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Exempt organization developments.

In Kern County Electrical Pension Fund, 96 TC No. 41 (1991), the Tax Court held that a tax-exempt pension fund was taxable on the net interest on certificates of deposit (CDs) when these certificates were obtained with the proceeds of a loan collateralized with other CDs.

In 1978, the pension fund owned three CDs totaling $750,000 with maturity dates in 1983. In 1980, the board of trustees borrowed money to purchase CDs with higher interest rates; the old certificates were used as collateral for the loan. The trust thereby earned $33,989 more than the amount of interest that would have been paid on the old CDs. The court held that the collateralization of the old CDs constituted acquisition indebtedness and, therefore, the new CDs were debt-financed property. Thus, the income earned thereon was taxable as unrelated business income under Sec. 514.

In rejecting several of the trust's arguments for nontaxation of the excess interest, the court held that --the excess interest did not merely represent additional exempt interest on the old CDs; the pension fund was obligated to abide by the consequences of the transactional form it chose, and the court was unwilling to recharacterize the collateralization of old CDs as the acquisition of old and new ones; and --the transaction was not a payment with respect to a security loan as defined in Sec. 512(a)(5); hence, it was not exempt.

Community trusts often form an affiliated organization (sometimes referred to as a "donor-directed fund") to collect and distribute contributions from individual donors. Each individual donor retains the authority to direct the fund to distribute each donor's contributions. Each individual donor retains the authority to direct the fund to distribute gifts from his account to a qualified public charity. Most community trusts have assumed that donor-directed funds are private foundations as described in Sec. 170(b)(1)(E)(iii), and have obtained IRS determination letters to that effect. Private foundations are generally subject to an excise tax under Sec. 4940 on their net investment income as well as numerous other restrictions and burdensome reporting requirements.

The author understands that a favorable private letter ruling, based on GCM 39748 and Rev. Rul. 73-504, concludes that a donor-directed fund may retroactively qualify as a nonprivate foundation (i.e., as a "public charity"), provided the fund satisfies the public support test of Sec. 170(b)(1)(A)(vi) and does not receive contributions as an agent of the ultimate charitable recipient. As such, donor-directed funds may avoid the tax on net investment income as well as the private foundation restrictions and reporting requirements, and obtain refunds of the tax on net investment income for open years. (Note: This ruling will not be published or otherwise made available to the public; see Regs. Secs. 301.6110-1(a) and 301.6104(a)1(i)(5).)

The IRS ruled in Letter Ruling 9112006 that implementation of a proposed incentive compensation plan by a tax-exempt medical clinic would not result in private benefit or inurement and would therefore not adversely affect the clinic's exempt status under Sec. 501(c)(3), provided that all payments under the plan remained within the range of reasonable compensation. The plan covered all employees of the clinic, including physicians and support staff. Individuals on the clinic's governing body, comprised of physician-employees, were also covered. This ruling may be helpful to those assisting exempt organizations in structuring similar plans.
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Author:Royalty, Phillip G.
Publication:The Tax Adviser
Date:Jan 1, 1992
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