The Chief Counsel Advice (CCA 202504014) memorandum discusses the examination of a tax-exempt private foundation (the Foundation) and its financial dealings with business entities owned and operated by its foundation manager. Here’s a breakdown of the key facts:

Foundation Formation and Management: The Foundation was incorporated in State 1 and recognized by the IRS as a private nonoperating foundation. It was initially funded with stock by Foundation Manager 1 and Foundation Manager 2, who are spouses. These two individuals have served as the sole members of the Foundation’s board and as its only officers. Therefore they are "foundation managers". Investment decisions, including loans, were primarily made by Foundation Manager 1.
Loans to Company 1: Company 1 was formed by Foundation Manager 1. He served as its ------------ and ------ and, in Year 7, owned more than 35% of the company’s voting stock, though this interest later decreased. The Foundation issued multiple unsecured balloon loans to Company 1. Company 1 received its largest loans in Year 6 and 7, totaling $F and $G respectively. Company 1 paid interest quarterly, and by Year 15, had an outstanding principal balance of $H.
Loans to Company 2: Company 2 was formed by Foundation Manager 1 as a State 2 limited liability company. State 2 is a community property state. Foundation Manager 1 owned C percent of the profits interest in Company 2, and Foundation Manager 2 was also active in the company’s operations. In Year 13, the Foundation Managers acquired 100 percent of Company 2. Company 2 received at least I loans from the Foundation each year between Year 3 and Year 12, and failed to make interest payments on some of these loans. By the end of Year 12, Company 2 owed the Foundation $J in unpaid principal. The loans to both Company 1 and Company 2 made up a substantial portion of the Foundation’s assets.
Loan Terms and Extensions: The loans were generally for a --------year repayment period with interest paid quarterly at the --------------------------percent. Extensions on the loans were granted in multiple years, with Foundation Manager 1 signing the extension letters on behalf of both the Foundation and the companies. The Foundation did not keep board meeting minutes reflecting approval of the loans.
Attempted Transfer of Company 2 Notes: In Year 13, Foundation Manager 1 planned to purchase the remaining equity in Company 2. The Foundation’s tax return preparer proposed transferring the Company 2 notes to public charities at zero-dollar value to remove them from the Foundation’s books. The Foundation and Company 2 modified the notes, extending the repayment period by --- years to Date 3 and reducing the interest rate to ---- percent. Foundation Manager 1 signed the modification agreement on behalf of both the Foundation and Company 2. Although the Return Preparer reported the transfers on the Foundation’s Year 13 Form 990-PF, the notes were never actually transferred.
Company 2 Entity Classification: Company 2 filed partnership returns for the Year 15 and Year 16 tax years, but did not file a Form 8832 to change its entity classification from a disregarded entity to a partnership. The IRS accepted the Foundation Managers’ treatment of Company 2 as a disregarded entity for tax purposes, consistent with Rev. Proc. 2002-69, because they are spouses in a community property state who treated the LLC as a disregarded entity.
Foundation’s Stance: The Foundation conceded that an act of self-dealing occurred with respect to the Company 2 notes in Year 13 and proposed to correct this by transferring the notes to public charities.
Overall Financial Situation: At year-end Year 12, the face value of the Foundation’s loans to Company 1 and Company 2 comprised over ----percent of its assets by fair market value as reported on its Form 990-PF, and the loans comprised almost --- percent of its assets by book value at the beginning of calendar-year Year 13.

The CCA memorandum goes on to analyze these facts in relation to private benefit, self-dealing, correction, and jeopardizing investments.

Operation of the Foundation for Private Benefit

The Chief Counsel Advice (CCA) memorandum addresses the issue of whether the Foundation was operated for private benefit, and concludes that it was. Here’s a breakdown of the legal analysis and its application to the facts of this case:

Analysis of the Law

Exempt Purpose Requirement: Section 501(c)(3) of the Internal Revenue Code grants tax exemption to organizations that are organized and operated exclusively for one or more exempt purposes, such as religious, charitable, or educational purposes.
Primary Activities: To be considered as operating exclusively for exempt purposes, an organization must primarily engage in activities that accomplish those exempt purposes. An organization will not be regarded as operating for exempt purposes if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
Public vs. Private Interest: An organization must serve a public rather than a private interest to be considered as operating for exempt purposes. It cannot be organized or operated for the benefit of private interests such as designated individuals, the creator or their family, shareholders of the organization, or persons controlled by such private interests.
Serving as a Private Source of Credit: When an exempt organization serves as a private source of credit for its founder, it is considered to be serving private rather than public interests.
Substantial Nonexempt Purpose: The presence of a single nonexempt purpose, if substantial in nature, will preclude exemption, regardless of the number or importance of truly exempt purposes.
Burden of Proof: An organization claiming 501(c)(3) status has the burden to establish that it is not operated for the benefit of private interests.

Application of Law to the Facts

Loans to Companies Controlled by Foundation Manager: The Foundation made a substantial number of unsecured loans, totaling over $B in principal, to two companies (Company 1 and Company 2) that were founded, partially owned, and operated by Foundation Manager 1.
- Through his control of the Foundation’s investment decisions, Foundation Manager 1 was able to direct significant amounts of capital to his two businesses.
- Company 1 received significant loans, especially in its early years.
- Company 2 also received regular loans from the Foundation.
- These loans constituted substantially all of the Foundation’s assets.
Foundation as “Incorporated Pocketbook”: The memorandum argues that the Foundation was operated by Foundation Manager 1 as an “incorporated pocketbook” where he could transfer assets and retain control, directing them towards his private business interests. This arrangement does not qualify for 501(c)(3) status.
Benefits Beyond Dollar Amounts: Company 1 and Company 2 benefited by avoiding the formalities and delays of applying for commercial loans, as the Foundation was a readily available source of credit.
Lack of Loan Enforcement: Due to Foundation Manager 1’s position on both sides of the loan transactions, the Foundation was unlikely to enforce loan terms, as demonstrated by the Foundation not seeking to enforce loan terms when Company 2 failed to make interest payments.
Loans Motivated by Private Needs: The Foundation continued to lend to Company 2 despite its history of not making payments, which suggests the loans were motivated by the company’s need for funds, rather than any return provided to the Foundation.
Control and Conflict of Interest: The Foundation’s two-person board was fully controlled by Foundation Managers 1 and 2 who used this control to direct the Foundation’s assets to their business interests. The memorandum questions whether the loans were reasonable investments due to Foundation Manager 1’s significant involvement in Company 1 and Company 2. The lack of records of loan reviews by disinterested directors further undermines the idea that the loans were in the best interest of the Foundation.
Substantial Nonexempt Purpose: The loans to Company 1 and Company 2 served the private interests of the Foundation Managers by providing a private source of credit for their business interests. This resulted in the Foundation operating for a substantial nonexempt purpose.
Charitable Activities Not Sufficient: The Foundation’s charitable activities are not sufficient to overcome the substantial nonexempt purpose of benefiting the Foundation’s managers and their companies. Even though the Foundation made over $L in grants to charitable organizations, the presence of a substantial nonexempt purpose precludes tax exemption.
Conclusion: The Foundation’s actions served the private interests of the foundation manager and his businesses, causing the Foundation to be operated for a substantial nonexempt purpose, which warrants the revocation of the Foundation’s tax-exempt status.

Indirect Self-Dealing

The Chief Counsel Advice (CCA) memorandum addresses the issue of whether the Foundation engaged in indirect acts of self-dealing under section 4941(d)(1)(E) of the Internal Revenue Code, and concludes that it did. Here’s a breakdown of the legal analysis and its application to the facts of this case:

Analysis of the Law

Excise Tax on Self-Dealing: Section 4941(a)(1) of the Internal Revenue Code imposes an excise tax on each act of self-dealing between a disqualified person and a private foundation.
Definition of Self-Dealing: Section 4941(d)(1)(B) defines “self-dealing” to include any direct or indirect lending of money or other extension of credit between a private foundation and a disqualified person. Section 4941(d)(1)(E) expands this to include any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation.
Definition of Disqualified Person: Section 4946 defines the term “disqualified person”. This includes:
- Substantial contributors to the foundation
- Foundation managers (officers, directors, or trustees)
- Family members of substantial contributors or foundation managers
- Corporations or partnerships in which a substantial contributor, foundation manager, or their family members own more than 35% of the total combined voting power or profits interest.
Indirect Self-Dealing:
- Treas. Reg. § 53.4941(d)-1(b)(4) states that a transaction between a private foundation and an organization not controlled by the foundation and not described in section 4946(a)(1)(E), (F), or (G) because persons described in section 4946(a)(1)(A), (B), (C), or (D) own no more than 35 percent of the total combined voting power or profits or beneficial interest of such organization, shall not be treated as an indirect act of self-dealing solely because of the ownership interest of such persons in such organization.
- Treas. Reg. § 53.4941(d)-2(f)(2) states that the fact that a disqualified person receives an incidental or tenuous benefit from the use by a foundation of its income or assets will not, by itself, make such use an act of self-dealing.
Use of Assets for Benefit of Disqualified Person: Rev. Rul. 77-160, 1977-1 C.B. 351, provides that payment of a disqualified person’s church membership dues by a private foundation is not an incidental or tenuous benefit and is an act of self-dealing under section 4941(d)(1)(E).
Precedent from Rollins v. Commissioner: The Tax Court’s decision in Rollins v. Commissioner, T.C. Memo. 2004-260, held that a qualified employee plan trustee engaged in prohibited transactions under section 4975(c)(1)(D) when the trustee caused the plan to lend money to three entities in which the trustee owned minority (less than 35-percent) interests. Section 4975(c)(1)(D) is a provision that closely parallels section 4941(d)(1)(E).

Application of Law to the Facts

Foundation Managers as Disqualified Persons: The memorandum confirms that Foundation Managers 1 and 2 are disqualified persons with respect to the Foundation under section 4946(a)(1)(A), (B), and (D).
Company 1 and Company 2 as Not Initially Disqualified Persons: During the years under examination, Foundation Manager 1 owned less than 35% of Company 1’s voting power, and Company 1 was not a disqualified person. Prior to Year 13, Company 2 was also not a disqualified person because the Foundation Managers’ interest was less than the required 35%. Therefore, the loans to Company 1 and Company 2 do not fall under the definition of self-dealing described in section 4941(d)(1)(B).
Loans as Use of Foundation Assets: The loan transactions resulted in the transfer of over ----percent of the Foundation’s assets by fair market value to entities founded, partially owned, and operated by Foundation Manager 1.
Benefit to Foundation Manager 1: The loans enabled Foundation Manager 1 to obtain financing for his two businesses. The loans therefore constitute the use of Foundation assets for the benefit of a disqualified person, and thus were an indirect act of self-dealing.
Application of Rollins v Commissioner: The analysis is supported by the Rollins v. Commissioner case, where the Tax Court concluded that loans made by a trustee of a qualified plan to business entities in which the trustee owned minority interests were a use of plan assets for the benefit of a disqualified person. Similar to the trustee in Rollins, Foundation Manager 1 sat on both sides of the loan transactions, controlling the decision to loan Foundation funds while also serving as an officer of Company 1 and a -------------------------of Company 2.
Ownership Interest Not Sole Factor: While Treas. Reg. § 53.4941(d)-1(b)(4) indicates that transactions with organizations where disqualified persons own less than 35% are not considered self-dealing “solely because of the ownership interest,” the memorandum emphasizes that other factors can lead to a finding of self-dealing. In this case, these factors included Foundation Manager 1’s control over the Foundation’s investment decisions, his use of that control to lend a large amount of money to businesses he founded, partially owned, and operated, and the lack of board minutes reflecting review of the loans or any alternative investment options.
Benefit Not Incidental or Tenuous: The memorandum concludes that the benefit received by Foundation Manager 1 was substantial, economic, and not merely incidental or tenuous, thus not falling under the exception provided in Treas. Reg. § 53.4941(d)-2(f)(2). The loans were a significant portion of the Foundation’s assets, made on favorable terms to the business entities, and with loan extensions liberally granted.
Conclusion: The loans from the Foundation to Company 1 and Company 2 constituted indirect acts of self-dealing under section 4941(d)(1)(E) because they represented a use of Foundation assets for the benefit of Foundation Manager 1, a disqualified person.

Correction of the Company 2 Loan Transaction

The Chief Counsel Advice (CCA) memorandum addresses the issue of whether the Foundation’s proposed transfer of the Company 2 promissory notes to public charities constitutes a correction of a self-dealing transaction, and concludes that it does not. Here’s a breakdown of the legal analysis and its application to the facts of this case:

Analysis of the Law

Definition of Correction: Section 4941(e)(3) of the Internal Revenue Code defines “correction” of an act of self-dealing as "undoing the transaction to the extent possible, but in any case placing the private foundation in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards."
Use of Foundation Property: Treas. Reg. § 53.4941(e)-1(c)(4)(i) provides that when a disqualified person has used property owned by a private foundation, undoing the transaction includes, but is not limited to, terminating the use of such property. Additionally, the disqualified person must make certain payments to the private foundation.
Examples of Correction: Treas. Reg. § 53.4941(e)-1(c)(4)(ii) provides examples of self-dealing involving the rental of office space from private foundations. These examples show that to correct the act of self-dealing, the disqualified person must terminate their use of the property.

Application of Law to the Facts

Self-Dealing in Year 13: The Foundation conceded that self-dealing occurred in Year 13 under section 4941(d)(1)(B) because the Foundation Managers acquired 100 percent of the interest in Company 2, making it a disqualified person, while loans from the Foundation to Company 2 were still outstanding.
Company 2 as a Disregarded Entity: Although Company 2 filed partnership returns in Years 15 and 16, the memorandum concludes, based on Rev. Proc. 2002-69 and Treas. Reg. § 301.7701-3(c)(1)(i), that Company 2 remained a disregarded entity for federal tax purposes for those years. This is because, as a limited liability company wholly owned by a married couple in a community property state, the Foundation Managers could choose to treat Company 2 as a disregarded entity, and they did not file Form 8832 to change its classification. Therefore, for tax purposes, the activities of Company 2, including any self-dealing, are attributed to its owners, the Foundation Managers, who are disqualified persons with respect to the Foundation.
Indirect Self-Dealing Prior to Year 13: The memorandum reiterates that the Company 2 loans constituted indirect self-dealing between the Foundation and Foundation Manager 1 under section 4941(d)(1)(E) prior to Year 13.
Proposed Correction: The Foundation proposed to correct the self-dealing by assigning and distributing the Company 2 promissory notes to public charities. The intent was to remove the loans from the Foundation’s books.
Proposed Correction is Insufficient: The memorandum concludes that the proposed transfer of the Company 2 notes to public charities would not constitute correction as defined in section 4941(e)(3).
- No Termination of Use: The transfer would not result in the termination of the use of property by the disqualified person. Although the Foundation would no longer hold the notes, Company 2 would continue to use the loaned funds until Date 3.
- No Undoing of the Transaction: The transfer would not undo the loan transactions nor would it make the Foundation whole. Instead, the proposed correction would allow Company 2 to continue to use the loans on a long-term basis.
Required Action: The memorandum emphasizes that, at a minimum, the Foundation’s loans to Company 2 must be repaid to correct the act of self-dealing. This is consistent with the principles outlined in section 4941(e)(3) and Treas. Reg. § 53.4941(e)-1(c)(4).
Conclusion: The Foundation’s proposed transfer of the Company 2 notes to public charities is insufficient to correct the acts of self-dealing. To properly correct the situation, the loans must be repaid, as the self-dealing involves the use of foundation property, and correction requires termination of the use of such property and the making of payments to the foundation.

Application of IRC §4944 to the Company 2 Note Transactions

The Chief Counsel Advice (CCA) memorandum addresses the issue of whether the Year 13 modification of the Company 2 promissory notes constituted a jeopardizing investment under section 4944 of the Internal Revenue Code, and concludes that it did. Here’s a breakdown of the legal analysis and its application to the facts of this case:

Analysis of the Law

Excise Tax on Jeopardizing Investments: Section 4944(a)(1) imposes an excise tax on any amount invested by a private foundation in a manner that jeopardizes the carrying out of any of the foundation’s exempt purposes.
Definition of Jeopardizing Investment: Treas. Reg. § 53.4944-1(a)(2)(i) provides that an investment is considered to jeopardize the carrying out of a foundation’s exempt purposes if the foundation managers failed to exercise ordinary business care and prudence under the facts and circumstances at the time of making the investment, in providing for the long- and short-term financial needs of the foundation.
- This includes taking into account the expected return, risks of price fluctuations, and the need for diversification within the investment portfolio.
- The determination is made on an investment-by-investment basis, considering the foundation’s portfolio as a whole.
- The determination of whether an investment jeopardizes the foundation’s exempt purposes is made at the time the investment is made, not based on hindsight.
Change in Form or Terms of Investment: Treas. Reg. § 53.4944-1(a)(2)(iii) states that if a private foundation changes the form or terms of an investment after December 31, 1969, it will be considered to have made a new investment on the date of the change, and a determination of whether this new investment jeopardizes the foundation’s exempt purposes must be made. This excludes changes solely due to a corporate reorganization.
Prudent Trustee Approach: The Senate Committee on Finance report on the Tax Reform Act of 1969 indicates that the determination of whether an investment is jeopardizing is to be made “in accordance with a ‘prudent trustee’ approach.”
- This prudent trustee standard, or prudent investor standard, requires the trustee to invest and manage funds as a prudent investor would, considering the purposes, terms, distribution requirements, and other circumstances of the trust.
- A key factor is whether the trustee acted in the best interest of the trust beneficiary.
- The presence of a conflict of interest between a foundation manager and a private foundation is relevant when determining if an investment is jeopardizing.
Procedures for Conflicts of Interest: Comment d of section 2.02 of the Restatement of Charitable Nonprofit Organizations provides that a procedure for authorizing transactions with a conflict of interest should require that (1) the fiduciary with the conflict disclose it, (2) the fiduciary delegate the ultimate decision to nonconflicted board members, and (3) the nonconflicted board members determine the transaction is fair to the charity.

Application of Law to the Facts

Company 2 Notes as Investments: The Company 2 notes were considered investments of the Foundation.
Modification of Loan Terms: In Year 13, the Foundation and Company 2 modified the terms of the notes, reducing the annual interest rate from ----------- percent to -- percent and extending the loan term by ----years to Date 3. This change in the terms of the investment means that the Foundation is considered to have made a new investment at the time of the modification.
Conflict of Interest: At the time of the modifications, Foundation Manager 1 was in the process of acquiring, or had already acquired, 100 percent of the interest in Company 2. Foundation Manager 1 represented both Company 2 and the Foundation in their loan dealings, creating a conflict of interest. There is no evidence of bargaining for the loan modifications, and they were made in conjunction with the Foundation’s plan to grant the notes to public charities in order to facilitate Foundation Manager 1’s acquisition of Company 2.
Lack of Independent Review: Because the Foundation Managers were the Foundation’s sole managers and board members, there were no independent board members who could review and approve the proposed modifications to ensure that they represented prudent, non-jeopardizing investments.
Failure to Exercise Ordinary Business Care and Prudence: The memorandum concludes that Foundation Manager 1 did not act prudently in agreeing to the loan modifications. The modifications were a significant benefit to Company 2 (reduced interest rate and extended loan term) with no benefit to the Foundation. Given the conflict of interest, the fact that the loans were a significant percentage of the Foundation’s assets, and the fact the modifications were made with no consideration to the Foundation, Foundation Manager 1 did not exercise ordinary business care and prudence.
Additional Factors Showing Jeopardizing Investment:
- The extension of the loan term from short-term to long-term increased the Foundation’s risk of loss, especially considering Company 2’s inconsistent payment history.
- The Foundation did not seek to secure the loans, despite the risks involved and the fact that Company 2 had previously shown itself to be inconsistent in honoring the terms of the notes.
- The significant reduction in interest rate, without any documentation of the basis for the reduction or consideration of alternative options, was detrimental to the Foundation.
Conclusion: The Year 13 loan modifications fell well short of the prudent investor standard and constituted jeopardizing investments under section 4944.

The full memorandum may be read at https://www.irs.gov/pub/irs-wd/202504014.pdf

Prepared with the assistance of NotebookLM.