Private Inurement Trumps Tax Exemption

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September 26, 2007

The IRS published a private determination revoking the exemption of a private grant-making foundation under Internal Revenue Code (“Code”) section 501(c)(3). The determination is a good example of how the private use of an organization’s assets can defeat its entitlement to the significant benefits of tax exemption.

To preserve its exemption, a code section 501(c)(3) entity must, among other things, (i) operate exclusively for one or more charitable, educational or similar exempt purposes, and (ii) avoid private inurement of net earnings (and, as explained in the corresponding regulations, avoid private benefit generally). In Letter Ruling 200730031, the IRS concluded that a foundation failed these tests because of payments that improperly benefited its trustees and grants made to individuals for personal reasons.

What did the foundation do wrong? Well . . .

The foundation paid airfare, lodging, meals and car rental for a 10-day trip to Orlando, Florida, for both of the organization’s trustees and their children. The foundation’s explanation (i.e., the trip was for the purpose of touring two hospitals that were prospective grantees) did not fly – the tours took about 4 hours over a two-day period, and no grants were made to either hospital.
The foundation donated an automobile received from its founders to an individual without seeking prior grant-making authority from the IRS, following established procedures for selecting grantees, or exercising responsibility over the individual’s use of the vehicle.

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This certainly was an egregious case. But private foundations of all shapes and sizes are under closer scrutiny and using a foundation’s resources to make questionable payments to donors, directors, trustees or friends waves a red flag for the IRS in any audit.

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