E. Termination Tax — 0824 Publ 5580 (PDF)

(1) This section focuses on those situations when tax is due under Section 507 for

termination of private foundation status. The termination tax acts like a third tier excise tax. The phrase “termination” has several different meanings in the context of private foundations. The term is ordinarily used when an entity dissolves or goes out of business. For a private foundation, however, termination of foundation status doesn’t necessarily mean dissolution has occurred. Termination for Section 507 purposes means any of the following:

a. The foundation notifies the IRS and pays the Section 507(c) tax (if any)

(Section 507(a)(1)).

b. The IRS involuntarily terminates the foundation and imposes Section 507(c)

tax (Section 507(a)(2)).

c. The foundation transfers all of its net assets to certain public charities

(Section 507(b)(1)(A)).

d. The foundation becomes a public charity (Section 507(b)(1)(B)).

Note: Transfer under Section 507(b)(2) of all of a foundation’s net assets to one or more other foundations does not, by itself, terminate private foundation status. The foundation must separately terminate, whether voluntarily (507(a)(1)) or involuntarily (507(a)(2)).

(2) If the foundation hasn’t engaged in repeated willful acts or one flagrant, willful act

triggering Chapter 42 taxes, the foundation may opt for termination under Section 507(b)(1)(A) or (b)(1)(B). If terminated under Section 507(b)(1), the foundation pays $0 in termination taxes.

(3) If the foundation voluntarily terminates under Section 507(a)(1), the foundation

submits its final Form 990-PF and pays a termination tax ($0 tax if the foundation distributes all of its net assets before providing notice of termination). The foundation follows the instructions to the Form 990-PF as to the method of notification.

(4) Consider a Section 507(a)(2) involuntary termination (resulting in Section 507(c)

tax) when there have been multiple willful repeated acts committed under Chapter 42. Also consider Section 507(a)(2) if there has been one willful flagrant act committed triggering Chapter 42 treatment. If proposing involuntary termination, revocation may be proposed at the same time.

Note: If a private foundation’s Section 501(c)(3) status is revoked but its private foundation status is not terminated under Section 507, then the foundation becomes a taxable private foundation; it is no longer tax-exempt but still subject to Chapter 42 taxes as a private foundation. See Section 509(b) and Treas. Reg. 1.509(b)-1(b).

Note: As a practical matter, termination tax assessments are more likely to occur during a subsequent examination. Once Chapter 42 taxes have been assessed, any new violations identified in a later examination will provide proof of willfulness.

(5) Computing the termination tax requires multiple smaller computations normally

provided by the foundation:

The Termination Tax is the Smaller of:

A) The aggregate tax benefit - the sum of:	A) The aggregate tax benefit - the sum of:	B) The value of the net assets as of the date the foundation first committed a Chapter 42 violation that culminates in its Section 507 termination, or the effective termination date, whichever amount is higher. See Section 507(e)(1). Default to this amount unless the “aggregate tax benefit” is calculated.
1.	The increase in income, estate, and gift taxes** on substantial contributors that would result from the disallowance of their contributions. The taxes are computed from the later of the foundation inception date or March 1, 1913. Section 507(d)(1)(A))	The increase in income, estate, and gift taxes** on substantial contributors that would result from the disallowance of their contributions. The taxes are computed from the later of the foundation inception date or March 1, 1913. Section 507(d)(1)(A))

2.	The income taxes of the foundation, had the foundation filed Forms 1120, U.S. Corporation Income Tax Return, or Forms 1041, U.S. Income Tax Return for Estates and Trusts, in lieu of Forms 990-PF. The taxes are computed from the later of the foundation inception date or January 1, 1913.* (Section 507(d)(1)(B))
3.	The aggregate tax benefit from other private foundations in Section 507(b)(2) transfers. (Treas. Regs. 1.507-5(a)(3) and 1.507-3(a)(2))	The aggregate tax benefit from other private foundations in Section 507(b)(2) transfers. (Treas. Regs. 1.507-5(a)(3) and 1.507-3(a)(2))
4.	The accumulated interest on the above amounts as computed via Report Generated System NT (RGS NT) or Integrated Data Retrieval System (IDRS) command code INTST. (Section 507(d)(1)(C))	The accumulated interest on the above amounts as computed via Report Generated System NT (RGS NT) or Integrated Data Retrieval System (IDRS) command code INTST. (Section 507(d)(1)(C))
* For purposes of this calculation, the charitable contribution deduction allowed a trust is deemed to have been limited to 20% of taxable income. Section 507(d)(1)(B)(ii). ** For any year in which a gift tax would be due if a charitable deduction were not available, refer to the Instructions to Form 709, United States Gift (and Generation - Skipping Transfer) Tax Return, for that particular year for assistance in calculating the appropriate amount of deemed gift tax.

(6) Aggregate tax benefit is used as the amount of the termination tax only if the

foundation substantiates the amount by adequate records or other corroborating evidence. See Section 507(c)(1). As the IRS retains records for a limited period, it may not be feasible to compute the tax from the date of inception. Obtain what information is available via IDRS, return requests, and Online Statistics of Income EO Image Net (SEIN). Establish Audit Information Management System (AIMS) controls via the Reporting Compliance and Case Management System (RCCMS) using source code 45 to retrieve the returns of the substantial contributors.

(7) See IRM 4.70.14, Resolving the Examination, for guidance on converting the

Form 990-PF to Forms 1120 or 1041. Use the RGS NT to determine the increase in income tax from the disallowance of charitable contributions deductions.

(8) Propose the tax using Forms 4883 and 4621. Use Form 990-PF to assess the tax

in lieu of Form 4720.

(9) Imposition of the termination tax doesn’t eliminate liability for the underlying

Chapter 42 taxes that initiated the termination process. See Treas. Reg. 1.5071(b)(2).

(10) When you close the case as a termination, prepare Form 2363-A, Request for

IDRS Input for BMF/EO Entity Change, to update the status code, indicating the effective date in YYYYMM format:

a. Status 23: 507(a)

b. Status 24: 507(b)(1)(A) (no termination tax applies)

c. Status 25: 507(b)(1)(B) (no termination tax applies)

(11) Termination of private foundation status under Section 507 results in the

foundation being treated as an organization created on the day after termination. See Section 509(c).