The termination or liquidation of a private foundation is generally governed by Internal Revenue Code section 507, applicable state law, and the governing documents of the private foundation. The process to advance depends on various factors, including whether the private foundation is a nonprofit corporation or an unincorporated charitable trust.
At the federal level, Section 507(a) of the IRC provides: “Except as provided in subsection (b),” the status of a private foundation shall be terminated only if the private foundation notifies the IRS of the foundation’s intent to terminate and either the private foundation pays the tax imposed by subsection 507(c) or the entire amount of such tax is abated under subsection 507(g).
Section 507(c) imposes a tax on each organization whose private foundation status is voluntarily terminated under section 507(a). The tax imposed is equal to the lower of: (1) the amount which the private foundation substantiates as the aggregate tax benefit resulting from the section 501(c)(3) status of such foundation, or (2) the value of the net assets of the foundation.
To avoid the termination tax, the private foundation may, as part of a plan of liquidation, transfer its assets to a private foundation, either by transfer or merger, or otherwise ensure that, at the time of notification to the IRS, the value of the net assets of the foundation is appropriately zero. Before deciding a path for liquidation – and certainly before providing the IRS with statutory notice of termination – the private foundation is wise to consider, at a minimum, IRS Rev. Rul. 2002-28, 2002-20 I.R.B. 941 and its Situations 1, 2, and 3, as well as state law requirements for dissolution and termination.
All good things come to an end, and the good that private foundations do is no exception. Bringing those good things to a compliant end should be carefully considered from a federal, state, and internal level.
