Closing Up Shop: How to Successfully Shut Down a Private Foundation


The precipitous drop in wealth in the United States during the 2008–2009 financial meltdown accelerated a trend of many private foundations’ considering closing their doors. Foundations gave 8.4% less in grants in 2009 from the year before, as the value of their assets fell by 17.2%. Between 2007 and 2008, the number of active foundations grew by only 0.5%, the lowest rate since 1981 ( Foundation Growth and Giving Estimates, 2010 Edition, The Foundation Center). At least 147 private foundations had invested their assets directly in funds controlled by Bernard Madoff, and many may have been shut down as a result of Madoff’s admitted Ponzi scheme (see “Madoff and America’s (Poorer) Foundations,” by Nicholas Kristof, The New York Times, Jan. 29, 2009).


Other motivations have also fueled private foundation dissolutions. Increased awareness of donor-advised funds and other related instruments that provide many of the same benefits as a private foundation highlight the complexities of running a foundation. Individuals interested in being involved in philanthropy may not want the hassle associated with foundation administration. Additionally, some benefactors have established foundations with a limited life option, which sets a predetermined end to a foundation’s life (see Limited Life Foundations: Motivations, Experiences, and Strategies, The Urban Institute Center on Nonprofits and Philanthropy, 2009, Because of the increased interest in private foundation terminations, the IRS in May 2009 issued Publication 4779, Facts about Terminating or Merging Your Exempt Organization. CPAs should consider the facts described in Publication 4779 for foundation clients considering termination.


A primary concern of CPAs relates to the severe penalties associated with an inappropriate termination of private foundation status. Foundations that voluntarily but improperly dissolve their operations may be subject to penalties in the form of a termination tax. In addition, foundations that commit repeated willful acts or failures to act giving rise to a tax liability under the foundation tax laws may be involuntarily terminated and subject to termination tax. A single act or lapse that is willful and flagrant can also terminate the foundation (see IRC § 507(a) and Treas. Reg. § 1.507-1(c)). In many cases, the termination tax is severe, often equal to all of a private foundation’s net assets.


The amount of termination tax (section 507(c)) equals the lesser of the:

  • Aggregate tax benefit, including interest, received by both the private foundation and all substantial contributors, or
  • Value of the private foundation’s net assets.


This is by no means the only potential tax-related hazard of administering a private foundation. For more, see “Advising Private Foundations,” JofA, April 2008, page 36, and “Capital With a Conscience,” JofA, July 2008, page 54.



In 1999, Hazel and Claire each contribute $1 million to create the HC Foundation. Over the next 10 years, the foundation earns 5% annually after expenses on its endowed investments and pays out all investment income earned to public charities. No other contributions are received by the foundation over its lifetime. In 2008 and 2009, Hazel and Claire suffer significant financial losses in the stock market in their personal finances and decide in 2009 to liquidate the foundation’s net assets. On Dec. 31, 2009, Hazel and Claire transfer the foundation’s assets into their personal bank accounts to compensate for their financial losses and to pay for large, unexpected personal expenses. On the transfer date, the foundation’s net assets total $2 million. Assume that for Hazel and Claire, the tax benefit received was equal to their contributions (that is, they were able to deduct in 1999 the full amount as a charitable contribution) times the applicable marginal tax rate, which in 1999 was 39.6% (see


Hazel and Claire voluntarily transferred the foundation’s net assets into their personal accounts instead of to an appropriate organization (discussed later), so their foundation is subject to the private foundation termination tax. The termination tax is applied to the aggregate tax benefit received by both the private foundation and all substantial contributors. Substantial contributors are generally those that have given or bequeathed to the foundation an aggregate amount of more than $5,000 that also exceeds 2% percent of the total contributions and bequests received by the foundation (see section 507(d)(2)).


The tax benefit for Hazel and Claire as substantial contributors is based on the deduction for charitable contributions received for the 1999 tax year, with interest from the date of filing of the 1999 return (April 17, 2000) to the end of 2009. The IRS underpayment annual interest rate varied within the period from a high of 9% in part of 2000–2001 to a low of 4% in portions of 2003 and 2004.


Combined contributions paid in 1999


Times marginal tax rate


Tax benefit in 1999


Estimated interest*


Hazel and Claire's tax benefit in 2009



* Calculated by historical applicable underpayment interest rates, April 17, 2000, to Dec. 31, 2009, compounded daily.


The tax benefit for the foundation is based on the tax-exempt treatment of investment income earned. The annual investment income earned was 5% on assets of $2 million, or $100,000. Assuming the foundation had no other deductible expenses, the annual tax benefit for the foundation for each year 1999 through 2009 is calculated at graduated rates as follows: 15% on the first $50,000, 25% on the next $25,000 and 34% on the remaining $25,000 ($7,500 + $6,250 + 8,500 = $22,250). The total tax due at the termination date (Dec. 31, 2009) is the total of the annual tax benefits plus interest.


Foundation average investment balance


Times investment rate of return


Annual income


Annual taxes saved through its tax-exempt status


Estimated cumulative annual tax liability plus interest*



* Calculated by historical applicable underpayment interest rates, April 17, 2000, to Dec. 31, 2009, compounded daily.


Substantial contributors' benefit


Foundation's benefit


HC Foundation's aggregate tax benefit



The foundation’s net assets ($2 million) are only $226,012 more than the calculated aggregate tax benefit with interest ($1,773,988), so you see how the termination tax could easily wipe out a large amount of assets. If the foundation has no assets because of an inappropriate terminating distribution, the person receiving the terminating distribution would pay the tax out of the private foundation assets he or she received.



Section 507(b) and IRS Publication 4779 describe how a private foundation can shut down without being subject to the termination tax (see Exhibit 1).



Exhibit 1: Terminating a Private Foundation



The termination tax is easily avoided if a private foundation either transfers its net assets to an allowable organization or converts its net assets to an allowable organization



Transfer of private foundation net assets. When foundation benefactors want to completely “close up shop” and no longer be actively involved in the philanthropy business, they often transfer all of the foundation’s net assets pursuant to section 507(b)(1)(A) to one or more appropriate public charities, to a donor-advised fund or to another private foundation. Identifying appropriate public charities is not likely to be difficult, since many are likely to have been receiving ongoing support from the terminating foundation.


Appropriate public charities include organizations receiving substantial public support, those dependent on program service revenue, and certain types of supporting organizations. Depending on how a public charity is classified, different types of public support tests are required. Exhibit 2 shows the types of public charity classifications and public support tests.


If a foundation’s net assets are transferred to a section 509(a)(1) public charity that has been in existence for a continuous period of at least 60 months immediately preceding the transfer, the termination is automatic, and no termination tax is assessed. However, if they are transferred to a 509(a)(2) or 509(a)(3) organization, the termination is not automatic. In these cases, a foundation must file a notice of termination with the IRS subsequent to the terminating distribution. It is important to file this notice after the distribution so the foundation can report net assets equal to zero and thus limit any potential termination tax to zero.


Donor-advised funds are another attractive option for foundation benefactors who want to remain in the philanthropy business but on a smaller scale. With donor-advised funds, benefactors may continue to provide input about how funds should be disbursed to public charities, although the public charity sponsoring the donor-advised fund has final say over how the funds are invested and distributed. Notice of termination is required only when the donor-advised fund is housed in a 509(a)(2) or 509(a)(3) organization.


A private foundation may also consider transferring all its net assets to another foundation and then voluntarily terminating its private foundation status. Similarly to transfers to 509(a)(2) or 509(a)(3) organizations, while a notice of termination is required, penalties, including termination taxes, are avoided, since the closing foundation will not have any net assets after the transfer. This approach may be especially useful for family benefactors wanting to consolidate multiple foundations under their control.


One serious ramification of transferring significant amounts to a public charity is the potential effect on the recipient’s tax-exempt status. Public charities classified as 509(a)(1) organizations are required to receive significant public support, which means the amounts of individual donations that can be counted toward their public support test are limited (again, see Exhibit 2). Specifically, donations from a single donor that exceed 2% of a charity’s total support over a four-year period are not included as public support (see Treas. Reg. § 1.170A-9(f)(6)). Therefore, large donations by a single benefactor make it difficult to qualify as a public charity. Although large donations classified as an “unusual grant” may be excluded from the public support test, transfers from private foundations may not qualify for exclusion if (1) the foundation was considered a substantial contributor prior to the transfer or (2) the foundation benefactor holds a position of authority in the charity (see Temp. Treas. Reg. § 1.509(a)-3T(c)(4)(i)).


Similar issues may arise with large donations made to charities dependent on program service revenue (for example, 509(a)(2) organizations). CPAs with private foundation or public charity clientele should discuss these potentially serious consequences prior to the transfer of foundation net assets.


In all of these cases, a final IRS Form 990-PF, Return of Private Foundation, should be filed by the 15th day of the fifth month following the liquidation. The final tax form should report zero net assets for the terminating foundation.


Conversion of private foundation net assets . Foundation benefactors need to realize that they will lose substantial control over the organization’s net assets if they decide to convert a private foundation to a public charity. In addition, the core activities of the organization require dramatic changes for the newly converted public charity to be financially and operationally viable. In essence, conversion creates a new form of organization and governance. Therefore, a foundation that converts is likely to be already operating as a public charity, even though its legal status is as a private foundation. A private foundation with established programs and considerable support from the public, as opposed to the founding benefactor, is a prime candidate for conversion.


A private foundation that wants to convert to a public charity must follow a complex set of regulations and successfully complete a three-step process. First, the foundation must notify the IRS of its intentions. Second, it must satisfy the requirements of section 509(a)(1), (2) or (3) (generally, those for public charities shown in Exhibit 2) for 60 months beginning on the first day of the tax year following the notification. Given that the conversion option for closing a foundation involves a five-year window, it is important for CPAs to clearly communicate the implications to their private foundation clients. Third, the foundation must establish that it has met the public charity requirements to the satisfaction of the IRS immediately after the end of the 60-month period. See section 507(b)(1)(B) and, for specific procedures, Temp. Treas. Reg. § 1.507-2T(b).


Supporting organizations may provide the best opportunity for a private foundation to convert to public charity status. Since supporting organizations are organized and operated exclusively for the benefit of one or more publicly supported charities, their day-to-day operations most closely mirror the primary activities of a typical private foundation. For foundations experiencing a sharp decline in assets, supporting a small set of beneficiaries may both simplify operations and produce the largest charitable impact from the remaining endowment. Unlike private foundations, moreover, functionally integrated Type III supporting organizations are not required to distribute a portion of assets each year, which could allow them to conserve assets (section 4943(f)(5)(B)). Because of the similarities in operations between supporting organizations and private foundations, supporting organizations are subject to a complex set of tax regulations, most of which pertain to participation by disqualified persons such as founding benefactors, as well as foundation managers. So, if a foundation benefactor wishes to remain involved in the organization, very strict rules must be followed to achieve a successful conversion from a private foundation to a supporting organization (see section 4958(c)(3)). Disqualified persons can include not only substantial contributors but also members of their families. Also, “excess benefit transactions” that can invoke a penalty tax include not just grants but loans and compensation—any transaction providing value to the disqualified person or manager beyond consideration received.



Exhibit 2: Public Charity Classifications and Public Support Tests


Public Charity Classification

Definition and Examples

Public Support Test

Section 509(a)(1) organization Receives substantial support from the general public. May include health and welfare organizations and churches.

One-third of the organization’s total support* comes from the government or general public, not including program service revenues received from the government or general public.


10% of the organization’s total support* comes from the government or general public, not including program service revenue received from the government or general public and satisfies a facts-and-circumstances test.
Section 509(a)(2) organization

Dependent on program service revenue. May include hospitals, schools, and colleges and universities.

One-third of the organization’s total support* comes from the government or general public, including program service revenue. No more than one-third of the organization’s total support comes from net investment income plus unrelated business income.
Section 509(a)(3) supporting organizations

Organized and operated exclusively for the benefit of one or more publicly supported charities. May include public university endowments and “friends-of” organizations.

No public support test applies.


Supporting organizations may not be controlled by a disqualified person. Subject to other types of tests, including an organizational test and an operational test. Functionally integrated supporting organizations (Type III) are also subject to a responsiveness test and an integral-part test.


* Large donations by a single benefactor make it more difficult for an organization to qualify as a public charity. The numerator in the support test excludes amounts contributed by individuals, corporations or trusts that exceed 2% of an organization’s total support, but the denominator includes amounts in excess of the 2%.





 Investment losses have diminished many private foundations’ assets in recent years, with a result that many foundations have sought to merge with or transfer their assets to other charitable organizations that may offer donors less control but face fewer restrictions.


 Foundation managers may need CPAs’ help in terminating a foundation correctly, since a mistake can be costly. Repeated willful acts or lapses or a single willful and flagrant act or failure can subject a foundation to involuntary termination. A termination tax in such instances can consume most or all of a foundation’s assets.


 However, the termination tax can be avoided by transferring the foundation’s net assets to an allowable public charity, donor-advised fund or another private foundation. Alternately, the foundation can convert its net assets into those of a public charity or supporting organization.


 For transferring assets into a public charity or supporting organization, IRC § 509(a) specifies three such types of organizations, with various tests the receiving organizations must meet for public support. Other requirements include IRS notification and that the public charity receiving the transfer has been in continuous existence for at least 60 months immediately preceding the transfer. Private foundations should consider the impact a large donation may have on a public charity’s public support test.


 Conversion of a private foundation’s net assets into a public charity may be a natural transition, especially for conversions to a supporting organization, since the latter’s operations and goals may be similar to those of a private foundation. However, managers and their advisers must guard against strict prohibitions for supporting organizations against “excess benefit transactions” involving “disqualified persons” and other rules.


Brian P. McAllister ( is an assistant professor of accounting at the University of Colorado at Colorado Springs. Timothy R. Yoder ( will start as an assistant professor at the University of Nebraska at Omaha in August.


To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at or 919-402-4434.





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