Trust u/w/o Henry A. Rudkin, Michael J. Knight, Trustee (CA 2 10/18/2006), cert granted 6/25/2007

ATTRIBUTING A TRADE OR BUSINESS FROM A PARTNERSHIP OR LLC FOR SECTION 355 PURPOSES

Usually, if a corporation distributes the stock of a corporation it owns, it will be taxed on any appreciation in the value of that stock over its basis for tax purposes. The shareholders of the distributing corporation may also recognize income or gain on the receipt of the distributed stock. However, Code Section 355 will allow a corporation to distribute a controlled corporation to its shareholders without either the distributing corporation or its recipient shareholders from recognizing gain.

One of the requirements for nonrecognition treatment is that the distributing corporation and the controlled corporation must each be engaged, immediately after the distribution, in the active conduct of a trade or business that has been carried on for the previous 5 years. In circumstances when the active trade or business is owned in a partnership or limited liability company (LLC) taxable as a partnership, under certain circumstances, the active trade or business will be imputed to the distributing or controlled corporation for purposes of meeting the 5 year active trade or business test. Under prior rulings and proposed regulations, a "look-through" for this purpose is allowed if (a) the corporation has a significant interest in the partnership (which means it owns at least 1/3 of the partnership or LLC interests), AND (b) the corporation performs active and substantial management functions for the partnership or LLC with respect to the trade or business assets or activities.

Under a recently issued Revenue Ruling, the IRS has liberalized the look-through rules. Under the new rules, there are now two different ways to qualify for look-through treatment. First, a corporation can impute the trade or business activities of the partnership or LLC if it has a "significant interest" in the partnership or LLC – for this purpose, a "significant interest" is a 1/3 or greater ownership interest. The second way is if the corporation owns less than a significant interest, but performs active and substantial management functions for the partnership or LLC.

The new Revenue Ruling applies to an LLC that is taxable as a partnership. There is no reason that these rules should not also apply to an actual partnership.

These concepts appear to have been borrowed from the continuity of business enterprise rules in the corporate reorganization area, which apply similar requirements of "significant interest" and/or active and substantial management functions in regard to qualifying the continuity requirements by reason of a look-through for a partnership or LLC.

Rev Rul 2007-42, 2007-28 IRB