For-Profit Subsidiaries of 501(c)(3) Nonprofits Under Delaware Law

Wallace v. Wood states that piercing the corporate veil under the alter ego theory requires that the corporate structure cause fraud or similar injustice.

Piercing the corporate veil under the alter ego theory “requires that the corporate structure cause fraud or similar injustice.”

See Wallace ex rel. Cencom Cable Income Partners II, Inc. v. Wood, 752 A.2d 1175, 1184 (Del. Ch. 1999).

Outokumpu holds that a parent's mere dominion and control over its subsidiary will not support alter ego liability.

Mere dominion and control of the parent over the subsidiary will not support alter ego liability.

See Outokumpu Eng'g Enters., Inc. v. Kvaerner EnviroPower, Inc., 685 A.2d 724, 729 (Del. Super. Ct. 1996).

Bestfoods distinguishes derivative-liability cases from those in which the wrong can be traced to the parent through its own personnel and management and the parent is directly a participant in the wrong.

As Justice (then-Professor) Douglas noted almost 70 years ago, derivative liability cases are to be distinguished from those in which “the alleged wrong can seemingly be traced to the parent through the conduit of its own personnel and management” and “the parent is directly a participant in the wrong complained of.”

See United States v. Bestfoods, 524 U.S. 51, 64 (1998).

Bestfoods holds that where the parent directly participates in the wrong, it is directly liable for its own actions.

In such instances, the parent is directly liable for its own actions.

See United States v. Bestfoods, 524 U.S. 51, 65 (1998).

The Delaware Supreme Court in Crosse requires a veil-piercing plaintiff to plead facts supporting an inference that the corporation, through its alter ego, created a sham entity designed to defraud investors and creditors.

To state a “veil-piercing claim,” the plaintiff must plead facts supporting an inference that the corporation, through its alter-ego, has created a sham entity designed to defraud investors and creditors.

See Crosse v. BCBSD, Inc., 836 A.2d 492, 497 (Del. 2003).

Sunstates holds that under Delaware corporation law the act of a subsidiary is not the act of its parent merely because of the parent-subsidiary relationship or treatment as a single economic enterprise for some other purpose.

For the purposes of the corporation law, the act of one corporation is not regarded as the act of another merely because the first corporation is a subsidiary of the other, or because the two may be treated as part of a single economic enterprise for some other purpose.

See In re Sunstates Corp. S'holder Litig., 788 A.2d 530, 534 (Del. Ch. 2001).

Bestfoods recognizes that the corporate veil may be pierced, in the parent-subsidiary relationship as elsewhere, when the corporate form would otherwise be misused for wrongful purposes such as fraud.

But there is an equally fundamental principle of corporate law, applicable to the parent-subsidiary relationship as well as generally, that the corporate veil may be pierced and the shareholder held liable for the corporation’s conduct when, inter alia, the corporate form would otherwise be misused to accomplish certain wrongful purposes, most notably fraud, on the shareholder’s behalf.

See United States v. Bestfoods, 524 U.S. 51, 62 (1998).

Kalb, Voorhis holds, applying New York choice-of-law rules, that the law of the state of incorporation determines when the corporate form will be disregarded.

The law of the state of incorporation determines when the corporate form will be disregarded and liability will be imposed on shareholders: “Because a corporation is a creature of state law whose primary purpose is to insulate shareholders from legal liability, the state of incorporation has the greater interest in determining when and if that insulation is to be stripped away.”

See Kalb, Voorhis & Co. v. American Fin. Corp., 8 F.3d 130, 132 (2d Cir. 1993).

Manichaean Capital lists the factors Delaware courts consider in deciding whether to pierce: adequate capitalization, solvency, observance of formalities, siphoning of funds by the dominant shareholder, and whether the company functioned as a facade.

Delaware courts consider a number of factors in determining whether to disregard the corporate form and pierce the corporate veil, including: “(1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.”

See Manichaean Capital, LLC v. Exela Techs., Inc., C.A. No. 2020-0601-JRS, slip op. at 17 (Del. Ch. May 25, 2021).

Manichaean Capital states that no single veil-piercing factor is determinative.

While these factors are useful, any single one of them is not determinative.

See Manichaean Capital, LLC v. Exela Techs., Inc., C.A. No. 2020-0601-JRS, slip op. at 17 (Del. Ch. May 25, 2021).

Fletcher v. Atex reads Delaware alter ego law to require no showing of fraud but an overall element of injustice or unfairness.

As noted above, a showing of fraud or wrongdoing is not necessary under an alter ego theory, but the plaintiff must demonstrate an overall element of injustice or unfairness.

See Fletcher v. Atex, Inc., 68 F.3d 1451, 1458 (2d Cir. 1995).

Harper reads Delaware case law to require, even under the alter ego theory, a showing that equitable considerations require disregarding separate entities.

On the contrary, the case law implies that, even under the alter ego theory, the Delaware courts will not disregard separate legal entities absent a showing that equitable considerations require such action.

See Harper v. Delaware Valley Broadcasters, Inc., 743 F. Supp. 1076, 1086 (D. Del. 1990), aff'd, 932 F.2d 959 (3d Cir. 1991) (table).

Kelley Drye's 2008 advisory treats adequate capitalization and insurance of the subsidiary as the most important step against a veil-piercing argument.

Properly capitalizing and insuring the subsidiary is by far the most important step to prevent a successful piercing argument (since doing so substantially weakens a potential argument based on alleged injustice).

See Philip D. Robben, Protecting the Parent Corporation from Disregard of the Corporate Form (Kelley Drye & Warren LLP, Sept. 22, 2008).

Fletcher v. Atex, applying Delaware law, relied on undisputed evidence that the subsidiary held regular board meetings, kept minutes, maintained its own financial records, filed its own tax returns and had its own employees and managers.

Significantly, the plaintiffs have not challenged Kodak’s assertions that Atex’s board of directors held regular meetings, that minutes from those meetings were routinely prepared and maintained in corporate minute books, that appropriate financial records and other files were maintained by Atex, that Atex filed its own tax returns and paid its own taxes, and that Atex had its own employees and management executives who were responsible for the corporation’s day-to-day business.

See Fletcher v. Atex, Inc., 68 F.3d 1451, 1459 (2d Cir. 1995).

Manichaean Capital lists the factors Delaware courts consider in deciding whether to pierce: adequate capitalization, solvency, observance of formalities, siphoning of funds by the dominant shareholder, and whether the company functioned as a facade.

Delaware courts consider a number of factors in determining whether to disregard the corporate form and pierce the corporate veil, including: “(1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.”

See Manichaean Capital, LLC v. Exela Techs., Inc., C.A. No. 2020-0601-JRS, slip op. at 17 (Del. Ch. May 25, 2021).

Fletcher v. Atex observes that parents and subsidiaries frequently have overlapping boards while maintaining separate business operations.

Parents and subsidiaries frequently have overlapping boards of directors while maintaining separate business operations.

See Fletcher v. Atex, Inc., 68 F.3d 1451, 1460 (2d Cir. 1995).

Bestfoods recognizes the established principle that directors and officers holding positions with both a parent and its subsidiary can change hats to represent the two corporations separately.

This recognition that the corporate personalities remain distinct has its corollary in the “well established principle [of corporate law] that directors and officers holding positions with a parent and its subsidiary can and do ‘change hats’ to represent the two corporations separately, despite their common ownership.”

See United States v. Bestfoods, 524 U.S. 51, 69 (1998).

Delaware General Corporation Law § 142(a) permits one person to hold any number of offices unless the certificate of incorporation or bylaws provide otherwise.

Any number of offices may be held by the same person unless the certificate of incorporation or bylaws otherwise provide.

See Del. Code Ann. tit. 8, § 142(a).

The Delaware Supreme Court in Anadarko holds that directors of a wholly owned subsidiary are obligated only to manage the subsidiary in the best interests of the parent and its shareholders.

However, in a parent and wholly-owned subsidiary context, the directors of the subsidiary are obligated only to manage the affairs of the subsidiary in the best interests of the parent and its shareholders.

See Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1174 (Del. 1988).

Fletcher v. Atex observes that courts have generally declined to find alter ego liability based on a parent's use of a cash management system.

Courts have generally declined to find alter ego liability based on a parent corporation’s use of a cash management system.

See Fletcher v. Atex, Inc., 68 F.3d 1451, 1459 (2d Cir. 1995).

Mobil Oil holds that a close connection and lax formalities, including payment of the parent's obligations from the subsidiary's bank account, were insufficient by themselves to pierce without an additional element.

Mobil alleges that the Delaware corporation and the Oklahoma corporation shared common officers and directors. (Id. at 31-32, 39, 43-44.) It claims that no minutes were kept or agendas prepared for board of directors meetings of the Oklahoma corporation, separate and apart from those for the Delaware corporation. (Id. at 17-18, 33-34.) The Delaware corporation’s board of directors allegedly approved the hiring and salaries of officers of the Oklahoma corporation, as well as other major expenditures and policies involving the subsidiary. (Id. at 19-20, 22-25, 30-31.) In addition, obligations of the Delaware corporation were paid from the Oklahoma corporation’s bank account. (Id. at 25-30, 39-40.) The foregoing factual allegations, if accurate, demonstrate that the Delaware corporation and the Oklahoma corporation were closely connected. Also, the Linear entities were less than steadfast in their observation of corporate formalities. Nevertheless, these facts standing alone are insufficient for the alter ego theory to operate to pierce the corporate veil. An additional element is required.

See Mobil Oil Corp. v. Linear Films, Inc., 718 F. Supp. 260, 267 (D. Del. 1989).

Delaware General Corporation Law § 141(a) provides that the business and affairs of a Delaware corporation are managed by or under the direction of its board of directors, except as the chapter or the certificate of incorporation provides otherwise.

(a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.

See Del. Code Ann. tit. 8, § 141(a).

Delaware General Corporation Law § 141(f) permits board action without a meeting if all directors consent in writing or by electronic transmission, unless the certificate or bylaws restrict it.

(f) Unless otherwise restricted by the certificate of incorporation or bylaws, (1) any action required or permitted to be taken at any meeting of the board of directors or of any committee thereof may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing, or by electronic transmission, and (2) a consent may be documented, signed and delivered in any manner permitted by § 116 of this title.

See Del. Code Ann. tit. 8, § 141(f).

Delaware General Corporation Law § 141(f) requires board consents to be filed with the minutes of board proceedings after the action is taken.

After an action is taken, the consent or consents relating thereto shall be filed with the minutes of the proceedings of the board of directors, or the committee thereof, in the same paper or electronic form as the minutes are maintained.

See Del. Code Ann. tit. 8, § 141(f).

Delaware General Corporation Law § 228(a) permits stockholders holding the votes needed to take an action to act by signed written consent without a meeting, unless the certificate of incorporation provides otherwise.

(a) Unless otherwise provided in the certificate of incorporation, any action required by this chapter to be taken at any annual or special meeting of stockholders of a corporation, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation in the manner required by this section.

See Del. Code Ann. tit. 8, § 228(a).

Levitt and Chiodini write that a nonprofit and its for-profit subsidiary should each have a separate governing body and hold separate board and committee meetings with separate minutes.

Corporate formalities must be observed to protect the separation of the entities. Each organization must have a separate governing body and should conduct separate board and committee meetings, with separate minutes taken.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Levitt and Chiodini recommend against complete overlap of directors and officers even though the nonprofit parent controls the subsidiary's board.

While the nonprofit parent will be the only (or at least the controlling) equity holder of the for-profit subsidiary and therefore will control the for-profit’s governing body, there are reasons to avoid complete overlap in the directors and officers of the two entities.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Venable's 1999 paper recommends a written arm's-length agreement covering shared facilities, equipment, services and employees, followed in practice, together with separate books, bank accounts and tax returns.

The parent and the subsidiary should enter into an arm's length written agreement covering all aspects of the shared facilities, equipment, supplies, services and employees. The agreement should, of course, be followed in practice. It is critical that strict financial separation be maintained (i.e., separate financial books and records, separate bank accounts, separate tax returns, and avoidance of any commingling of assets).

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

BCL § 1301(a) bars a foreign corporation from doing business in New York until it is authorized to do so.

(a) A foreign corporation shall not do business in this state until it has been authorized to do so as provided in this article.

See N.Y. Bus. Corp. Law § 1301(a).

The IRS's 1986 training text on for-profit subsidiaries states that a taxable subsidiary formed for a valid business purpose has its activities attributed to its parent only on clear and convincing evidence that it is an arm, agent or integral part of the parent.

Basically, once it is established that a taxable subsidiary was formed for a valid business purpose, the activities of such a subsidiary cannot be attributed to its parent unless the facts provide clear and convincing evidence that the subsidiary is in reality an arm, agent, or integral part of the parent.

See IRS, Exempt Organizations Continuing Professional Education Technical Instruction Program for FY 1986, Topic E, For-Profit Subsidiaries of Tax-Exempt Organizations, § 2.B.

The IRS's 1986 training text states that an incorporated subsidiary's commercial activities face a significant legal barrier to attribution because a parent and subsidiary are separate taxable entities while the subsidiary has a business purpose or carries on business.

A parent's exempt status may be jeopardized if the commercial activities of its subsidiary can be considered to be, in fact, activities of the parent. However, where the subsidiary is incorporated (as is virtually always the case with taxable subsidiaries), there is a significant legal barrier to overcome before the commercial activities of a subsidiary may be attributed to its parent. The barrier arises because, for federal income tax purposes, a parent corporation and its subsidiary are separate taxable entities so long as the purposes for which the subsidiary is incorporated are the equivalent of business activities or the subsidiary subsequently carries on business activities.

See IRS, Exempt Organizations Continuing Professional Education Technical Instruction Program for FY 1986, Topic E, For-Profit Subsidiaries of Tax-Exempt Organizations, § 2.A.

Moline Properties holds that, for revenue purposes, the corporate form may be disregarded where it is a sham or unreal.

In general, in matters relating to the revenue, the corporate form may be disregarded where it is a sham or unreal.

See Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 439 (1943).

National Carbide holds that complete ownership of a corporation, and the control that depends on it, are no longer significant in determining its taxability.

Complete ownership of the corporation, and the control primarily dependent upon such ownership — the important ingredients of the Southern Pacific case — are no longer of significance in determining taxability.

See National Carbide Corp. v. Commissioner, 336 U.S. 422, 429 (1949).

National Carbide holds that a corporation treated as its owner's agent for tax purposes must have agency relations that do not depend on the fact of ownership.

If the corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned by the principal, if such is the case.

See National Carbide Corp. v. Commissioner, 336 U.S. 422, 437 (1949).

Bollinger rejects reading National Carbide to bar agency whenever the corporate agent's relations with its owner depend on ownership, because that reading would invalidate all subsidiary-parent agencies for tax purposes.

Ultimately, the relations between a corporate agent and its owner-principal are always dependent upon the fact of ownership, in that the owner can cause the relations to be altered or terminated at any time. Plainly that is not what was meant, since on that interpretation all subsidiary-parent agencies would be invalid for tax purposes, a position which the National Carbide opinion specifically disavowed.

See Commissioner v. Bollinger, 485 U.S. 340, 348 (1988).

Bollinger declines to hold that unequivocal evidence of a genuine corporate agency can consist only of arm's-length dealing plus an agency fee.

We see no basis, however, for holding that unequivocal evidence can only consist of the rigid requirements (arm’s-length dealing plus agency fee) that the Commissioner suggests.

See Commissioner v. Bollinger, 485 U.S. 340, 349 (1988).

Geisinger states that separately incorporated entities generally must qualify for tax exemption on their own merits.

Generally, separately incorporated entities must qualify for tax exemption on their own merits.

See Geisinger Health Plan v. Commissioner, 30 F.3d 494, 498 (3d Cir. 1994).

Private Letter Ruling 201644019 (not precedent) states the IRS's view that only minimal business activities are needed for a corporation to be respected as a distinct taxable entity.

Only minimal business activities are needed for a corporation to be respected as a distinct taxable entity.

See I.R.S. Priv. Ltr. Rul. 201644019 (Aug. 2, 2016; released Oct. 28, 2016).

Private Letter Ruling 201644019 (not precedent) ruled that the subsidiary's business activity satisfied Moline Properties, so it would be respected as separate and its activities would not be attributed to the exempt parent.

S is engaged in business activity that is sufficient to satisfy the business activity requirement of Moline Properties and therefore it will be respected as an entity separate from Organization and its activities will not be attributed to Organization.

See I.R.S. Priv. Ltr. Rul. 201644019 (Aug. 2, 2016; released Oct. 28, 2016).

Private Letter Ruling 201644019 (not precedent) rested on representations that the exempt parent would not direct or participate in the subsidiary's day-to-day management and would exercise only the normal rights of a shareholder.

Organization represents that there is no understanding or agreement (oral or written) that Organization will direct or actively participate in the day-to-day management of S (or any S subsidiary or affiliate) or Partnership. Organization intends to exercise only the normal rights of a shareholder directly in S, or indirectly in any S subsidiary or affiliate, including but not limited to Partnership.

See I.R.S. Priv. Ltr. Rul. 201644019 (Aug. 2, 2016; released Oct. 28, 2016).

Section 6110(k)(3) bars using or citing a written determination, such as a private letter ruling, as precedent unless regulations provide otherwise.

Unless the Secretary otherwise establishes by regulations, a written determination may not be used or cited as precedent.

See 26 U.S.C. § 6110(k)(3) (2024 ed.).

Private Letter Ruling 201644019 (not precedent) rested on representations that the exempt parent would not direct or participate in the subsidiary's day-to-day management and would exercise only the normal rights of a shareholder.

Organization represents that there is no understanding or agreement (oral or written) that Organization will direct or actively participate in the day-to-day management of S (or any S subsidiary or affiliate) or Partnership. Organization intends to exercise only the normal rights of a shareholder directly in S, or indirectly in any S subsidiary or affiliate, including but not limited to Partnership.

See I.R.S. Priv. Ltr. Rul. 201644019 (Aug. 2, 2016; released Oct. 28, 2016).

Venable's 1999 paper reads IRS rulings as tolerating substantial director overlap if the parent stays out of day-to-day management and deals with the subsidiary at arm's length.

Even if most or all of the subsidiary's directors were directors or officers of the parent, the parent's tax exemption would not be jeopardized so long as other factors indicated that the parent was not involved in the day-to-day management of the subsidiary and dealt with the subsidiary at arm's length.

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Venable's 1999 paper warns that officer overlap between parent and subsidiary is a greater attribution risk than director overlap, because officers are more involved in day-to-day management.

A more substantial problem would arise if officers of the parent were also officers of the subsidiary. In that scenario, it is more likely that the subsidiary's activities would be attributed to the parent because the overlap between officers tends to show that the parent is managing the subsidiary on a daily basis (since officers, as opposed to directors, are generally more involved in the day-to-day management of a corporation).

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Section 501(c)(3) describes corporations organized and operated exclusively for religious, charitable, scientific, literary, educational and other listed purposes, no part of whose net earnings inures to any private shareholder or individual, subject to limits on lobbying and a bar on political campaign intervention.

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

See 26 U.S.C. § 501(c)(3) (2024 ed.).

Treasury Regulation § 1.501(c)(3)-1(e)(1) permits a section 501(c)(3) organization to operate a trade or business as a substantial part of its activities if the business furthers its exempt purposes and it is not organized or operated primarily to carry on an unrelated trade or business.

An organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization's exempt purpose or purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in section 513.

See 26 C.F.R. § 1.501(c)(3)-1(e)(1).

Douglas Mancino's 2008 paper calls protecting exemption a largely mythical reason for a taxable subsidiary, because public charities can earn substantial unrelated business income without losing exemption while their primary purpose is exempt.

In my view, this is more of a mythical reason to establish a subsidiary than a real reason, and often results in collateral, negative tax consequences which will be discussed later in this section. In fact, public charities can generate large amounts of income from UBI without jeopardizing their exempt status as long as they have an exempt primary purpose.

See Douglas M. Mancino, The Architecture of Charities' Commercial Activities: Managing Complex Structures (NYU School of Law, National Center on Philanthropy and the Law, 2008 conference paper).

Section 501(c)(3) describes corporations organized and operated exclusively for religious, charitable, scientific, literary, educational and other listed purposes, no part of whose net earnings inures to any private shareholder or individual, subject to limits on lobbying and a bar on political campaign intervention.

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

See 26 U.S.C. § 501(c)(3) (2024 ed.).

Revenue Ruling 68-489 holds that a section 501(c)(3) organization does not jeopardize its exemption by distributing funds to nonexempt organizations if it retains control and discretion over their use for section 501(c)(3) purposes.

An organization will not jeopardize its exemption under section 501(c)(3) of the Code, even though it distributes funds to nonexempt organizations, provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

Treasury Regulation § 1.501(c)(3)-1(c)(2) provides that an organization whose net earnings inure in whole or part to private shareholders or individuals is not operated exclusively for exempt purposes.

An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals.

See 26 C.F.R. § 1.501(c)(3)-1(c)(2).

Treasury Regulation § 1.501(c)(3)-1(d)(1)(ii) requires an organization to establish that it is not organized or operated for the benefit of private interests.

Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

See 26 C.F.R. § 1.501(c)(3)-1(d)(1)(ii).

Section 501(c)(3) describes corporations organized and operated exclusively for religious, charitable, scientific, literary, educational and other listed purposes, no part of whose net earnings inures to any private shareholder or individual, subject to limits on lobbying and a bar on political campaign intervention.

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

See 26 U.S.C. § 501(c)(3) (2024 ed.).

Treasury Regulation § 1.501(c)(3)-1(c)(1) treats an organization as operated exclusively for exempt purposes only if it engages primarily in exempt activities and no more than an insubstantial part of its activities fails to further an exempt purpose.

An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

See 26 C.F.R. § 1.501(c)(3)-1(c)(1).

American Campaign Academy holds that occasional economic benefits flowing to persons as an incidental consequence of pursuing exempt purposes generally are not prohibited private benefits.

Occasional economic benefits flowing to persons as an incidental consequence of an organization pursuing exempt charitable purposes will not generally constitute prohibited private benefits.

See American Campaign Academy v. Commissioner, 92 T.C. 1053, 1066 (1989).

American Campaign Academy holds that the absence of private inurement does not establish that an organization is operated exclusively for exempt purposes.

The absence of private inurement of earnings to the benefit of a private shareholder or individual does not, however, establish that the organization is operated exclusively for exempt purposes.

See American Campaign Academy v. Commissioner, 92 T.C. 1053, 1068 (1989).

United Cancer Council describes the inurement prohibition as barring a charity from siphoning its earnings to insiders, meaning persons fairly described as the equivalent of an owner or manager.

A charity is not to siphon its earnings to its founder, or the members of its board, or their families, or anyone else fairly to be described as an insider, that is, as the equivalent of an owner or manager.

See United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173, 1176 (7th Cir. 1999).

Levitt and Chiodini characterize a nonprofit parent's contribution to its subsidiary in return for equity as an investment.

The nonprofit parent must capitalize its subsidiary. A contribution in return for an equity interest is an investment.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Section 118(a) excludes a contribution to the capital of a corporation from the corporation's gross income.

In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.

See 26 U.S.C. § 118(a) (2024 ed.).

Levitt and Chiodini warn that a charity investing alongside others must receive adequate value and avoid using charitable assets to subsidize for-profit investors.

A charity must make sure that it receives adequate value in return for its contribution, and it must avoid using charitable assets to subsidize for-profit investors.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Section 512(b)(13)(C) defines a specified payment as interest, an annuity, a royalty or rent.

For purposes of this paragraph, the term "specified payment" means any interest, annuity, royalty, or rent.

See 26 U.S.C. § 512(b)(13)(C) (2024 ed.).

Section 512(b)(13)(A) requires an exempt organization to include a specified payment from an entity it controls as an item of gross income derived from an unrelated trade or business, to the extent the payment reduces the controlled entity's net unrelated income or increases its net unrelated loss.

If an organization (in this paragraph referred to as the "controlling organization") receives or accrues (directly or indirectly) a specified payment from another entity which it controls (in this paragraph referred to as the "controlled entity"), notwithstanding paragraphs (1), (2), and (3), the controlling organization shall include such payment as an item of gross income derived from an unrelated trade or business to the extent such payment reduces the net unrelated income of the controlled entity (or increases any net unrelated loss of the controlled entity).

See 26 U.S.C. § 512(b)(13)(A) (2024 ed.).

Revenue Ruling 68-489 describes an organization that limited distributions to specific projects furthering its own exempt purposes, retained control and discretion, and kept records showing the funds were used for section 501(c)(3) purposes.

The exempt organization ensured use of the funds for section 501(c)(3) purposes by limiting distributions to specific projects that are in furtherance of its own exempt purposes. It retains control and discretion as to the use of the funds and maintains records establishing that the funds were used for section 501(c)(3) purposes. Held, the distributions did not jeopardize the organization's exemption under section 501(c)(3) of the Code.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

Section 118(b) provides that a contribution to the capital of a corporation does not include a contribution by any governmental entity or civic group, other than a contribution made by a shareholder as such.

(b) Exceptions For purposes of subsection (a), except as provided in subsection (c), the term "contribution to the capital of the taxpayer" does not include— (1) any contribution in aid of construction or any other contribution as a customer or potential customer, and (2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).

See 26 U.S.C. § 118(b) (2024 ed.).

Section 118(a) excludes a contribution to the capital of a corporation from the corporation's gross income.

In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.

See 26 U.S.C. § 118(a) (2024 ed.).

Section 4958(e) defines an applicable tax-exempt organization to include a section 501(c)(3) organization, including one so described in the prior five years, and excludes private foundations.

(e) Applicable tax-exempt organization For purposes of this subchapter, the term "applicable tax-exempt organization" means— (1) any organization which (without regard to any excess benefit) would be described in paragraph (3), (4), or (29) of section 501(c) and exempt from tax under section 501(a), and (2) any organization which was described in paragraph (1) at any time during the 5-year period ending on the date of the transaction. Such term shall not include a private foundation (as defined in section 509(a)).

See 26 U.S.C. § 4958(e) (2024 ed.).

Section 4958(f)(1) defines a disqualified person to include anyone who, in the five years before the transaction, was in a position to exercise substantial influence over the organization's affairs, that person's family members, 35-percent controlled entities, and those persons with respect to a supporting organization of the applicable tax-exempt organization.

(1) Disqualified person The term "disqualified person" means, with respect to any transaction— (A) any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization, (B) a member of the family of an individual described in subparagraph (A), (C) a 35-percent controlled entity, (D) any person who is described in subparagraph (A), (B), or (C) with respect to an organization described in section 509(a)(3) and organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of the applicable tax-exempt organization,

See 26 U.S.C. § 4958(f)(1) (2024 ed.).

Section 4958(c)(1)(A) defines an excess benefit transaction as one in which an applicable tax-exempt organization directly or indirectly provides a disqualified person an economic benefit worth more than the consideration it receives.

The term "excess benefit transaction" means any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

See 26 U.S.C. § 4958(c)(1)(A) (2024 ed.).

Treasury Regulation § 53.4958-4(a)(2)(ii) treats economic benefits provided by an entity an applicable tax-exempt organization controls as provided by the applicable tax-exempt organization, and defines control of a stock corporation as ownership by vote or value of more than 50 percent of its stock.

An applicable tax-exempt organization may provide an excess benefit indirectly through the use of one or more entities it controls. For purposes of section 4958, economic benefits provided by a controlled entity will be treated as provided by the applicable tax-exempt organization. (B) Definition of control — (1) In general. For purposes of this paragraph, control by an applicable tax-exempt organization means— (i) In the case of a stock corporation, ownership (by vote or value) of more than 50 percent of the stock in such corporation;

See 26 C.F.R. § 53.4958-4(a)(2)(ii)(A)–(B).

Section 512(b)(1) excludes dividends, interest, annuities and certain securities-lending and loan-commitment income, with directly connected deductions, from unrelated business taxable income.

There shall be excluded all dividends, interest, payments with respect to securities loans (as defined in subsection (a)(5)), amounts received or accrued as consideration for entering into agreements to make loans, and annuities, and all deductions directly connected with such income.

See 26 U.S.C. § 512(b)(1) (2024 ed.).

Section 512(b)(13)(A) requires an exempt organization to include a specified payment from an entity it controls as an item of gross income derived from an unrelated trade or business, to the extent the payment reduces the controlled entity's net unrelated income or increases its net unrelated loss.

If an organization (in this paragraph referred to as the "controlling organization") receives or accrues (directly or indirectly) a specified payment from another entity which it controls (in this paragraph referred to as the "controlled entity"), notwithstanding paragraphs (1), (2), and (3), the controlling organization shall include such payment as an item of gross income derived from an unrelated trade or business to the extent such payment reduces the net unrelated income of the controlled entity (or increases any net unrelated loss of the controlled entity).

See 26 U.S.C. § 512(b)(13)(A) (2024 ed.).

Section 512(b)(13)(C) defines a specified payment as interest, an annuity, a royalty or rent.

For purposes of this paragraph, the term "specified payment" means any interest, annuity, royalty, or rent.

See 26 U.S.C. § 512(b)(13)(C) (2024 ed.).

Section 512(b)(4) includes income from debt-financed property, as section 514 determines it, in unrelated business income notwithstanding the exclusions in § 512(b)(1), (2), (3) and (5).

(4) Notwithstanding paragraph (1), (2), (3), or (5), in the case of debt-financed property (as defined in section 514) there shall be included, as an item of gross income derived from an unrelated trade or business, the amount ascertained under section 514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under section 514(a)(2).

See 26 U.S.C. § 512(b)(4) (2024 ed.).

Section 514(b)(1) defines debt-financed property as property held to produce income with respect to which there is acquisition indebtedness during the year, subject to listed exceptions.

(1) In general For purposes of this section, the term "debt-financed property" means any property which is held to produce income and with respect to which there is an acquisition indebtedness (as defined in subsection (c)) at any time during the taxable year (or, if the property was disposed of during the taxable year, with respect to which there was an acquisition indebtedness at any time during the 12-month period ending with the date of such disposition), except that such term does not include—

See 26 U.S.C. § 514(b)(1) (2024 ed.).

Section 514(c)(1) defines acquisition indebtedness to include indebtedness the organization incurred in acquiring or improving the property, and certain indebtedness incurred before or after that would not have been incurred but for the acquisition.

(1) General rule For purposes of this section, the term "acquisition indebtedness" means, with respect to any debt-financed property, the unpaid amount of— (A) the indebtedness incurred by the organization in acquiring or improving such property; (B) the indebtedness incurred before the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement; and (C) the indebtedness incurred after the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement and the incurrence of such indebtedness was reasonably foreseeable at the time of such acquisition or improvement.

See 26 U.S.C. § 514(c)(1) (2024 ed.).

Section 512(a)(1) defines unrelated business taxable income as gross income from an unrelated trade or business regularly carried on by the organization, less directly connected deductions.

Except as otherwise provided in this subsection, the term "unrelated business taxable income" means the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subsection (b).

See 26 U.S.C. § 512(a)(1) (2024 ed.).

Section 512(b)(13)(D) defines control of a corporation as ownership by vote or value of more than 50 percent of its stock, applying the section 318 constructive-ownership rules.

(D) Definition of control.—For purposes of this paragraph— (i) Control.—The term "control" means— (I) in the case of a corporation, ownership (by vote or value) of more than 50 percent of the stock in such corporation, (II) in the case of a partnership, ownership of more than 50 percent of the profits interests or capital interests in such partnership, or (III) in any other case, ownership of more than 50 percent of the beneficial interests in the entity. (ii) Constructive ownership.—Section 318 (relating to constructive ownership of stock) shall apply for purposes of determining ownership of stock in a corporation. Similar principles shall apply for purposes of determining ownership of interests in any other entity.

See 26 U.S.C. § 512(b)(13)(D) (2024 ed.).

Section 318(a)(2)(C) treats a person owning 50 percent or more in value of a corporation's stock as owning a proportionate share of the stock that corporation owns.

If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.

See 26 U.S.C. § 318(a)(2)(C) (2024 ed.).

Section 512(b)(13)(B) measures a taxable controlled entity's net unrelated income as the part of its taxable income that would be unrelated business taxable income if it were exempt and had the parent's exempt purposes.

(B) Net unrelated income or loss.—For purposes of this paragraph— (i) Net unrelated income.—The term "net unrelated income" means— (I) in the case of a controlled entity which is not exempt from tax under section 501(a), the portion of such entity's taxable income which would be unrelated business taxable income if such entity were exempt from tax under section 501(a) and had the same exempt purposes as the controlling organization, or (II) in the case of a controlled entity which is exempt from tax under section 501(a), the amount of the unrelated business taxable income of the controlled entity. (ii) Net unrelated loss.—The term "net unrelated loss" means the net operating loss adjusted under rules similar to the rules of clause (i).

See 26 U.S.C. § 512(b)(13)(B) (2024 ed.).

Section 511(a)(1) imposes tax on an exempt organization's unrelated business taxable income, computed as provided in section 11.

There is hereby imposed for each taxable year on the unrelated business taxable income (as defined in section 512) of every organization described in paragraph (2) a tax computed as provided in section 11.

See 26 U.S.C. § 511(a)(1) (2024 ed.).

Section 512(b)(13)(E) limits the controlled-entity inclusion to the amount exceeding an arm's-length payment, with a 20 percent addition to tax on that excess, only for qualifying specified payments made under a binding written contract in effect on the subparagraph's enactment date or its renewal on substantially similar terms.

(E) Paragraph to apply only to certain excess payments.— (i) In general.—Subparagraph (A) shall apply only to the portion of a qualifying specified payment received or accrued by the controlling organization that exceeds the amount which would have been paid or accrued if such payment met the requirements prescribed under section 482. (ii) Addition to tax for valuation misstatements.—The tax imposed by this chapter on the controlling organization shall be increased by an amount equal to 20 percent of the larger of— (I) such excess determined without regard to any amendment or supplement to a return of tax, or (II) such excess determined with regard to all such amendments and supplements. (iii) Qualifying specified payment.—The term "qualifying specified payment" means a specified payment which is made pursuant to— (I) a binding written contract in effect on the date of the enactment of this subparagraph, or (II) a contract which is a renewal, under substantially similar terms, of a contract described in subclause (I).

See 26 U.S.C. § 512(b)(13)(E) (2024 ed.).

The U.S. Code's editorial notes to section 512 identify the enactment date referred to in § 512(b)(13)(E)(iii)(I) as August 17, 2006.

The date of the enactment of this subparagraph, referred to in subsec. (b)(13)(E)(iii)(I), is the date of enactment of Pub. L. 109–280, which was approved Aug. 17, 2006.

See 26 U.S.C. § 512 note (References in Text) (2024 ed.).

The Schedule R instructions require a filing organization to report all receipts or accruals of interest, annuities, royalties or rent from a controlled entity under section 512(b)(13), regardless of amount.

All transactions described in line 1a, which includes all receipts or accruals of interest, annuities, royalties, or rent from a controlled entity under section 512(b)(13), regardless of amount.

See IRS, Instructions for Schedule R (Form 990) (Rev. Dec. 2024), Part V, line 2.

Treasury Regulation § 1.512(b)-1(l)(4)(i)(a) defines control of a stock corporation as an exempt organization's ownership of at least 80 percent of the total combined voting power and at least 80 percent of the total number of shares of all other classes of stock.

(a) Stock corporation. In the case of an organization which is a stock corporation, the term control means ownership by an exempt organization of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of such corporation.

See 26 C.F.R. § 1.512(b)-1(l)(4)(i)(a).

Section 4945(d)(4) and (5) make a private foundation's grant to an organization other than a public charity, a qualifying supporting organization or an exempt operating foundation a taxable expenditure unless the foundation exercises expenditure responsibility, and make any expenditure for a noncharitable purpose a taxable expenditure.

(4) as a grant to an organization unless— (A) such organization— (i) is described in paragraph (1) or (2) of section 509(a), (ii) is an organization described in section 509(a)(3) (other than an organization described in clause (i) or (ii) of section 4942(g)(4)(A)), or (iii) is an exempt operating foundation (as defined in section 4940(d)(2)), or (B) the private foundation exercises expenditure responsibility with respect to such grant in accordance with subsection (h), or (5) for any purpose other than one specified in section 170(c)(2)(B).

See 26 U.S.C. § 4945(d)(4)–(5) (2024 ed.).

Section 4945(h) defines expenditure responsibility as all reasonable efforts and adequate procedures to see that the grant is spent solely for its purpose, to obtain full reports from the grantee and to report to the IRS.

The expenditure responsibility referred to in subsection (d)(4) means that the private foundation is responsible to exert all reasonable efforts and to establish adequate procedures— (1) to see that the grant is spent solely for the purpose for which made, (2) to obtain full and complete reports from the grantee on how the funds are spent, and (3) to make full and detailed reports with respect to such expenditures to the Secretary.

See 26 U.S.C. § 4945(h) (2024 ed.).

Treasury Regulation § 53.4945-5(b)(2)(i) calls for a limited pre-grant inquiry complete enough to give reasonable assurance that the grantee will use the grant for proper purposes.

Before making a grant to an organization with respect to which expenditure responsibility must be exercised under this section, a private foundation should conduct a limited inquiry concerning the potential grantee. Such inquiry should be complete enough to give a reasonable man assurance that the grantee will use the grant for the proper purposes.

See 26 C.F.R. § 53.4945-5(b)(2)(i).

Treasury Regulation § 53.4945-5(b)(3) requires an expenditure-responsibility grant to be made subject to a signed written commitment in which the grantee agrees to repay unused funds, submit annual reports, keep and open its books and records, and not use the funds for listed noncharitable purposes, and the agreement must state the grant's purposes.

Except as provided in subparagraph (4) of this paragraph, in order to meet the expenditure responsibility requirements of section 4945(h), a private foundation must require that each grant to an organization, with respect to which expenditure responsibility must be exercised under this section, be made subject to a written commitment signed by an appropriate officer, director, or trustee of the grantee organization. Such commitment must include an agreement by the grantee: (i) To repay any portion of the amount granted which is not used for the purposes of the grant, (ii) To submit full and complete annual reports on the manner in which the funds are spent and the progress made in accomplishing the purposes of the grant, except as provided in paragraph (c)(2) of this section, (iii) To maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times, and (iv) Not to use any of the funds: (a) To carry on propaganda, or otherwise to attempt, to influence legislation (within the meaning of section 4945(d)(1)), (b) To influence the outcome of any specific public election, or to carry on, directly or indirectly, any voter registration drive (within the meaning of section 4945(d)(2)), (c) To make any grant which does not comply with the requirements of section 4945(d) (3) or (4), or (d) To undertake any activity for any purpose other than one specified in section 170(c)(2)(B). The agreement must also clearly specify the purposes of the grant.

See 26 C.F.R. § 53.4945-5(b)(3).

Treasury Regulation § 53.4945-6(c)(1) permits a private foundation to make a grant to an organization not described in section 501(c)(3) only if the grant is itself a direct charitable act or a program-related investment, or the foundation is reasonably assured through the separate-fund requirement that the grant will be used exclusively for charitable purposes.

Since a private foundation cannot make an expenditure for a purpose other than a purpose described in section 170(c)(2)(B), a private foundation may not make a grant to an organization other than an organization described in section 501(c)(3) unless (i) The making of the grant itself constitutes a direct charitable act or the making of a program-related investment, or (ii) Through compliance with the requirements of subparagraph (2) of this paragraph, the grantor is reasonably assured that the grant will be used exclusively for purposes described in section 170(c)(2)(B).

See 26 C.F.R. § 53.4945-6(c)(1).

Treasury Regulation § 53.4945-6(c)(2)(i) provides that, for a grant to an organization not described in section 501(c)(3), the grantor is reasonably assured of charitable use under the (c)(1)(ii) route only if the grantee keeps the funds in a separate fund dedicated to charitable purposes, and requires the grantor also to exercise expenditure responsibility.

(i) If a private foundation makes a grant which is not a transfer of assets pursuant to any liquidation, merger, redemption, recapitalization, or other adjustment, organization or reorganization to any organization (other than an organization described in section 501(c)(3) except an organization described in section 509(a)(4)), the grantor is reasonably assured (within the meaning of subparagraph (1)(ii) of this paragraph) that the grant will be used exclusively for purposes described in section 170(c)(2)(B) only if the grantee organization agrees to maintain and, during the period in which any portion of such grant funds remain unexpended, does continuously maintain the grant funds (or other assets transferred) in a separate fund dedicated to one or more purposes described in section 170(c)(2)(B). The grantor of a grant described in this paragraph must also comply with the expenditure responsibility provisions contained in sections 4945(d) and (h) and § 53.4945-5.

See 26 C.F.R. § 53.4945-6(c)(2)(i).

Celia Roady's 2013 seminar outline states that a private foundation must exercise expenditure responsibility over grants to organizations other than public charities.

A private foundation must exercise expenditure responsibility over grants made to organizations other than public charities in order for the grants not to be taxable expenditures under §4945(d)(4).

See Celia Roady, Grant-Making Part I: Routine Grants to Individuals and Public Charities (Morgan, Lewis & Bockius LLP, Rocky Mountain Tax Seminar for Private Foundations, Sept. 11, 2013).

Section 4944(c) excludes from jeopardizing investments those made primarily to accomplish charitable purposes where no significant purpose is the production of income or appreciation of property.

For purposes of this section, investments, the primary purpose of which is to accomplish one or more of the purposes described in section 170(c)(2)(B), and no significant purpose of which is the production of income or the appreciation of property, shall not be considered as investments which jeopardize the carrying out of exempt purposes.

See 26 U.S.C. § 4944(c) (2024 ed.).

Treasury Regulation § 53.4944-3(a)(2)(i) treats an investment as made primarily for charitable purposes if it significantly furthers the foundation's exempt activities and would not have been made but for that relationship.

An investment shall be considered as made primarily to accomplish one or more of the purposes described in section 170(c)(2)(B) if it significantly furthers the accomplishment of the private foundation's exempt activities and if the investment would not have been made but for such relationship between the investment and the accomplishment of the foundation's exempt activities.

See 26 C.F.R. § 53.4944-3(a)(2)(i).

Treasury Regulation § 53.4944-3(a)(2)(iii) makes it relevant whether profit-motivated investors would make the investment on the same terms as the foundation.

In determining whether a significant purpose of an investment is the production of income or the appreciation of property, it shall be relevant whether investors solely engaged in the investment for profit would be likely to make the investment on the same terms as the private foundation.

See 26 C.F.R. § 53.4944-3(a)(2)(iii).

Example 3 of Treasury Regulation § 53.4944-3(b) concludes, on its stated facts, that a foundation's purchase of common stock in a for-profit business is a program-related investment even though the foundation may realize a profit.

Accordingly, the purchase of the common stock is a program-related investment, even though Y may realize a profit if X is successful and the common stock appreciates in value.

See 26 C.F.R. § 53.4944-3(b), Example 3.

Simpson Thacher's 2016 memorandum reads the final regulations as clarifying that a foundation need not sell its stock in a business that becomes profitable for the investment to remain a program-related investment.

The Final Regulations remove the sentence regarding the private foundation’s intention to liquidate the stock, thereby clarifying that a private foundation does not need to sell its stock in a business that becomes profitable for the investment to qualify as a PRI.

See Simpson Thacher & Bartlett LLP, Final Regulations Providing Additional Examples of Program-Related Investments (Apr. 26, 2016).

Treasury Regulation § 53.4945-4(a)(2) treats charitable loans and program-related investments as grants for taxable-expenditure purposes.

Grants shall also include loans for purposes described in section 170(c) (2) (B) and “program related investments” (such as investments in small businesses in central cities or in businesses which assist in neighborhood renovation).

See 26 C.F.R. § 53.4945-4(a)(2).

Section 4942(g)(1)(A) excludes from qualifying distributions a contribution to an organization controlled directly or indirectly by the foundation or its disqualified persons, except as paragraph (3) provides.

(1) In general For purposes of this section, the term "qualifying distribution" means— (A) any amount (including that portion of reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in section 170(c)(2)(B), other than any contribution to (i) an organization controlled (directly or indirectly) by the foundation or one or more disqualified persons (as defined in section 4946) with respect to the foundation, except as provided in paragraph (3), or (ii) a private foundation which is not an operating foundation (as defined in subsection (j)(3)), except as provided in paragraph (3), or

See 26 U.S.C. § 4942(g)(1)(A) (2024 ed.).

Section 4942(g)(3) treats a contribution to a controlled section 501(c)(3) organization as a qualifying distribution only if the recipient makes an equal qualifying distribution out of corpus by the end of its next taxable year and the foundation obtains adequate records or other evidence of it.

(3) Certain contributions to section 501(c)(3) organizations For purposes of this section, the term "qualifying distribution" includes a contribution to a section 501(c)(3) organization described in paragraph (1)(A)(i) or (ii) if— (A) not later than the close of the first taxable year after its taxable year in which such contribution is received, such organization makes a distribution equal to the amount of such contribution and such distribution is a qualifying distribution (within the meaning of paragraph (1) or (2), without regard to this paragraph) which is treated under subsection (h) as a distribution out of corpus (or would be so treated if such section 501(c)(3) organization were a private foundation which is not an operating foundation), and (B) the private foundation making the contribution obtains adequate records or other sufficient evidence from such organization showing that the qualifying distribution described in subparagraph (A) has been made by such organization.

See 26 U.S.C. § 4942(g)(3) (2024 ed.).

Treasury Regulation § 53.4942(a)-3(a)(2)(i) defines qualifying distributions to include amounts, including program-related investments, paid to accomplish charitable purposes, other than any contribution to a non-operating private foundation or to an organization controlled by the contributing foundation or its disqualified persons, except as paragraph (c) provides.

Any amount (including program related investments, as defined in section 4944(c), and reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in section 170(c)(1) or (2)(B), other than any contribution to: (a) A private foundation which is not an operating foundation (as defined in section 4942(j)(3)), except as provided in paragraph (c) of this section; (b) An organization controlled (directly or indirectly) by the contributing private foundation or one or more disqualified persons with respect to such foundation, except as provided in paragraph (c) of this section; or

See 26 C.F.R. § 53.4942(a)-3(a)(2)(i).

Treasury Regulation § 53.4942(a)-3(a)(3) treats a donee as controlled by a private foundation or its disqualified persons if any of them, by aggregating votes or positions of authority, can require or prevent the donee's expenditures.

For purposes of subparagraph (2)(i)(b) of this paragraph, an organization is “controlled” by a foundation or one or more disqualified persons with respect to the foundation if any of such persons may, by aggregating their votes or positions of authority, require the donee organization to make an expenditure, or prevent the donee organization from making an expenditure, regardless of the method by which the control is exercised or exercisable.

See 26 C.F.R. § 53.4942(a)-3(a)(3).

Treasury Regulation § 53.4942(a)-3(a)(3) provides that the controlled organization need not be a private foundation and may be any exempt or nonexempt organization.

The “controlled” organization need not be a private foundation; it may be any type of exempt or nonexempt organization including a school, hospital, operating foundation, or social welfare organization.

See 26 C.F.R. § 53.4942(a)-3(a)(3).

The IRS states that imposing budgetary procedures on a supported organization does not, of itself, give a foundation control of it.

If a foundation provides support to an organization and imposes budgetary procedures on that organization, this will not, of itself, constitute control of the donee.

See IRS, Private Foundations: Qualifying Distributions to Organizations Controlled by Disqualified Persons (last reviewed June 27, 2026).

Treasury Regulation § 53.4946-1(a)(8) excludes section 501(c)(3) organizations, other than section 509(a)(4) organizations, from the disqualified persons relevant to self-dealing.

For purposes of section 4941 only, the term “disqualified person” shall not include any organization which is described in section 501(c)(3) (other than an organization described in section 509(a)(4)).

See 26 C.F.R. § 53.4946-1(a)(8).

Section 4946(a)(1) includes among a private foundation's disqualified persons any substantial contributor to the foundation and a corporation in which substantial contributors, foundation managers, certain 20 percent owners and their family members own more than 35 percent of the total combined voting power.

(1) In general For purposes of this subchapter, the term "disqualified person" means, with respect to a private foundation, a person who is— (A) a substantial contributor to the foundation, (B) a foundation manager (within the meaning of subsection (b)(1)), (C) an owner of more than 20 percent of— (i) the total combined voting power of a corporation, (ii) the profits interest of a partnership, or (iii) the beneficial interest of a trust or unincorporated enterprise, which is a substantial contributor to the foundation, (D) a member of the family (as defined in subsection (d)) of any individual described in subparagraph (A), (B), or (C), (E) a corporation of which persons described in subparagraph (A), (B), (C), or (D) own more than 35 percent of the total combined voting power,

See 26 U.S.C. § 4946(a)(1) (2024 ed.).

Section 4946(a)(3) requires indirect stockholdings, determined under section 267(c), to be taken into account in applying the 35 percent corporate ownership test.

(3) Stockholdings For purposes of paragraphs (1)(C)(i) and (1)(E), there shall be taken into account indirect stockholdings which would be taken into account under section 267(c), except that, for purposes of this paragraph, section 267(c)(4) shall be treated as providing that the members of the family of an individual are the members within the meaning of subsection (d).

See 26 U.S.C. § 4946(a)(3) (2024 ed.).

Treasury Regulation § 53.4941(d)-2(f)(1) makes the transfer to, or use by or for the benefit of, a disqualified person of a private foundation's income or assets an act of self-dealing.

The transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation shall constitute an act of self-dealing.

See 26 C.F.R. § 53.4941(d)-2(f)(1).

Treasury Regulation § 53.4941(d)-2(f)(2) gives as an example of incidental benefit a grant to a section 509(a)(1), (2) or (3) organization that shares an officer, director or trustee with the foundation.

For example, a grant by a private foundation to a section 509(a) (1), (2), or (3) organization will not be an act of self-dealing merely because such organization is located in the same area as a corporation which is a substantial contributor to the foundation, or merely because one of the section 509(a) (1), (2), or (3) organization's officers, directors, or trustees is also a manager of or a substantial contributor to the foundation.

See 26 C.F.R. § 53.4941(d)-2(f)(2).

Section 118(b)(2) excludes from contributions to capital a contribution by any governmental entity or civic group other than a contribution made by a shareholder as such, without defining civic group.

(b) Exceptions For purposes of subsection (a), except as provided in subsection (c), the term "contribution to the capital of the taxpayer" does not include— (1) any contribution in aid of construction or any other contribution as a customer or potential customer, and (2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).

See 26 U.S.C. § 118(b) (2024 ed.).

The IRS states that a grant not subject to statutory expenditure responsibility must still meet the standards of Revenue Ruling 68-489.

If a grant to an organization is not subject to statutory expenditure responsibility, the grant must still meet the standards of Rev. Rul. 68-489.

See IRS, IRC Section 4945(h) - Expenditure Responsibility, Issue Snapshot (last reviewed Mar. 19, 2026).

Treasury Regulation § 1.509(a)-4(e)(1) treats a supporting organization as operated exclusively to support its supported organizations only if it engages solely in activities that support or benefit them.

A supporting organization will be regarded as operated exclusively to support one or more specified publicly supported organizations (hereinafter referred to as the operational test) only if it engages solely in activities which support or benefit the specified publicly supported organizations.

See 26 C.F.R. § 1.509(a)-4(e)(1).

Section 4958(c)(3)(A) treats any grant, loan, compensation or other similar payment by a supporting organization to a person described in § 4958(c)(3)(B) as an excess benefit transaction, with the full amount as the excess benefit.

(3) Special rules for supporting organizations (A) In general In the case of any organization described in section 509(a)(3)— (i) the term "excess benefit transaction" includes— (I) any grant, loan, compensation, or other similar payment provided by such organization to a person described in subparagraph (B), and (II) any loan provided by such organization to a disqualified person (other than an organization described in subparagraph (C)(ii)), and (ii) the term "excess benefit" includes, with respect to any transaction described in clause (i), the amount of any such grant, loan, compensation, or other similar payment.

See 26 U.S.C. § 4958(c)(3)(A) (2024 ed.).

Section 4958(c)(3)(B) describes the persons covered by the supporting-organization rule: substantial contributors, their family members and specified 35-percent controlled entities.

(B) Person described A person is described in this subparagraph if such person is— (i) a substantial contributor to such organization, (ii) a member of the family (determined under section 4958(f)(4)) of an individual described in clause (i), or (iii) a 35-percent controlled entity (as defined in section 4958(f)(3) by substituting "persons described in clause (i) or (ii) of section 4958(c)(3)(B)" for "persons described in subparagraph (A) or (B) of paragraph (1)" in subparagraph (A)(i) thereof).

See 26 U.S.C. § 4958(c)(3)(B) (2024 ed.).

Section 4958(f)(3) defines a 35-percent controlled entity as a corporation, partnership, trust or estate in which the specified persons own more than 35 percent of the voting power, profits interest or beneficial interest, applying constructive ownership rules.

(3) 35-percent controlled entity (A) In general The term "35-percent controlled entity" means— (i) a corporation in which persons described in subparagraph (A) or (B) of paragraph (1) own more than 35 percent of the total combined voting power, (ii) a partnership in which such persons own more than 35 percent of the profits interest, and (iii) a trust or estate in which such persons own more than 35 percent of the beneficial interest. (B) Constructive ownership rules Rules similar to the rules of paragraphs (3) and (4) of section 4946(a) shall apply for purposes of this paragraph.

See 26 U.S.C. § 4958(f)(3) (2024 ed.).

Section 509(a) defines a private foundation as a domestic or foreign section 501(c)(3) organization other than the organizations described in its paragraphs (1) through (4), which include section 170(b)(1)(A) organizations, publicly supported organizations, supporting organizations and organizations operated exclusively for testing for public safety.

(a) General rule For purposes of this title, the term "private foundation" means a domestic or foreign organization described in section 501(c)(3) other than— (1) an organization described in section 170(b)(1)(A) (other than in clauses (vii) and (viii)); (2) an organization which— (A) normally receives more than one-third of its support in each taxable year from any combination of— (i) gifts, grants, contributions, or membership fees, and (ii) gross receipts from admissions, sales of merchandise, performance of services, or furnishing of facilities, in an activity which is not an unrelated trade or business (within the meaning of section 513), not including such receipts from any person, or from any bureau or similar agency of a governmental unit (as described in section 170(c)(1)), in any taxable year to the extent such receipts exceed the greater of $5,000 or 1 percent of the organization's support in such taxable year, from persons other than disqualified persons (as defined in section 4946) with respect to the organization, from governmental units described in section 170(c)(1), or from organizations described in section 170(b)(1)(A) (other than in clauses (vii) and (viii)), and (B) normally receives not more than one-third of its support in each taxable year from the sum of— (i) gross investment income (as defined in subsection (e)) and (ii) the excess (if any) of the amount of the unrelated business taxable income (as defined in section 512) over the amount of the tax imposed by section 511; (3) an organization which— (A) is organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (1) or (2), (B) is— (i) operated, supervised, or controlled by one or more organizations described in paragraph (1) or (2), (ii) supervised or controlled in connection with one or more such organizations, or (iii) operated in connection with one or more such organizations, and (C) is not controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more organizations described in paragraph (1) or (2); and (4) an organization which is organized and operated exclusively for testing for public safety.

See 26 U.S.C. § 509(a) (2024 ed.).

Section 4958(c)(3)(C)(ii) excludes organizations described in section 509(a)(1), (2) or (4), and certain supported organizations, from the term substantial contributor for the supporting-organization rule.

(ii) Exception Such term shall not include— (I) any organization described in paragraph (1), (2), or (4) of section 509(a), and (II) any organization which is treated as described in such paragraph (2) by reason of the last sentence of section 509(a) and which is a supported organization (as defined in section 509(f)(3)) of the organization to which subparagraph (A) applies.

See 26 U.S.C. § 4958(c)(3)(C)(ii) (2024 ed.).

Treasury Regulation § 53.4945-5(a)(6)(i) treats a private foundation's grant as a grant to the secondary grantee if the foundation earmarks it for a named secondary grantee or has an agreement under which it may cause the secondary grantee's selection, but not merely because the foundation expects the secondary grantee to benefit, so long as the original grantee in fact controls the selection and makes it independently.

A grant by a private foundation to a grantee organization which the grantee organization uses to make payments to another organization (the secondary grantee) shall not be regarded as a grant by the private foundation to the secondary grantee if the foundation does not earmark the use of the grant for any named secondary grantee and there does not exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the secondary grantee by the organization to which it has given the grant. For purposes of this subdivision, a grant described herein shall not be regarded as a grant by the foundation to the secondary grantee even though such foundation has reason to believe that certain organizations would derive benefits from such grant so long as the original grantee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of the private foundation.

See 26 C.F.R. § 53.4945-5(a)(6)(i).

Section 4945(d)(4)(A) excludes from taxable expenditures a grant to a public charity described in section 509(a)(1) or (2), or a qualifying supporting organization, without expenditure responsibility.

(4) as a grant to an organization unless— (A) such organization— (i) is described in paragraph (1) or (2) of section 509(a), (ii) is an organization described in section 509(a)(3) (other than an organization described in clause (i) or (ii) of section 4942(g)(4)(A)), or (iii) is an exempt operating foundation (as defined in section 4940(d)(2)), or (B) the private foundation exercises expenditure responsibility with respect to such grant in accordance with subsection (h), or (5) for any purpose other than one specified in section 170(c)(2)(B).

See 26 U.S.C. § 4945(d)(4)–(5) (2024 ed.).

Treasury Regulation § 53.4945-5(b)(1) provides that when a grant is treated as made to a secondary grantee, the foundation's reporting obligation is satisfied by appropriate reports from the secondary grantee.

In cases in which pursuant to paragraph (a)(6) of this section a grant is considered made to a secondary grantee rather than the primary grantee, the grantor foundation's obligation to obtain reports from the grantee pursuant to section 4945(h)(2) and this section will be satisfied if appropriate reports are obtained from the secondary grantee.

See 26 C.F.R. § 53.4945-5(b)(1).

Celia Roady's 2013 outline reads the intermediary rule to apply even when the foundation expects others to benefit, provided the original grantee in fact controls the selection and makes it independently.

This rule applies even if the grantor foundation has reason to believe that certain organizations would derive benefits from the grant, provided that the original grantee organization exercises control, in fact, over the selection process and makes the selection independently of the grantor foundation.

See Celia Roady, Grant-Making Part I: Routine Grants to Individuals and Public Charities (Morgan, Lewis & Bockius LLP, Rocky Mountain Tax Seminar for Private Foundations, Sept. 11, 2013).

Revenue Ruling 68-489 allows a section 501(c)(3) organization to distribute funds to a nonexempt organization while retaining control and discretion over their use for section 501(c)(3) purposes.

An organization will not jeopardize its exemption under section 501(c)(3) of the Code, even though it distributes funds to nonexempt organizations, provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

Revenue Ruling 68-489 describes Revenue Rulings 63-252 and 66-79 as addressing the deductibility of individuals' contributions to a United States charity that transmits funds to a foreign charitable organization.

See also Revenue Ruling 67-149, C.B. 1967-1, 133, holding a charitable organization exempt under section 501(c)(3) where it provides financial assistance to other charitable organizations that are also exempt under section 501(c)(3); and Revenue Ruling 63-252, C.B. 1963-2, 101, and Revenue Ruling 66-79, C.B. 1966-1, 48, for requirements with respect to deductibility under section 170 of the Code of contributions by individuals to a charity organized in the United States that thereafter transmits some or all of its funds to a foreign charitable organization.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

Treasury Regulation § 1.509(a)-4(e)(1) treats a supporting organization as operated exclusively to support its supported organizations only if it engages solely in activities that support or benefit them.

A supporting organization will be regarded as operated exclusively to support one or more specified publicly supported organizations (hereinafter referred to as the operational test) only if it engages solely in activities which support or benefit the specified publicly supported organizations.

See 26 C.F.R. § 1.509(a)-4(e)(1).

Treasury Regulation § 1.509(a)-4(e)(1) permits a supporting organization to support or benefit a section 501(c)(3) organization, other than a private foundation, that is operated, supervised, or controlled directly by or in connection with the supported organizations, or an organization described in section 511(a)(2)(B).

Similarly, an organization will be regarded as operated exclusively to support or benefit one or more specified publicly supported organizations even if it supports or benefits an organization, other than a private foundation, which is described in section 501(c)(3) and is operated, supervised, or controlled directly by or in connection with such publicly supported organizations, or which is described in section 511(a)(2)(B).

See 26 C.F.R. § 1.509(a)-4(e)(1).

Section 509(a)(3) excludes from private foundation status an organization operated exclusively for the benefit of specified public charities that is operated, supervised, or controlled by them, supervised or controlled in connection with them, or operated in connection with them, and that is not controlled by disqualified persons other than foundation managers and those public charities.

(3) an organization which— (A) is organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in paragraph (1) or (2), (B) is— (i) operated, supervised, or controlled by one or more organizations described in paragraph (1) or (2), (ii) supervised or controlled in connection with one or more such organizations, or (iii) operated in connection with one or more such organizations, and (C) is not controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more organizations described in paragraph (1) or (2); and

See 26 U.S.C. § 509(a)(3) (2024 ed.).

Treasury Regulation § 1.509(a)-4(h)(1) requires common supervision or control for a supporting organization supervised or controlled in connection with a public charity, with its control or management vested in the same persons who control or manage the public charity.

(1) In order for a supporting organization to be supervised or controlled in connection with one or more publicly supported organizations, there must be common supervision or control by the persons supervising or controlling both the supporting organization and the publicly supported organizations to insure that the supporting organization will be responsive to the needs and requirements of the publicly supported organizations. Therefore, in order to meet such requirement, the control or management of the supporting organization must be vested in the same persons that control or manage the publicly supported organizations.

See 26 C.F.R. § 1.509(a)-4(h)(1).

Section 509(f)(2)(A) provides that, for purposes of § 509(a)(3)(B), an organization is not considered operated, supervised, or controlled by, or operated in connection with, a public charity if it accepts a gift or contribution from a person described in § 509(f)(2)(B).

(2) Organizations controlled by donors (A) In general For purposes of subsection (a)(3)(B), an organization shall not be considered to be— (i) operated, supervised, or controlled by any organization described in paragraph (1) or (2) of subsection (a), or (ii) operated in connection with any organization described in paragraph (1) or (2) of subsection (a), if such organization accepts any gift or contribution from any person described in subparagraph (B).

See 26 U.S.C. § 509(f)(2)(A) (2024 ed.).

Section 509(f)(2)(B) describes, with respect to a supported organization, a person other than an organization described in section 509(a)(1), (2) or (4) who directly or indirectly controls its governing body, alone or with family members and controlled entities, as well as that person's family members and specified 35-percent controlled entities.

(B) Person described A person is described in this subparagraph if, with respect to a supported organization of an organization described in subparagraph (A), such person is— (i) a person (other than an organization described in paragraph (1), (2), or (4) of section 509(a)) who directly or indirectly controls, either alone or together with persons described in clauses (ii) and (iii), the governing body of such supported organization, (ii) a member of the family (determined under section 4958(f)(4)) of an individual described in clause (i), or (iii) a 35-percent controlled entity (as defined in section 4958(f)(3) by substituting "persons described in clause (i) or (ii) of section 509(f)(2)(B)" for "persons described in subparagraph (A) or (B) of paragraph (1)" in subparagraph (A)(i) thereof).

See 26 U.S.C. § 509(f)(2)(B) (2024 ed.).

Treasury Regulation § 1.509(a)-4(e)(1) provides that an organization is not operated exclusively to support its supported organizations if any part of its activities furthers a purpose other than supporting or benefiting them.

However, an organization will not be regarded as operated exclusively if any part of its activities is in furtherance of a purpose other than supporting or benefiting one or more specified publicly supported organizations.

See 26 C.F.R. § 1.509(a)-4(e)(1).

Treasury Regulation § 1.509(a)-4(e)(1) permits payments to or for members of the supported organization's charitable class, including indirectly through another unrelated organization only if the payment is a grant to an individual under the standard of § 53.4945-4(a)(4).

Such activities may include making payments to or for the use of, or providing services or facilities for, individual members of the charitable class benefited by the specified publicly supported organization. A supporting organization may also, for example, make a payment indirectly through another unrelated organization to a member of a charitable class benefited by the specified publicly supported organization, but only if such a payment constitutes a grant to an individual rather than a grant to an organization. In determining whether a grant is indirectly to an individual rather than to an organization the same standard shall be applied as in § 53.4945-4(a)(4) of this chapter.

See 26 C.F.R. § 1.509(a)-4(e)(1).

Section 511(a)(2)(B) describes a college or university that is an agency or instrumentality of, or owned or operated by, a government, political subdivision or governmental agency, and any corporation wholly owned by one or more such colleges or universities.

(B) State colleges and universities The tax imposed by paragraph (1) shall apply in the case of any college or university which is an agency or instrumentality of any government or any political subdivision thereof, or which is owned or operated by a government or any political subdivision thereof, or by any agency or instrumentality of one or more governments or political subdivisions. Such tax shall also apply in the case of any corporation wholly owned by one or more such colleges or universities.

See 26 U.S.C. § 511(a)(2)(B) (2024 ed.).

Treasury Regulation § 1.509(a)-4(e)(2) allows a supporting organization to carry on its own programs that support or benefit the supported organizations, but requires all such support to be limited to permissible beneficiaries.

(2) Permissible activities. A supporting organization is not required to pay over its income to the publicly supported organizations in order to meet the operational test. It may satisfy the test by using its income to carry on an independent activity or program which supports or benefits the specified publicly supported organizations. All such support must, however, be limited to permissible beneficiaries in accordance with subparagraph (1) of this paragraph.

See 26 C.F.R. § 1.509(a)-4(e)(2).

Section 4958(c)(3)(A) treats any grant, loan, compensation or similar payment by a supporting organization to a person described in § 4958(c)(3)(B), and any loan to a disqualified person other than an organization described in § 4958(c)(3)(C)(ii), as an excess benefit transaction, with the full amount as the excess benefit.

(3) Special rules for supporting organizations (A) In general In the case of any organization described in section 509(a)(3)— (i) the term "excess benefit transaction" includes— (I) any grant, loan, compensation, or other similar payment provided by such organization to a person described in subparagraph (B), and (II) any loan provided by such organization to a disqualified person (other than an organization described in subparagraph (C)(ii)), and (ii) the term "excess benefit" includes, with respect to any transaction described in clause (i), the amount of any such grant, loan, compensation, or other similar payment.

See 26 U.S.C. § 4958(c)(3)(A) (2024 ed.).

Section 4958(c)(3)(B) describes the persons covered by the supporting-organization rule: substantial contributors, their family members and specified 35-percent controlled entities.

(B) Person described A person is described in this subparagraph if such person is— (i) a substantial contributor to such organization, (ii) a member of the family (determined under section 4958(f)(4)) of an individual described in clause (i), or (iii) a 35-percent controlled entity (as defined in section 4958(f)(3) by substituting "persons described in clause (i) or (ii) of section 4958(c)(3)(B)" for "persons described in subparagraph (A) or (B) of paragraph (1)" in subparagraph (A)(i) thereof).

See 26 U.S.C. § 4958(c)(3)(B) (2024 ed.).

Section 4958(f)(3) defines a 35-percent controlled entity as a corporation, partnership, trust or estate in which the specified persons own more than 35 percent of the voting power, profits interest or beneficial interest, applying constructive ownership rules.

(3) 35-percent controlled entity (A) In general The term "35-percent controlled entity" means— (i) a corporation in which persons described in subparagraph (A) or (B) of paragraph (1) own more than 35 percent of the total combined voting power, (ii) a partnership in which such persons own more than 35 percent of the profits interest, and (iii) a trust or estate in which such persons own more than 35 percent of the beneficial interest. (B) Constructive ownership rules Rules similar to the rules of paragraphs (3) and (4) of section 4946(a) shall apply for purposes of this paragraph.

See 26 U.S.C. § 4958(f)(3) (2024 ed.).

Section 4958(c)(3)(C)(ii) excludes organizations described in section 509(a)(1), (2) or (4), and certain supported organizations, from the term substantial contributor for the supporting-organization rule.

(ii) Exception Such term shall not include— (I) any organization described in paragraph (1), (2), or (4) of section 509(a), and (II) any organization which is treated as described in such paragraph (2) by reason of the last sentence of section 509(a) and which is a supported organization (as defined in section 509(f)(3)) of the organization to which subparagraph (A) applies.

See 26 U.S.C. § 4958(c)(3)(C)(ii) (2024 ed.).

Treasury Regulation § 53.4958-3(d)(1) deems a section 501(c)(3) organization exempt under section 501(a) not to be in a position to exercise substantial influence over an applicable tax-exempt organization.

(d) Persons deemed not to have substantial influence. A person is deemed not to be in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization if that person is described in one of the following categories: (1) Tax-exempt organizations described in section 501(c)(3). This category includes any organization described in section 501(c)(3) and exempt from tax under section 501(a).

See 26 C.F.R. § 53.4958-3(d)(1).

Treasury Regulation § 53.4958-3(b)(2)(i) defines a 35-percent controlled entity by the holdings of disqualified persons, excluding the holdings of persons described in paragraphs (b)(2) and (d), such as section 501(c)(3) organizations.

(2) Thirty-five percent controlled entities — (i) In general. A person is a disqualified person with respect to any transaction with an applicable tax-exempt organization if the person is a 35-percent controlled entity. A 35-percent controlled entity is— (A) A corporation in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the combined voting power; (B) A partnership in which persons described in this section (except in paragraphs (b)(2) and (d) of this section) own more than 35 percent of the profits interest;

See 26 C.F.R. § 53.4958-3(b)(2)(i).

Section 4958(c)(1)(A) defines an excess benefit transaction as one in which an applicable tax-exempt organization directly or indirectly provides a disqualified person an economic benefit worth more than the consideration it receives.

The term "excess benefit transaction" means any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

See 26 U.S.C. § 4958(c)(1)(A) (2024 ed.).

Section 4958(f)(1)(D) makes a person who is a disqualified person with respect to a supporting organization of an applicable tax-exempt organization also a disqualified person of that organization, alongside persons with substantial influence in the prior five years, their family members and 35-percent controlled entities.

(1) Disqualified person The term "disqualified person" means, with respect to any transaction— (A) any person who was, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization, (B) a member of the family of an individual described in subparagraph (A), (C) a 35-percent controlled entity, (D) any person who is described in subparagraph (A), (B), or (C) with respect to an organization described in section 509(a)(3) and organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of the applicable tax-exempt organization,

See 26 U.S.C. § 4958(f)(1) (2024 ed.).

Section 501(c)(3) describes corporations organized and operated exclusively for religious, charitable, scientific, literary, educational and other listed purposes, no part of whose net earnings inures to any private shareholder or individual, subject to limits on lobbying and a bar on political campaign intervention.

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

See 26 U.S.C. § 501(c)(3) (2024 ed.).

Revenue Ruling 68-489 holds that a section 501(c)(3) organization does not jeopardize its exemption by distributing funds to nonexempt organizations if it retains control and discretion over their use for section 501(c)(3) purposes.

An organization will not jeopardize its exemption under section 501(c)(3) of the Code, even though it distributes funds to nonexempt organizations, provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

Treasury Regulation § 53.4945-5(a)(6)(i) states its earmarking rule for a grant by a private foundation to a grantee organization that uses it to pay a secondary grantee.

A grant by a private foundation to a grantee organization which the grantee organization uses to make payments to another organization (the secondary grantee) shall not be regarded as a grant by the private foundation to the secondary grantee if the foundation does not earmark the use of the grant for any named secondary grantee and there does not exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the secondary grantee by the organization to which it has given the grant. For purposes of this subdivision, a grant described herein shall not be regarded as a grant by the foundation to the secondary grantee even though such foundation has reason to believe that certain organizations would derive benefits from such grant so long as the original grantee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of the private foundation.

See 26 C.F.R. § 53.4945-5(a)(6)(i).

Treasury Regulation § 53.4945-5(b)(3) requires an expenditure-responsibility grantee to agree to repay unused funds, report annually, keep records of receipts and expenditures open to the grantor, and use the funds only for the grant's stated charitable purposes.

Except as provided in subparagraph (4) of this paragraph, in order to meet the expenditure responsibility requirements of section 4945(h), a private foundation must require that each grant to an organization, with respect to which expenditure responsibility must be exercised under this section, be made subject to a written commitment signed by an appropriate officer, director, or trustee of the grantee organization. Such commitment must include an agreement by the grantee: (i) To repay any portion of the amount granted which is not used for the purposes of the grant, (ii) To submit full and complete annual reports on the manner in which the funds are spent and the progress made in accomplishing the purposes of the grant, except as provided in paragraph (c)(2) of this section, (iii) To maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times, and (iv) Not to use any of the funds: (a) To carry on propaganda, or otherwise to attempt, to influence legislation (within the meaning of section 4945(d)(1)), (b) To influence the outcome of any specific public election, or to carry on, directly or indirectly, any voter registration drive (within the meaning of section 4945(d)(2)), (c) To make any grant which does not comply with the requirements of section 4945(d) (3) or (4), or (d) To undertake any activity for any purpose other than one specified in section 170(c)(2)(B). The agreement must also clearly specify the purposes of the grant.

See 26 C.F.R. § 53.4945-5(b)(3).

Treasury Regulation § 53.4945-5(a)(6)(i) treats a private foundation's grant as a grant to the secondary grantee if the foundation earmarks it for a named secondary grantee or has an agreement under which it may cause the secondary grantee's selection, but not merely because the foundation expects the secondary grantee to benefit, so long as the original grantee in fact controls the selection and makes it independently.

A grant by a private foundation to a grantee organization which the grantee organization uses to make payments to another organization (the secondary grantee) shall not be regarded as a grant by the private foundation to the secondary grantee if the foundation does not earmark the use of the grant for any named secondary grantee and there does not exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the secondary grantee by the organization to which it has given the grant. For purposes of this subdivision, a grant described herein shall not be regarded as a grant by the foundation to the secondary grantee even though such foundation has reason to believe that certain organizations would derive benefits from such grant so long as the original grantee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of the private foundation.

See 26 C.F.R. § 53.4945-5(a)(6)(i).

Revenue Ruling 68-489 describes an organization that limited distributions to specific projects furthering its own exempt purposes, retained control and discretion, and kept records showing the funds were used for section 501(c)(3) purposes.

The exempt organization ensured use of the funds for section 501(c)(3) purposes by limiting distributions to specific projects that are in furtherance of its own exempt purposes. It retains control and discretion as to the use of the funds and maintains records establishing that the funds were used for section 501(c)(3) purposes. Held, the distributions did not jeopardize the organization's exemption under section 501(c)(3) of the Code.

See Rev. Rul. 68-489, 1968-2 C.B. 210.

The Schedule D instructions require an organization acting as agent or intermediary for funds payable to others, and not reporting them on Part X, to check Yes and explain the arrangement.

If the organization acts as an agent, trustee, custodian, or other intermediary for funds payable to other organizations or individuals and hasn't reported those amounts on Form 990, Part X, as an asset or liability, check “Yes” and provide an explanation of the arrangement in Part XIII.

See IRS, Instructions for Schedule D (Form 990) (Rev. Dec. 2024), Part IV, lines 1a–1f.

The Schedule R instructions state that Part V collects information on transactions between the organization and its related organizations, other than disregarded entities.

Part V requires information on transactions between the organization and related organizations (excluding disregarded entities).

See IRS, Instructions for Schedule R (Form 990) (Rev. Dec. 2024), Purpose of Schedule.

The Form 990 instructions exclude from an organization's gross receipts funds it collects merely as an agent for another organization without asserting any right to use them.

If a local chapter of a section 501(c)(8) fraternal organization collects insurance premiums for its parent lodge and merely sends those premiums to the parent without asserting any right to use the funds or otherwise deriving any benefit from them, the local chapter doesn’t include the premiums in its gross receipts. The parent lodge reports them instead. The same treatment applies in other situations in which one organization collects funds merely as an agent for another.

See IRS, Instructions for Form 990 (2025), Appendix B, Gross Receipts.

The Form 990 instructions describe donor restrictions as requiring resources to be used after a specified date, for a specified purpose, or both.

Donors’ restrictions may require that resources be used after a specified date (time restrictions), or that resources be used for a specified purpose (purpose restrictions), or both.

See IRS, Instructions for Form 990 (2025), Part X, line 28.

The Form 990 instructions require all funds without donor-imposed restrictions to be reported as net assets without donor restrictions regardless of board designations or appropriations.

All funds without donor-imposed restrictions must be reported on line 27, regardless of the existence of any board designations or appropriations.

See IRS, Instructions for Form 990 (2025), Part X, line 27.

The Schedule D instructions state that board-designated endowments result from internal designation, are generally not donor-restricted, and may be spent whenever the governing board decides.

Board-designated endowments or quasi-endowments result from an internal designation and are generally not donor-restricted and are classified as net assets without donor restrictions. The governing board has the right to decide at any time to expend such funds.

See IRS, Instructions for Schedule D (Form 990) (Rev. Dec. 2024), Part V.

The Form 990 instructions bar an organization from filing a consolidated Form 990 that aggregates information from another organization with a different employer identification number, apart from group returns, joint ventures, disregarded entities and other listed exceptions.

An organization may not file a “consolidated” Form 990 to aggregate information from another organization that has a different employer identification number (EIN), unless it is filing a group return and reporting information from a subordinate organization or organizations, reporting information from a joint venture or disregarded entity (see Appendix E. Group Returns—Reporting Information on Behalf of the Group, and Appendix F. Disregarded Entities and Joint Ventures—Inclusion of Activities and Items, later), or as otherwise provided for in the Code, regulations, or official IRS guidance.

See IRS, Instructions for Form 990 (2025), General Instructions, A. Who Must File.

The Schedule R instructions treat persons owning more than 50 percent of a stock corporation's stock by voting power or value as controlling it.

One or more persons (whether individuals or organizations) control a stock corporation if they own more than 50% of the stock (by voting power or value) of the corporation.

See IRS, Instructions for Schedule R (Form 990) (Rev. Dec. 2024), Definition of Control.

Section 512(a)(1) defines unrelated business taxable income as gross income from an unrelated trade or business regularly carried on by the organization, less directly connected deductions.

Except as otherwise provided in this subsection, the term "unrelated business taxable income" means the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subsection (b).

See 26 U.S.C. § 512(a)(1) (2024 ed.).

Section 513(a) defines an unrelated trade or business as one not substantially related to the organization's exempt purpose, apart from its need for income, and excludes a business in which substantially all the work is done without compensation.

(a) General rule The term "unrelated trade or business" means, in the case of any organization subject to the tax imposed by section 511, any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501 (or, in the case of an organization described in section 511(a)(2)(B), to the exercise or performance of any purpose or function described in section 501(c)(3)), except that such term does not include any trade or business— (1) in which substantially all the work in carrying on such trade or business is performed for the organization without compensation; or

See 26 U.S.C. § 513(a) (2024 ed.).

Section 512(b)(13)(A) requires an exempt organization to include a specified payment from an entity it controls as an item of gross income derived from an unrelated trade or business, to the extent the payment reduces the controlled entity's net unrelated income or increases its net unrelated loss.

If an organization (in this paragraph referred to as the "controlling organization") receives or accrues (directly or indirectly) a specified payment from another entity which it controls (in this paragraph referred to as the "controlled entity"), notwithstanding paragraphs (1), (2), and (3), the controlling organization shall include such payment as an item of gross income derived from an unrelated trade or business to the extent such payment reduces the net unrelated income of the controlled entity (or increases any net unrelated loss of the controlled entity).

See 26 U.S.C. § 512(b)(13)(A) (2024 ed.).

Section 512(b)(13)(C) defines a specified payment as interest, an annuity, a royalty or rent.

For purposes of this paragraph, the term "specified payment" means any interest, annuity, royalty, or rent.

See 26 U.S.C. § 512(b)(13)(C) (2024 ed.).

Treasury Regulation § 1.513-1(d)(2) treats a business as substantially related only if its conduct has a substantial causal relationship to achieving exempt purposes other than through producing income.

Trade or business is related to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is substantially related, for purposes of section 513, only if the causal relationship is a substantial one.

See 26 C.F.R. § 1.513-1(d)(2).

Treasury Regulation § 1.513-1(d)(4)(iii) provides that using a facility in exempt functions does not by itself make income from a commercial use of the same facility related income; the test is whether the income-producing activity contributes importantly to exempt purposes.

In such cases, the mere fact of the use of the asset or facility in exempt functions does not, by itself, make the income from the commercial endeavor gross income from related trade or business. The test, instead, is whether the activities productive of the income in question contribute importantly to the accomplishment of exempt purposes.

See 26 C.F.R. § 1.513-1(d)(4)(iii).

IRS Publication 598 requires expenses of facilities or personnel used for both exempt functions and an unrelated business to be allocated between the two uses on a reasonable basis.

When facilities or personnel are used both to conduct exempt functions and to conduct an unrelated trade or business, expenses, depreciation, and similar items attributable to the facilities or personnel must be allocated between the two uses on a reasonable basis.

See IRS, Publication 598, Tax on Unrelated Business Income of Exempt Organizations (Rev. Mar. 2021), ch. 4.

Venable's 1999 paper recommends a written arm's-length agreement covering shared facilities, equipment, services and employees, followed in practice, together with separate books, bank accounts and tax returns.

The parent and the subsidiary should enter into an arm's length written agreement covering all aspects of the shared facilities, equipment, supplies, services and employees. The agreement should, of course, be followed in practice. It is critical that strict financial separation be maintained (i.e., separate financial books and records, separate bank accounts, separate tax returns, and avoidance of any commingling of assets).

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Private Letter Ruling 202005020 (not precedent) concluded that an agreement under which an exempt organization provided services and other resources to its subsidiary for cost reimbursement would cause the organization to be operated for the benefit of private interests.

The Agreement between Taxpayer and Subsidiary, in which Taxpayer provides services and other resources to Subsidiary, and Subsidiary reimburses Taxpayer for the costs incurred by Taxpayer in providing such services and resources, will cause Taxpayer to be operated for the benefit of private interests and will not further an exempt purpose, within the meaning of section 501(c)(3).

See I.R.S. Priv. Ltr. Rul. 202005020 (released Jan. 31, 2020).

Private Letter Ruling 202005020 (not precedent) arose on facts in which the subsidiary would establish and operate a political action committee within the meaning of section 527.

Subsidiary will establish and operate a political action committee within the meaning of section 527 (“PAC”).

See I.R.S. Priv. Ltr. Rul. 202005020 (released Jan. 31, 2020).

Section 6110(k)(3) bars using or citing a written determination, such as a private letter ruling, as precedent unless regulations provide otherwise.

Unless the Secretary otherwise establishes by regulations, a written determination may not be used or cited as precedent.

See 26 U.S.C. § 6110(k)(3) (2024 ed.).

Kelley Drye's 2008 advisory treats adequate capitalization and insurance of the subsidiary as the most important step against a veil-piercing argument.

Properly capitalizing and insuring the subsidiary is by far the most important step to prevent a successful piercing argument (since doing so substantially weakens a potential argument based on alleged injustice).

See Philip D. Robben, Protecting the Parent Corporation from Disregard of the Corporate Form (Kelley Drye & Warren LLP, Sept. 22, 2008).

Levitt and Chiodini write that a nonprofit and its for-profit subsidiary should each have a separate governing body and hold separate board and committee meetings with separate minutes.

Corporate formalities must be observed to protect the separation of the entities. Each organization must have a separate governing body and should conduct separate board and committee meetings, with separate minutes taken.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Venable's 1999 paper recommends a written arm's-length agreement covering shared facilities, equipment, services and employees, followed in practice, together with separate books, bank accounts and tax returns.

The parent and the subsidiary should enter into an arm's length written agreement covering all aspects of the shared facilities, equipment, supplies, services and employees. The agreement should, of course, be followed in practice. It is critical that strict financial separation be maintained (i.e., separate financial books and records, separate bank accounts, separate tax returns, and avoidance of any commingling of assets).

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Delaware General Corporation Law § 141(f) permits board action without a meeting if all directors consent in writing or by electronic transmission, unless the certificate or bylaws restrict it.

(f) Unless otherwise restricted by the certificate of incorporation or bylaws, (1) any action required or permitted to be taken at any meeting of the board of directors or of any committee thereof may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing, or by electronic transmission, and (2) a consent may be documented, signed and delivered in any manner permitted by § 116 of this title.

See Del. Code Ann. tit. 8, § 141(f).

Delaware General Corporation Law § 141(f) requires board consents to be filed with the minutes of board proceedings after the action is taken.

After an action is taken, the consent or consents relating thereto shall be filed with the minutes of the proceedings of the board of directors, or the committee thereof, in the same paper or electronic form as the minutes are maintained.

See Del. Code Ann. tit. 8, § 141(f).

The Form 990 instructions require each organization to have its own employer identification number and state that an organization should never use another organization's number, even if the organizations are related.

Each organization (including a subordinate of a central organization) must have its own EIN. Use the EIN provided to the organization for filing its Form 990 and federal tax returns. An organization should never use the EIN issued to another organization, even if the organizations are related.

See IRS, Instructions for Form 990 (2025), Item D. EIN.

The Form 990 instructions bar an organization from filing a consolidated Form 990 that aggregates information from another organization with a different employer identification number, apart from group returns, joint ventures, disregarded entities and other listed exceptions.

An organization may not file a “consolidated” Form 990 to aggregate information from another organization that has a different employer identification number (EIN), unless it is filing a group return and reporting information from a subordinate organization or organizations, reporting information from a joint venture or disregarded entity (see Appendix E. Group Returns—Reporting Information on Behalf of the Group, and Appendix F. Disregarded Entities and Joint Ventures—Inclusion of Activities and Items, later), or as otherwise provided for in the Code, regulations, or official IRS guidance.

See IRS, Instructions for Form 990 (2025), General Instructions, A. Who Must File.

Fletcher v. Atex, applying Delaware law, relied on undisputed evidence that the subsidiary held regular board meetings, kept minutes, maintained its own financial records, filed its own tax returns and had its own employees and managers.

Significantly, the plaintiffs have not challenged Kodak’s assertions that Atex’s board of directors held regular meetings, that minutes from those meetings were routinely prepared and maintained in corporate minute books, that appropriate financial records and other files were maintained by Atex, that Atex filed its own tax returns and paid its own taxes, and that Atex had its own employees and management executives who were responsible for the corporation’s day-to-day business.

See Fletcher v. Atex, Inc., 68 F.3d 1451, 1459 (2d Cir. 1995).

Levitt and Chiodini recommend against complete overlap of directors and officers even though the nonprofit parent controls the subsidiary's board.

While the nonprofit parent will be the only (or at least the controlling) equity holder of the for-profit subsidiary and therefore will control the for-profit’s governing body, there are reasons to avoid complete overlap in the directors and officers of the two entities.

See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Business Law Today (ABA, June 18, 2014).

Venable's 1999 paper warns that officer overlap between parent and subsidiary is a greater attribution risk than director overlap, because officers are more involved in day-to-day management.

A more substantial problem would arise if officers of the parent were also officers of the subsidiary. In that scenario, it is more likely that the subsidiary's activities would be attributed to the parent because the overlap between officers tends to show that the parent is managing the subsidiary on a daily basis (since officers, as opposed to directors, are generally more involved in the day-to-day management of a corporation).

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Venable's 1999 paper recommends that, if the subsidiary's name incorporates the parent's name, the trademark license terms be part of the written intercompany agreement.

If the parent's name is incorporated into the subsidiary, the terms of such a trademark license should be part of the written agreement discussed above.

See George E. Constantine et al., Forming and Operating Subsidiaries and Related Entities: Maximizing the Benefits and Minimizing the Risks (Venable 1999).

Proskauer's 2023 blog post suggests separate management and separated assets for a subsidiary, reflected consistently in securities filings and other public information.

For example, it could hire separate management for the subsidiary or separate the two entities’ assets, and then ensure those changes are reflected in securities filings and other publicly available information.

See Proskauer Rose LLP, Two Sides of a Different Coin: Separating Businesses and Subsidiaries for Liability Protection, Minding Your Business blog (Aug. 18, 2023).

BCL § 1301(a) bars a foreign corporation from doing business in New York until it is authorized to do so.

(a) A foreign corporation shall not do business in this state until it has been authorized to do so as provided in this article.

See N.Y. Bus. Corp. Law § 1301(a).

Section 512(b)(13)(A) requires an exempt organization to include a specified payment from an entity it controls as an item of gross income derived from an unrelated trade or business, to the extent the payment reduces the controlled entity's net unrelated income or increases its net unrelated loss.

If an organization (in this paragraph referred to as the "controlling organization") receives or accrues (directly or indirectly) a specified payment from another entity which it controls (in this paragraph referred to as the "controlled entity"), notwithstanding paragraphs (1), (2), and (3), the controlling organization shall include such payment as an item of gross income derived from an unrelated trade or business to the extent such payment reduces the net unrelated income of the controlled entity (or increases any net unrelated loss of the controlled entity).

See 26 U.S.C. § 512(b)(13)(A) (2024 ed.).

Treasury Regulation § 53.4958-4(a)(2)(ii) treats economic benefits provided by an entity an applicable tax-exempt organization controls as provided by the applicable tax-exempt organization, and defines control of a stock corporation as ownership by vote or value of more than 50 percent of its stock.

An applicable tax-exempt organization may provide an excess benefit indirectly through the use of one or more entities it controls. For purposes of section 4958, economic benefits provided by a controlled entity will be treated as provided by the applicable tax-exempt organization. (B) Definition of control — (1) In general. For purposes of this paragraph, control by an applicable tax-exempt organization means— (i) In the case of a stock corporation, ownership (by vote or value) of more than 50 percent of the stock in such corporation;

See 26 C.F.R. § 53.4958-4(a)(2)(ii)(A)–(B).

Treasury Regulation § 53.4945-5(a)(6)(i) treats a private foundation's grant as a grant to the secondary grantee if the foundation earmarks it for a named secondary grantee or has an agreement under which it may cause the secondary grantee's selection, but not merely because the foundation expects the secondary grantee to benefit, so long as the original grantee in fact controls the selection and makes it independently.

A grant by a private foundation to a grantee organization which the grantee organization uses to make payments to another organization (the secondary grantee) shall not be regarded as a grant by the private foundation to the secondary grantee if the foundation does not earmark the use of the grant for any named secondary grantee and there does not exist an agreement, oral or written, whereby such grantor foundation may cause the selection of the secondary grantee by the organization to which it has given the grant. For purposes of this subdivision, a grant described herein shall not be regarded as a grant by the foundation to the secondary grantee even though such foundation has reason to believe that certain organizations would derive benefits from such grant so long as the original grantee organization exercises control, in fact, over the selection process and actually makes the selection completely independently of the private foundation.

See 26 C.F.R. § 53.4945-5(a)(6)(i).

Section 4945(d)(4) and (5) make a private foundation's grant to an organization other than a public charity, a qualifying supporting organization or an exempt operating foundation a taxable expenditure unless the foundation exercises expenditure responsibility, and make any expenditure for a noncharitable purpose a taxable expenditure.

(4) as a grant to an organization unless— (A) such organization— (i) is described in paragraph (1) or (2) of section 509(a), (ii) is an organization described in section 509(a)(3) (other than an organization described in clause (i) or (ii) of section 4942(g)(4)(A)), or (iii) is an exempt operating foundation (as defined in section 4940(d)(2)), or (B) the private foundation exercises expenditure responsibility with respect to such grant in accordance with subsection (h), or (5) for any purpose other than one specified in section 170(c)(2)(B).

See 26 U.S.C. § 4945(d)(4)–(5) (2024 ed.).

Treasury Regulation § 1.509(a)-4(e)(1) treats a supporting organization as operated exclusively to support its supported organizations only if it engages solely in activities that support or benefit them.

A supporting organization will be regarded as operated exclusively to support one or more specified publicly supported organizations (hereinafter referred to as the operational test) only if it engages solely in activities which support or benefit the specified publicly supported organizations.

See 26 C.F.R. § 1.509(a)-4(e)(1).

Treasury Regulation § 1.509(a)-4(e)(1) permits a supporting organization to support or benefit a section 501(c)(3) organization, other than a private foundation, that is operated, supervised, or controlled directly by or in connection with the supported organizations, or an organization described in section 511(a)(2)(B).

Similarly, an organization will be regarded as operated exclusively to support or benefit one or more specified publicly supported organizations even if it supports or benefits an organization, other than a private foundation, which is described in section 501(c)(3) and is operated, supervised, or controlled directly by or in connection with such publicly supported organizations, or which is described in section 511(a)(2)(B).

See 26 C.F.R. § 1.509(a)-4(e)(1).

Section 4958(c)(3)(A) treats any grant, loan, compensation or similar payment by a supporting organization to a person described in § 4958(c)(3)(B), and any loan to a disqualified person other than an organization described in § 4958(c)(3)(C)(ii), as an excess benefit transaction, with the full amount as the excess benefit.

(3) Special rules for supporting organizations (A) In general In the case of any organization described in section 509(a)(3)— (i) the term "excess benefit transaction" includes— (I) any grant, loan, compensation, or other similar payment provided by such organization to a person described in subparagraph (B), and (II) any loan provided by such organization to a disqualified person (other than an organization described in subparagraph (C)(ii)), and (ii) the term "excess benefit" includes, with respect to any transaction described in clause (i), the amount of any such grant, loan, compensation, or other similar payment.

See 26 U.S.C. § 4958(c)(3)(A) (2024 ed.).

Section 4958(c)(3)(B) describes the persons covered by the supporting-organization rule: substantial contributors, their family members and specified 35-percent controlled entities.

(B) Person described A person is described in this subparagraph if such person is— (i) a substantial contributor to such organization, (ii) a member of the family (determined under section 4958(f)(4)) of an individual described in clause (i), or (iii) a 35-percent controlled entity (as defined in section 4958(f)(3) by substituting "persons described in clause (i) or (ii) of section 4958(c)(3)(B)" for "persons described in subparagraph (A) or (B) of paragraph (1)" in subparagraph (A)(i) thereof).

See 26 U.S.C. § 4958(c)(3)(B) (2024 ed.).

Section 4958(f)(3) defines a 35-percent controlled entity as a corporation, partnership, trust or estate in which the specified persons own more than 35 percent of the voting power, profits interest or beneficial interest, applying constructive ownership rules.

(3) 35-percent controlled entity (A) In general The term "35-percent controlled entity" means— (i) a corporation in which persons described in subparagraph (A) or (B) of paragraph (1) own more than 35 percent of the total combined voting power, (ii) a partnership in which such persons own more than 35 percent of the profits interest, and (iii) a trust or estate in which such persons own more than 35 percent of the beneficial interest. (B) Constructive ownership rules Rules similar to the rules of paragraphs (3) and (4) of section 4946(a) shall apply for purposes of this paragraph.

See 26 U.S.C. § 4958(f)(3) (2024 ed.).

Section 4958(c)(3)(C)(ii) excludes organizations described in section 509(a)(1), (2) or (4), and certain supported organizations, from the term substantial contributor for the supporting-organization rule.

(ii) Exception Such term shall not include— (I) any organization described in paragraph (1), (2), or (4) of section 509(a), and (II) any organization which is treated as described in such paragraph (2) by reason of the last sentence of section 509(a) and which is a supported organization (as defined in section 509(f)(3)) of the organization to which subparagraph (A) applies.

See 26 U.S.C. § 4958(c)(3)(C)(ii) (2024 ed.).