E.2. Permitted — Publication 5590

(1) Treas. Reg. 53.4945-6(b)(1) describes several types of expenditures which will

not be treated as taxable expenditures under Section 4945(d)(5). They include the following:

a. Expenditures made to acquire investments and related investment expenses

(for the purpose of obtaining income or funds to be used in furtherance of purposes described in Section 170(c)(2)(B));

b. Expenditures made to pay taxes;

c. Expenditures made to pay expenses that qualify as deductions for purposes

of determining Section 511 unrelated business income tax;

d. Payments constituting a deduction under Section 4940 or qualifying

distributions under Section 4942(g);

e. Reasonable expenditures to evaluate, acquire, modify, and dispose of

program-related investments; and

f. Business expenditures by the recipient of a program-related investment.

(2) For example, in Rev. Rul. 77-161, 1977-1 C.B. 358, a private foundation made a

loan to a disqualified person. The loan was at a reasonable interest rate, adequately secured and met prudent investment standards. The IRS concluded that the loan was not automatically a taxable expenditure under Section 4945(d)(5) even though it was a self-dealing act under Section 4941.

(3) Conversely, any unreasonable administrative expenses, including salaries,

consultant fees, and other fees for services rendered are taxable expenditures

under Section 4945(d)(5) unless the foundation can demonstrate that the expenses were paid or incurred in the good faith belief that they were reasonable and that payment or incurring of such expenses in such amounts was consistent with ordinary business care and prudence. See Treas. Reg. 53.4945-6(b)(2).

Example: In Kermit Fischer Foundation v. Commissioner, T.C. Memo. 1990-300, the sole trustee of a private foundation received annual compensation of as much as $45,000 during the tax years under examination. In addition, the private foundation paid the costs of his office, two automobiles, and a computer while its assets during this same tax years never exceeded $211,268. The Tax Court concluded that the trustee’s salary was excessive and unreasonable in view of facts and circumstances. It cited the following facts and circumstances for its conclusion: the trustee kept no records of services performed and time spent thereof, payments of compensation correlated with his personal financial needs and was in irregular amounts, the large amount of the salary received in relation to the private foundation’s small corpus, and the small percentage of money actually donated to charity. As to the other expenditures, the court noted that the rental of office space and purchase of the computer and automobiles were not necessary to the operations and investments of the private foundation. Thus, the Tax Court held that these expenditures were taxable expenditures under Section 4945(d)(5).

(4) Under certain circumstances, a private foundation may indemnify a foundation

manager for expenses incurred in contesting a Chapter 42 tax and in certain state legal proceedings. See Treas. Reg. 53.4941(d)-2(f)(3) as to "reasonable administrative expenses" being a Section 170(c)(2)(B) expense.

(5) For example, in Rev. Rul. 82-223, 1982-2 C.B. 301, a private foundation suffered

a loss of assets in a transaction involving its foundation manager. The foundation manager’s actions were not willful or without reasonable cause. State officials sued the manager under state laws relating to the mismanagement of funds of charitable organizations. Under an existing indemnification agreement, the foundation proposed to indemnify the manager for attorney fees, court costs, and the amount paid in settlement of the suit from its own assets.

(6) The private foundation also proposed to pay the premiums for an insurance policy

that would provide liability insurance to its foundation manager for liabilities, including settlement amounts, arising from a state mismanagement proceeding. The premiums paid by the foundation would be treated as part of the compensation paid to the manager. The purchase of insurance for indemnification is a common practice which enables an organization to attract and retain qualified management personnel. Therefore, payments of the premiums for such an insurance policy would not be taxable expenditures within the meaning of Section 4945(d)(5) and Treas. Reg. 53.4945-6(b)(2) because such expenses constitute reasonable administrative expenses and, thus, are incurred for charitable purposes within the meaning of Section 170(c)(2)(B).

(7) Similarly, the payment of attorney’s fees and court costs in connection to the

foundation manager’s employment would ordinarily be treated as part of his/her

compensation and, if reasonable, would not be an unreasonable administrative expense under Treas. Reg. 53.4945-6(b)(2). However, the proposed indemnification of the settlement amount would constitute a payment in satisfaction of the foundation manager’s personal liability. As such, it would primarily benefit the foundation manager, would be unreasonable administrative expense under Treas. Reg. 53.4945-6(b)(2), and would constitute an expenditure for a purpose other than one of the charitable purposes specified in Section 170(c)(2)(B).