Commentary: The rules for private foundation dissolution

Daily Record (Rochester, NY), Oct 10, 2008 by Anthony G Sandonato

Many people who set up private foundations hope they will continue for generations.

Yet a variety of factors conspire against that, ranging from the death of the original founder to a desire for greater privacy in charitable affairs. A popular solution is to dissolve the foundation and distribute its assets to a public charity.

Advisors to high net worth individuals need at least a working knowledge of the issues involved in winding down such entities, and should be able to recommend alternative charitable tools to their clients.

The easiest way for a private foundation to terminate is for its assets to be transfered to one or more public charities described in Internal Revenue Code (IRC) Sect. 509(a)(1) -- those that are publicly supported and have been in existence for more than 60 months. A private foundation that chooses that path does not have to give the IRS advance warning of its intention to terminate. It is obliged to note on the 990-PF for the year in which the transfer has occurred that it will be the organization's final return.

Private foundations that transfer their assets to something other than publicly-supported charities do not automatically terminate their private foundation status. They must notify the IRS of their intention to terminate in order to free themselves permanently from the obligations of private foundation status (filing Form 990-PF, paying excise tax and so forth). With the required notification comes the imposition of a termination tax, a levy designed to recapture all of the tax benefit the private foundation ever provided to its donors. The so-called termination tax is the lesser of the aggregate tax benefits the organization's private foundation status provided, or the net fair market value of the organization's assets.

Two recent IRS Revenue Rulings (2002-28 and 2003-13) recommend a two-step approach for private foundations seeking to terminate and distribute assets to organizations other than long-established, publicly-supported charities.

First, private foundation should distribute its assets. The IRS recommends the distribution be made to other private foundations, newly-created, publicly-supported charities and supporting organizations. Distributions to an individual will not qualify for the two-step relief provision, and the termination tax still will be imposed.

Secondly, as soon as the day after such distributions are made, the foundation should notify the IRS of its intention to terminate. Due to the fact that the private foundation will have no net assets on that date, the termination tax will be zero; however, the foundation's notice to the IRS must detail the computation and amount of tax imposedeven though the bottom line will be no tax.

When a private foundation makes a terminating distribution and notifies the IRS of its intention to terminate, it must file a Form 990-PF for the taxable year in which the distribution was made. It has no further IRS filing requirements, but may have state-level dissolution requirements.

With careful planning and a knowledge of the rules, private foundations can wind down operations without incurring a stiff tax liability.

Anthony G. Sandonato is a principal with Mengel, Metzger, Barr and Co. in Rochester. He can be reached at (585) 423-1860 or asandonato@mmb-co.com.