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Form 990-PF instructions adversely affect some grant-making foundations.

Nonoperating private foundations. with income from charitable activities should be aware that the instructions to Form 990-PF reduce the amount of the foundation's qualifying distributions in a way not contemplated by the law or regulations. This result occurs when the foundation derives income from its charitable activities. The proper calculation of qualifying distributions is important, with implications for current and future years, because a private nonoperating foundation must make qualifying distributions at least equal to the required amount for the year or face penalties under Sec. 4949, until the shortfall is corrected.

In general, the required amount of qualifying distributions equals the foundation's minimum investment return--5% of the net fair market value of the foundation's noncharitable assets--reduced by the excise tax on net investment income and any unrelated business income tax (UBIT) (Sec. 4942(d)). Qualifying distributions generally are amounts paid to accomplish charitable purposes, including reasonable and necessary administrative expenses paid to support the foundation's charitable activities; amounts paid to acquire assets used directly in a charitable activity, and certain amounts set aside for specific charitable projects (Sec. 49421(g)).

In calculating its qualifying distributions, a private nonoperating foundation computes the cash expenses paid to support its charitable activities, such as grant-making expenditures. These expenses are added to amounts distributed for charitable activities, and all amounts are entered on Form 990-PF, Page 1, Part 1, Column d as "disbursements for charitable purposes." The total of the expenditures listed in Column d of Part I also is entered on Page 7, Part XII, along with other types of qualifying distributions (program-related investments, amounts paid to acquire assets used directly in a charitable activity and certain amounts set aside for charitable purposes). Total qualifying distributions from Part XII are carried to Part XIII of Form 990-PF to be applied to any prior year deficit in required distributions, and to the current year distribution requirement. In these regards, the form and instructions follow the statutory and regulatory provisions for a private foundation that has no income from a direct charitable activity.

However, there is a gap between the statute and the instructions to the form in the case of a private nonoperating foundation with income from charitable activities, for example, when a grant-making foundation derives some revenues (not subject to UBIT) from selling educational materials or charging fees for providing charitable services. The instructions for Form 990-PF act to decrease qualifying distributions by the lesser of the amount of income the foundation receives from a charitable activity or the expenses directly allocable to the production of that income. iCompare definitions of adjusted net income (Sec. 4942(f)) and qualifying distributions (Sec. 4942(g)) with 1991 Form 990-PF instructions pages 10-11.)

Ii a private nonoperating foundation derives income from a charitable activity, the income is entered on Form 990-PF, Part 1, Column c ("adjusted net income"). The instructions to the form require a private nonoperating foundation to allocate the costs incurred to produce that income-expenditures that would be qualifying distributions--to the income in Column c. The amount of expenses allocated to Column c is limited to the amount of the charitable activity income. Any expenses directly related to the charitable activity income that exceed the income from the activity are entered in Column d, and hence are carried forward in the return as qualifying distributions. By contrast, expenses entered in Column c simply offset some or all of the income from charitable activities, and are not carried to any other portion of the form. The Column c expenses thus drop out of the calculation of the foundation's total qualifying distributions.

There appears to be no statutory or regulatory basis for this reduction. The Service contends that the Form 990-PF instructions reflect its interpretation of the law. It appears, however, that in requiring an allocation of expenses to Column c, the IRS is applying portions of Sec. 4942 prior to amendment by the Economic Recovery Tax Act of 1981 (ERTA). Prior to the ERTA, private nonoperating foundations were required to distribute the greater of the minimum investment return (reduced by UBIT and excise taxes) or the adjusted net income. Now that the calculation of adjusted net income no longer applies to nonoperating foundations, there is no basis for requiring expense allocations against charitable activity income on Form 990-PF. If the Service believes that the law should operate to reduce qualified distributions by those expenses that generate charitable activity income, an amendment to the statute would be required. Under the current law, there are no explicit provisions for this reduction.

From Karen Dingfelder, CPA, Washington, D.C.
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Dingfelder, Karen
Publication:The Tax Adviser
Date:Jul 1, 1992
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